Workhouse Financing Terms Could Have Been Better, So I’m Reversing Course (NASDAQ:WKHS)

After I published my previous article about Workhorse Group Inc. (WKHS), the stock delivered 50%-100% returns. In my conclusion section from June 29, I purported mainly a long-term bullish view. However, I do now believe that the current valuation is too elevated, so I decided to close my position. At a company valuation of nearly ~$1.4 billion, versus a target market is $18 billion, it’s difficult to justify staying invested. Besides, the company signed a deal with debt holders, with terms that I don’t view positively. In my opinion, the company has not modeled dilution from convertible debt. The financial terms obtained could be better. There’s also the matter of large stockholders deciding to decrease their stake that has further motivated me to reverse course on my bullishness.

Recent ~50% Stock Return

In June 2020, I wrote a bullish thesis about Workhorse Group. I opined that the shares of Workhorse would most likely run if the company will obtain new financing from investors:

When I found out about the company’s innovative technology and partners, I bought shares. Since the IPO, the company’s share price ranged from $1 to $10-$11. In June 2020, the shares were sold at $8-$10.

My thesis was correct as the company signed a deal with debt holders. Consequently, the stock price increased from $9-$10 to more than $20. Some investors were able to make more than 100% in a few weeks. Congratulations if you made it.

Source: Seeking Alpha – WKHS

Given the amount of attention that Workhorse Group received from the media and the recent stock returns, I believe that investors would be receptive to a follow-up article. In my view, most investors are likely wondering what to do with the money. Shares of WKHS are trading at $15-$18, and the current valuation is ~$1.4 billion. In my opinion, the upside in the valuation is limited. Some shareholders are most likely thinking about selling shares. I agree with them.

Overview Of Workhorse Group

Workhorse sells drone-integrated electric vehicles to the delivery sector. The company is also responsible for designing and manufacturing battery-electric vehicles like trucks and aircrafts. I don’t want to give a lot of details about the company’s patents and technology. Readers should have a look at my previous post, where I provided a lot of information.

Is The Deal With Ryder A New Deal?

In July 2020, the company reported that it is prepared to deliver the first C-Series all-electric vans. The company Ryder Systems Inc. was responsible for distributing the vehicles. Some journalists suggested that the deal was new, whereas it was not:

Source: Bizjournals

From researching the last quarterly report, I confirmed that WKHS signed a deal with Ryder a long time ago. It is not a deal signed in July. The vehicles are about to be distributed in July. Ryder is not only distributing vehicles for WKHS, but it also offers repair services, and maintenance services among others:

The Company has an agreement with Ryder to serve as the primary distributor, except with respect to certain exclusive accounts, in the United States, Mexico and Canada. Ryder also serves as a provider of certain repair services and distributor of certain vehicle parts in the United States, Canada and Mexico.

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The Company sells its vehicles to fleet customers directly and through its primary distributor, Ryder System, Inc. (“Ryder”). Ryder also is a maintenance provider for Workhorse, which provides fleet operators with access to Ryder’s network of 800 maintenance facilities and nearly 6,000 trained service technicians across North America.

Source: Quarterly Report

The issue of whether the deal is new or not is, in my view, very relevant. Traders may be buying shares because some media outlets let them to believe that the company has a new deal. I don’t think that any spike in the share price is legitimately related to the company’s relationship with Ryder System. It is good to know that the company is delivering vehicles, but we all knew about the deal with Ryder.

Share Price Increased Following The New Financing

As I predicted in my previous report, Workhorse’s share price increased when a new financing was obtained. The company raised as much as $70 million through the sale of convertible debt. Investors need to understand that the company will use the proceeds for general corporate purposes. However, the company also indicated that some funds will be used to pay holders of existing warrants. I don’t like that the money is used to pay other equity holders:

Unless we indicate otherwise in an accompanying prospectus supplement, we intend to use the net proceeds from the sale of our securities offered by this prospectus for general corporate purposes, which may include, but not be limited to, working capital, capital expenditures, acquisitions, refinancing of indebtedness and repurchases or redemptions of securities. In the event a selling shareholder exercises a Stock Purchase Warrant for cash, we will use the proceeds for general corporate purposes, which may include, but not be limited to, working capital, capital expenditures, acquisitions, refinancing of indebtedness and repurchases or redemptions of securities. We will not receive any proceeds from the sale of our common stock issued upon exercise of any Stock Purchase Warrants by the selling shareholders.

