Trina Solar has become a minor obsession of mine. I was originally attracted as a fraud short as per many China names and there are plenty of red-flags. However it is not a typical Bronte China short because unlike other names we have been short (China Media Express or China Agritech) there is no doubt about the existence of Trina. Indeed a fair bit of the Trina story can be easily proved to be real.
Project” refers to Changzhou Trina Solar Energy Co., Ltd.’s Solar PV Industry Vertical Integration Product Project with an Annual Capacity of 500MV. The Project is located in Changzhou City of Jiangsu Province, to the south of Xinghan Electronic, the north of Nenjiang Road, the east of Chuangxin Road and the west of Keji Road, and to the north and west of Xinxi Road, the south of Nenjiang Road and the east of Keji Road. The content of the Project construction is to build a production base of solar PV industry vertical integration products with an annual capacity of 500MW and reach a production capacity of 250MW for each of mono-silicon rod and multicrystalline ingot, and 500MW for each of wafers, solar cells and PV modules. A “PV Integration Engineering Technology Research Center of Jiangsu Province” backed up by Changzhou Trina Solar Energy Co., Ltd. is to be established. The project has planned to use land in about 596 mus for construction, build an area of 329,983 square meters of new buildings and purchase production equipment (1,064 items per set). The total investment of the Project is USD597,900,000, of which the fixed assets investment is USD392,940,000, and the working capital is USD204,960,000. The sources of the Project funds are as follows: USD200,000,000 as capital funds of the Project; USD93,690,000 raised by the enterprise; USD304,210,000 coming from the syndicated loan.
These numbers do not quite match the balance sheet as there is another $42 million of "current portion of long-term bank borrowings". So short term borrowings in the balance sheet total $159 million.
Then here is the disclosure that makes it all make sense. It is a doozy - but after I read it much of my original thesis about Trina just evaporated - and was replaced with another thesis. The new thesis is the main content of this blog post. So please double-read this disclosure:
Trina is a large company making many solar panels and many journalists have visited it.
This is not obviously Longtop Financial or China Media Express and suspected fraud is not a good basis for shorting the stock.
Still suspected fraud was our original basis for shorting the stock. We purchased a large number of put options (a scatter of maturities and strike prices) almost all of which were out of the money and all of which were effectively levered bets on bankruptcy.
We have made money on our position (fortuitously) but I am reminded of the Bob Dylan line that “somebody got lucky, but it was an accident”. Luck in this case is a market collapse and fairly good timing in our transactions. Having done considerable work I am not sure that our original thesis was correct.
We have covered much of the put position and may cover a little more but it is our intention to let most of the remaining position ride to maturity. We covered some puts by going long the stock. Put-call parity tells you this is economically similar to selling the put and buying calls – so the way to think of our current position is a “butterfly”. We make a lot of money if the stock collapses to low single digits. We make some money if the stock price moves up sharply and we lose money if the stock price goes sideways. What we have is a bearish weighted “butterfly” stock payoff schedule. Largely we are playing with "house money" now too as we have cashed quite a lot of our original position at a profit.
This (unfortunately very long) blog post goes through how we thought about Trina Solar and what we learned along the way. If you are interested in why the Chinese solar stocks trade at very low PE ratios despite massive growth rates and high ROEs then this blog post will answer your question. Ultimately though it won't tell you whether to be long or short but it will explain the risks in both positions. As I said we make money in all events except a range-bound stock – and we think a sideways stock is vanishingly unlikely.
Red flag number 1: the people at Trina Solar
What originally attracted us to Trina Solar as a short were people. Top of the list was Peter Mak – the head of the Audit Committee of Trina Solar. For those with a lurid sense of voyeurism this is Peter Mak dancing on his (I think 49th) birthday.
Peter Mak was the CFO of A-Power – a company we profitably shorted on the NASDAQ. A-Power is currently suspended with director resignations and other red-flags but the management deny it was fraudulent. I do not want to add to the debate other than to point you to Eiad Asbahi's analysis of the company.