-Source: Prospectus

I carefully went through the conditions included in the prospectus. Most equity analysts don’t incorporate convertible debt, which I fully respect. Notice that debt holders usually have the right to convert debt into equity, which leads to equity dilution and share price depreciation. In this particular case, debt holders can convert debt and receive shares at an exercise price of $19.

The conversion rate will initially be 52.6316 shares of common stock per $1,000 principal amount of the Note (equivalent to an initial conversion price of approximately $19.00 per share of common stock). The conversion rate with respect to the notes and the conversion price for notes in effect at any given time are referred to as the “applicable conversion rate” and the “applicable conversion price”, respectively, and will be subject to adjustment as described below. The applicable conversion price at any given time will be computed by dividing $1,000 by the applicable conversion rate at such time.

-Source: Prospectus

But, that’s not all. Debt holders can receive payments both in cash and equity, which I don’t like. In my opinion, they haven’t modeled dilution from convertible debt. If the company issues equity to pay back the $70 million received, the share price may decline.

Source: Prospectus

I said that the company’s share price would increase if the company receives financing. However, the financial terms obtained could be better. As a result, the share price may increase for some months, but if the company begins to issue a lot of shares, the stock price will most likely decline.

That’s not all. Let me say that I view negatively that several shareholders decided to decrease their stake in the company. In my previous article, I said the following:

I believe that Workhorse Group Inc. would receive money from Marathon when the company decides to raise capital.

-Source: Previous Article

Marathon and TRS did not acquire debt or shares, which resulted in them having a less significant position in the stock. In my view, not acquiring a position sends a message to the market: the company may not expand at the impressive level as many investors were expecting:

Source: Prospectus

Insiders Sold Shares At $15-$17 And Bought At $2.5-$3

The most significant shareholders decreased their stakes in the company. The below links show that relevant people inside the organization are selling shares:

I want to ensure that my article focuses on why my long-term view of WKHS has changed meaningfully. Many management share sales have occurred since the end of June, when I wrote my first article. Most of the directors acquired shares before the company announced the issuance of convertible debt. Many of them acquired shares at $2.5-$3, and have now sold at ~$15-$17. These sales may not be surprising, but lend credence to the idea that shares are a bit expensive at $15-$17.

Target Market Is $18 Billion, And Workhorse’s Valuation Is ~$1.4 billion

Before heading to valuation, let me review the company’s target market. In the last quarterly report, the company said that its target market is worth $18 billion.

There are over 300,000 last mile delivery trucks replaced annually in an $18.0 billion market space. Our sales team is focused on securing purchase orders from commercial transportation companies, in this space. These purchases will give us additional data on demand related to electric and extended range electric vehicles.

-Source: Quarterly Report

Additionally, Grand View Research believes that the commercial vehicles market will grow at a CAGR of 7.5% from 2018 to 2025:

Source: Grand View Research

In June and July 2020, Workhorse had a total valuation of $1.4 billion, which represents 7% of the total market. I don’t think that the valuation is realistic; the company reported sales of less than $ 1 million in the last quarterly report.

Source: Ycharts

Source: Ycharts

In my previous article, I believed that the most relevant issue at hand was whether the company would obtain financing or not. It looks like I was correct because the share price increased once a deal was signed with debt investors. With that said, right now, I believe that WKHS’s valuation is too high. I also don’t see any clear catalyst, which could drive more upside.

Even in a very optimistic case, where Workhorse increases sales and reaches $10 million in annual revenue, the total valuation of $1-1.4 billion looks too expensive.

I said in a previous article that there’s not much value in looking at the company’s EV/Sales and EV/EBITDA ratio. The company appears to be at too early of a growth stage to use those ratios. With that, for the sake of completeness, take a look at the chart below. Workhorse appears much more expensive than other competitors in the electric vehicle industry:

Source: Ycharts

Some short sellers are betting on a declining WKHS share price, including Hindenburg Research claimed who predicted that the stock has a 50% downside. They said that the company’s sales were not enough to justify the current valuation:

Source: Twitter

Conclusion

After profiting substantially from my previous long position in WKHS, I have decided to close my position in Workhorse. I believe that the current valuation cannot be justified. The company has already obtained financing, taking a catalyst off the table. In my opinion, the share price will most likely decline back to the $7-$9 range or even lower. Note that the company was trading around below that mark when it announced its debt offering.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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