There were other lesser red-flags at Trina Solar. For instance the current CFO (Terry Wang) used to be Executive Vice President of Finance of Spreadtrum Communications. I know nothing original about Spreadtrum but it was the subject of criticism by Muddy Waters (a firm I have found reliable elsewhere). But these are weak-tells – enough to focus your attention – but not enough to make you want to short a fast-growing company with a PE ratio of three.
Peter Mak has now resigned from the board of Trina Solar. I can't find a single solid negative thing about the new head of the audit committee (Jerome Corcoran). The only (minor) problem I have with Jerome Corcoran is that he joined the board the same day as Peter Mak which suggests some commonality of origin or purpose.
There are other red-flags too. The company used to use Crocker Coulson as an IR officer. That is a light-red flag. Crocker you see is not my favorite person as he threatened to sue me over this post on Universal Travel Group. Universal Travel is now suspended from the NYSE.
Crocker Coulson, like Peter Mak, is no longer associated with Trina Solar.
There are other red-flags too. The company used to use Crocker Coulson as an IR officer. That is a light-red flag. Crocker you see is not my favorite person as he threatened to sue me over this post on Universal Travel Group. Universal Travel is now suspended from the NYSE.
Crocker Coulson, like Peter Mak, is no longer associated with Trina Solar.
Red Flag number 2: matching capital expenditure with capacity
The next problem we had with Trina Solar was that we found it hard to reconcile their capital expenditure with their capacity. The company has been massively expanding their capacity and that would normally take some considerable investment in machines and other infrastructure. There however appears to be little correlation between capacity investment and capacity.
Trina Solar's debt covenant for their long term debt (the covenant in my last post on this company) has the following statement about a 500 megawatt project. The project is for 500MV of ingot making and module making capacity.
Project” refers to Changzhou Trina Solar Energy Co., Ltd.’s Solar PV Industry Vertical Integration Product Project with an Annual Capacity of 500MV. The Project is located in Changzhou City of Jiangsu Province, to the south of Xinghan Electronic, the north of Nenjiang Road, the east of Chuangxin Road and the west of Keji Road, and to the north and west of Xinxi Road, the south of Nenjiang Road and the east of Keji Road. The content of the Project construction is to build a production base of solar PV industry vertical integration products with an annual capacity of 500MW and reach a production capacity of 250MW for each of mono-silicon rod and multicrystalline ingot, and 500MW for each of wafers, solar cells and PV modules. A “PV Integration Engineering Technology Research Center of Jiangsu Province” backed up by Changzhou Trina Solar Energy Co., Ltd. is to be established. The project has planned to use land in about 596 mus for construction, build an area of 329,983 square meters of new buildings and purchase production equipment (1,064 items per set). The total investment of the Project is USD597,900,000, of which the fixed assets investment is USD392,940,000, and the working capital is USD204,960,000. The sources of the Project funds are as follows: USD200,000,000 as capital funds of the Project; USD93,690,000 raised by the enterprise; USD304,210,000 coming from the syndicated loan.
Fixed asset investment for 500MW is given in the contract as USD393 million – or 78c per watt. This is somewhat more than my third party checks give me (55 cents per watt but if anyone can give me real data not sourced from a Chinese company I would be thrilled.)
Whatever – it is very difficult to reconcile this cost-of-capacity versus the company accounts.
Trina Solar had expenditure on fixed assets (gross of depreciation) of 165, 136 and 144 million for the three years ended 2008, 2009 and 2010 respectively. End of year capacity in ingots and modules was as follows:
| Year | Ingots (MW capacity) | Modules (MW capacity) |
| 2007 | 150 | 150 |
| 2008 | 350 | 350 |
| 2009 | 500 | 600 |
| 2010 | 750 | 1200 |
In 2008 spending 165 million purchased 200MW of capacity in both ingots and modules. That is a little more than the Changzhou project. In 2009 spending 136 purchased 250 of capacity. In 2010 spending 144 purchased 250 of capacity in ingots and 600 in capacity for modules. Quarterly capital equipment numbers are also hard to reconcile with capacity expansions quarterly.
But and this is an important but – it is entirely possible (in fact probable) that they made old capacity more efficient (by better processes etc) and so capacity spend and capacity should not entirely match. The quarterly numbers are so wonky when I started looking though I never seemed to get comfortable.
When I tried starting to get numbers to match (eg starting property plant and equipment plus new investment less depreciation less sales of PP&E etc) I could not quite get them to balance and I could not work out what I was missing. The differences were minor – and I understand that accounts never quite balance (you are always missing something) but the more I looked the more discomfort I got.
Red flag number 3: Capital Management
The biggest red-flag I had with Trina Solar was their strange capital management. Trina had – at year end – over 750 million dollars in cash – cold hard unencumbered cash on the balance sheet and was still very actively rolling money in the short term market. The cash yielded maybe 50bps. The money borrowed was maybe 8-10 times as expensive. In 2009 for instance the company borrowed $537 million in the short term market, repaid almost precisely the same amount and had substantial cash balances the whole time.
I have no problem with a company taking long term debt whilst sitting cash on the balance sheet. Indeed it makes sense to borrow money when you don't need it because one day you may need or want it and it is not available. Any company that did that sailed through the financial crisis relatively unscathed.
But taking short term debt – lots of it and actively rolling it – whilst you have lots of cash sitting on the balance sheet is unusual. Moreover the company went to market several times raising equity or convertibles – and the cumulative raising just sat in cash. Raising money when you don't need it to sit in cash always raises my eyebrow. The most telling point about Longtop's accounts was that they went to market to raise cash when they did not appear to need it. (In that case the cash raised has somehow disappeared – or at least the auditor could not find it.)
Problems with the red-flags
The problem with my red flags is that when I tested things there was always an alternative explanation. My last blog post on Trina Solar went through a covenant which I thought Trina had broken in their long term debt covenants. Indeed I thought that was a “slam dunk”. The company provided me an (entirely unconvincing) explanation of why the covenant was not broken.
However my blog readers (and you are a clever lot) managed to find the original covenant and demonstrate that the covenant was indeed not broken. What appeared to me to be a "red flag" was just a bit of the financial accounts where meaning had been lost in the translation between the covenant and the annual filing. Meaning may have literally been lost in translation from Chinese to English.
Other red-flags were like this too. Look hard enough and the red-flag disappeared.
Taking Trina's accounts seriously
My first view of Trina was to take the accounts not-so-seriously. After all some things did not reconcile and I distrusted the head of the audit committee. But as I checked things out my red-flags disappeared. Which left me pondering in an altogether different fashion. What happens if I take Trina's accounts entirely seriously – what does this say about the business?
The first thing to take seriously is the three quarters of a billion dollars in cash on the balance sheet – cash that is there despite rolling considerable short term debt. That demands an explanation.
Normal financial management would have you take the cash and pay off the short term debt. There are two circumstances where it makes sense to have cash and short term debt. The first is that the debt is in different structures to the cash. (For instance an insurance company might have debt in the parent company balance sheet and cash in the insurance subsidiary.) The second circumstance is that you might have a massive and short term need for the cash which you may or may not be disclosing.
So I went looking at the disclosure for short term debt to see if it was in different structures. Here is the key text.
Short-term borrowings
The Company's short-term bank borrowings consisted of the following
| Simplified table – 2010 only | $million |
| Short-term borrowings guaranteed by Trina | 15 |
| Short term borrowings secured by machinery of Changzhou Energy Trina Solar Energy Corp | 77 |
| Unsecured short-term borrowings | 24 |
| Total | 117 |
The average interest rate on short term borrowings was 7.11%, 5.14% and 4.04% per annum for the years ended December 31, 2008, 2009 and 2010, respectively. The funds borrowed under the above short-term arrangements have no covenants or restrictions, and are repayable within one year.
These numbers do not quite match the balance sheet as there is another $42 million of "current portion of long-term bank borrowings". So short term borrowings in the balance sheet total $159 million.
Then here is the disclosure that makes it all make sense. It is a doozy - but after I read it much of my original thesis about Trina just evaporated - and was replaced with another thesis. The new thesis is the main content of this blog post. So please double-read this disclosure:
The Company has short-term bank facilities of $483,851,907, $590,622,009 and $1,741,578,929 with various banks, of which $282,496,077, $327,899,446 and $650,880,259 had been drawn down and $201,355,830, $262,722,563 and $1,090,698,670 were available as of December 31, 2008, 2009 and 2010, respectively. Those short-term bank facilities are renewable annually by mutual agreement between the parties.
Trina Solar has a $1.741 billion (that is with a b) facility with "various banks" it is "short-term" and "renewable annually" and it has been drawn to $651 million.
That $651 million in debt does not appear anywhere on the balance sheet. But it is there and it is due-and -payable at some date in the next twelve months.
And now we have a perfectly reasonable explanation of why there is more than three quarters of a billion dollars in cash on the balance sheet and the company is repeatedly selling equity to raise cash and rolling over lots of short term debt.
They have a really big obligation which is "short-term" and relies on the banks to renew their facility. And the obligation is not on the balance sheet.
So I went looking for it. After all this obligation is sufficient to get Trina to willingly undertake contorted capital management. So I tried to find everything the company has said about "off-balance-sheet arrangements". Fortunately (and a little unusually for this company) there is a remarkably simple disclosure as to the entirety of their off-balance sheet arrangements:
So it is purchase arrangements. There are no other off-balance sheet obligations.
They even spell out what those forward purchase contracts are. Here is the key paragraph:
You see in the last quarter revenue was only $550 million. That is just over $2 billion a year. It is roughly $14 billion over seven years. The entire revenue line is committed to buying polysilicon.
This only makes sense if the company grows and grows and grows. Without massive growth this company can't meet its purchase obligations.
And we know what is backing the purchase obligations - lines of credit secured by bank loans and not appearing on balance sheet.
If this company stops producing lots and lots of panels (and buying lots of silicon) it goes bust because it is committed to buying the silicon.
People ask why the Chinese solar panel makers are massively expanding production even though there is a glut: well there is your answer.
Italy was a huge market for utility-scale solar plants. These require viable financial markets because a solar-farm is like a power station where you purchase all your fuel up front. They are capital intensive beasts. And if you haven't noticed the Italian financial markets are not working as well as say eight months ago.
And the subsidies are being reduced in markets like Australia and Germany.
But - driven by their humungous polysilicon purchase agreements the companies are driven to expand production. If they do not their polysilicon purchase agreements make them go bust.
If they can sell the panels at good margins they are going to make a fortune. The companies are growing very rapidly - and are compelled to do so by their polysilicon purchase contracts.
If they can't sell the panels then the companies will burn and the 750 million in cash sitting on the balance sheet will evaporate. It will be transferred to the polysilicon makers. The $650 million drawn bank loan - the one not on balance sheet - will suck them into financial oblivion.
And this contract is not easy to renegotiate because the polysilicon makers hold the bank lines which is the equivalent of holding the cash. If Trina tries to get out of the contract then the polysilicon maker just draws the bank line and gets paid anyway. And Trina will wind up owing the money to the bank...
Success or failure for Trina all depends on whether they can profitably sell the panels.
Massive and compelled growth at high margins will send this stock to $50 or more. Massive and compelled growth when you can't sell the panels at good margins will send the stock to zero. There is not much in-between - this company is attached to the rocket-ship and and will either explode or go into orbit. It has to double in size and double in size again. It may even have to double again after that. By the end of this year it will be over ten times as large as at the end of 2007 - and it is compelled to grow beyond that too.
This is (with apologies to the Clash) death or glory Chinese stock market style.
Now you can see why we at Bronte have rejigged our position so we make money at the tails of the distribution and lose money with a sideways stock. Both $50 and $0 are hugely profitable to us. $15 in a year is ugly but given the power of this rocket-ship we don't think that is going to happen. Strapped onto a rocket-ship you are going to have a wild time.
So is it death or is it glory for Trina Solar?
Lets be blunt. At the moment it is looking like death. If nothing changes death comes within nine months, and probably far faster than that.
Production is going up, sales are going down and the difference is sitting in inventory. The company is selling some product but is also collecting its receivables much slower. The changes in the last balance sheet are a just startling - this is from the end of the first quarter.
The things to notice in this balance sheet is that inventory went from $79 million to $180 million in a single quarter. Accounts receivable went from $377 to $543 million.
They finally spent a lot on property, plant and equipment - probably over $100 million - as PP&E went from $571 to $664 million.
All of this is cash consumptive - and the cash balance went from $753 to $490 million. That cash fall happened whilst liabilities went up. They did not repay any debt. Cash burn was $263 million. At that rate of burn they die in less than seven months from the end of the March quarter - that is sometime about October. They might delay death by collecting the above-mentioned receivables - but that is only a short-stay of execution.
Revenue went down even though production went up (pricing was terrible). If they actually tried to sell the product to people who paid them (rather than sit in warehouses as inventory or sell it to people and count it as "receiveables") then you could just imagine how ugly the pricing would have got.
The company does not publish a quarterly cash flow statement but there was this amazing exchange in the last conference call...
I figure $120 million negative is an underestimate - but without a cash flow statement that is a guess.
Bluntly though it looks like death because you can't run a business with that much negative cash flow.
This company has "profits" but negative cash flow because (in accordance with accounting standards) it counts increased receivables and increased inventory as part of its profits.
And the negative cash flow looks like it going to get worse. Much worse. You see the company pre-announced the second quarter earnings. The critical phrase is this.
Shipments are up (320MW to 395MW in consecutive quarters) but sales are down. Guess where inventory is going? Presumably some warehouse somewhere.
Pricing has deteriorated further too - so to be blunt, cash flow has got to be getting worse. There is a possible offset if they collect the increased receivable balance described above.
Moreover they expect a significant increase in shipment volumes in the third quarter. Of course shipment volumes are going up - they have to driven by the massive polysilicon purchase obligations.
But they better hope they can sell those shipments or they are dead very rapidly. You can't bleed a couple of hundred million a quarter for very long. Not when you have to roll all that bank debt and you are obligated to issue bank guarantees over all those purchases.
And given the big markets for this are in Southern Europe (where solar-farms are suddenly hard to finance) the chance of selling all that product is reduced.
So I think the outcome is death and our position in the stock is sharply weighted towards death.
The glory-case for Trina solar
Fast growth into declining sales does not necessarily mean death if sales miraculously turn around. A large Chinese solar subsidy might do that but the recently announced solar subsidy is set at a low level (feed in tariffs are under a third of the European equivalents). The really rich markets (Southern Europe) don't look like they are coming back soon.
The second - and more important way that they can sell the massively increased production is if they cut prices far enough that the relatively expensive capital markets of Europe can finance the projects. They will do that if they get (even-more) super-efficient and if the polysilicon costs drop far enough.
They have been very efficient in the past - processing costs have dropped but nothing like as fast prices for panels.
But the real cost drops have been driven by polysilicon which peaked at over $400 per kilogram and is down by at least 80 percent.
The main polysilicon contract is attached to the 2009 annual report. This contract specifies the way in which polysilicon prices in the contract are to drop if the spot price for polysilicon drops.
In other words they are obligated to buy lots and lots of polysilicon - they are just not obligated to buy it at the current price.
The contractual terms of their lending agreements require that they do actually process the polysilicon.
In other words if they can get their processing costs low enough and they can grow the market enough, they might be able to sell all of their obligated polysilicon by growing the market.
If this happens the company - now on a PE of 3 - will (at least) quadruple in size and get repriced as a growth stock. $50 in that case is conservative. Glory for this company is a long way up from here. A very long way up from here.
But they better start getting the costs down and selling the product really rapidly (like right now) because the current large and increasing negative cash flow will leave this company as just more road kill in the US listed Chinese space.
For thought and conversation.
John
That $651 million in debt does not appear anywhere on the balance sheet. But it is there and it is due-and -payable at some date in the next twelve months.
And now we have a perfectly reasonable explanation of why there is more than three quarters of a billion dollars in cash on the balance sheet and the company is repeatedly selling equity to raise cash and rolling over lots of short term debt.
They have a really big obligation which is "short-term" and relies on the banks to renew their facility. And the obligation is not on the balance sheet.
So I went looking for it. After all this obligation is sufficient to get Trina to willingly undertake contorted capital management. So I tried to find everything the company has said about "off-balance-sheet arrangements". Fortunately (and a little unusually for this company) there is a remarkably simple disclosure as to the entirety of their off-balance sheet arrangements:
Other than our purchase obligations for raw materials and equipment, we have not entered into any financial guarantees or other commitments to guarantee the payment obligations of third parties. We have not entered into any derivative contracts that are indexed to our shares and classified as shareholders’ equity, or that are not reflected in our consolidated financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or that engages in leasing, hedging or research and development services with us.
So it is purchase arrangements. There are no other off-balance sheet obligations.
They even spell out what those forward purchase contracts are. Here is the key paragraph:
As of December 31, 2010, the Company had entered into certain long-term silicon procurement contracts, under which the Company agreed to purchase silicon materials in an aggregate amount of approximately $14.6 billion over the next four to seven years.Like wow. Like hooley-dooley. This is the disclosure which makes Trina make sense.
You see in the last quarter revenue was only $550 million. That is just over $2 billion a year. It is roughly $14 billion over seven years. The entire revenue line is committed to buying polysilicon.
This only makes sense if the company grows and grows and grows. Without massive growth this company can't meet its purchase obligations.
And we know what is backing the purchase obligations - lines of credit secured by bank loans and not appearing on balance sheet.
If this company stops producing lots and lots of panels (and buying lots of silicon) it goes bust because it is committed to buying the silicon.
People ask why the Chinese solar panel makers are massively expanding production even though there is a glut: well there is your answer.
Italy was a huge market for utility-scale solar plants. These require viable financial markets because a solar-farm is like a power station where you purchase all your fuel up front. They are capital intensive beasts. And if you haven't noticed the Italian financial markets are not working as well as say eight months ago.
And the subsidies are being reduced in markets like Australia and Germany.
But - driven by their humungous polysilicon purchase agreements the companies are driven to expand production. If they do not their polysilicon purchase agreements make them go bust.
If they can sell the panels at good margins they are going to make a fortune. The companies are growing very rapidly - and are compelled to do so by their polysilicon purchase contracts.
If they can't sell the panels then the companies will burn and the 750 million in cash sitting on the balance sheet will evaporate. It will be transferred to the polysilicon makers. The $650 million drawn bank loan - the one not on balance sheet - will suck them into financial oblivion.
And this contract is not easy to renegotiate because the polysilicon makers hold the bank lines which is the equivalent of holding the cash. If Trina tries to get out of the contract then the polysilicon maker just draws the bank line and gets paid anyway. And Trina will wind up owing the money to the bank...
Success or failure for Trina all depends on whether they can profitably sell the panels.
Massive and compelled growth at high margins will send this stock to $50 or more. Massive and compelled growth when you can't sell the panels at good margins will send the stock to zero. There is not much in-between - this company is attached to the rocket-ship and and will either explode or go into orbit. It has to double in size and double in size again. It may even have to double again after that. By the end of this year it will be over ten times as large as at the end of 2007 - and it is compelled to grow beyond that too.
This is (with apologies to the Clash) death or glory Chinese stock market style.
Now you can see why we at Bronte have rejigged our position so we make money at the tails of the distribution and lose money with a sideways stock. Both $50 and $0 are hugely profitable to us. $15 in a year is ugly but given the power of this rocket-ship we don't think that is going to happen. Strapped onto a rocket-ship you are going to have a wild time.
So is it death or is it glory for Trina Solar?
Lets be blunt. At the moment it is looking like death. If nothing changes death comes within nine months, and probably far faster than that.
Production is going up, sales are going down and the difference is sitting in inventory. The company is selling some product but is also collecting its receivables much slower. The changes in the last balance sheet are a just startling - this is from the end of the first quarter.
Trina Solar Limited
Unaudited Consolidated Balance Sheet
(US dollars in thousands, except share and per share data)
Unaudited Consolidated Balance Sheet
(US dollars in thousands, except share and per share data)
The things to notice in this balance sheet is that inventory went from $79 million to $180 million in a single quarter. Accounts receivable went from $377 to $543 million.
They finally spent a lot on property, plant and equipment - probably over $100 million - as PP&E went from $571 to $664 million.
All of this is cash consumptive - and the cash balance went from $753 to $490 million. That cash fall happened whilst liabilities went up. They did not repay any debt. Cash burn was $263 million. At that rate of burn they die in less than seven months from the end of the March quarter - that is sometime about October. They might delay death by collecting the above-mentioned receivables - but that is only a short-stay of execution.
Revenue went down even though production went up (pricing was terrible). If they actually tried to sell the product to people who paid them (rather than sit in warehouses as inventory or sell it to people and count it as "receiveables") then you could just imagine how ugly the pricing would have got.
The company does not publish a quarterly cash flow statement but there was this amazing exchange in the last conference call...
Gordon Johnson - Axiom Capital Management: Just a couple of housekeeping questions, what was the operating cash flow in the quarter?
Terry Wang - CFO: It's negative for more than $100 million.
Gordon Johnson - Axiom Capital Management: Negative $100 million?
Terry Wang - CFO: It's more than $100 million, $120 million around roughly.
I figure $120 million negative is an underestimate - but without a cash flow statement that is a guess.
Bluntly though it looks like death because you can't run a business with that much negative cash flow.
This company has "profits" but negative cash flow because (in accordance with accounting standards) it counts increased receivables and increased inventory as part of its profits.
And the negative cash flow looks like it going to get worse. Much worse. You see the company pre-announced the second quarter earnings. The critical phrase is this.
While shipment volumes in the second quarter were our highest ever, sales were adversely impacted by extended slower demand and high industry inventory due in part to recently issued regulatory revisions and reduction in solar subsidies in Italy,” said Mr. Jifan Gao, Chairman and CEO of Trina Solar. “We expect a significant improvement in production costs and an increase in shipment volumes in the third quarter."
Shipments are up (320MW to 395MW in consecutive quarters) but sales are down. Guess where inventory is going? Presumably some warehouse somewhere.
Pricing has deteriorated further too - so to be blunt, cash flow has got to be getting worse. There is a possible offset if they collect the increased receivable balance described above.
Moreover they expect a significant increase in shipment volumes in the third quarter. Of course shipment volumes are going up - they have to driven by the massive polysilicon purchase obligations.
But they better hope they can sell those shipments or they are dead very rapidly. You can't bleed a couple of hundred million a quarter for very long. Not when you have to roll all that bank debt and you are obligated to issue bank guarantees over all those purchases.
And given the big markets for this are in Southern Europe (where solar-farms are suddenly hard to finance) the chance of selling all that product is reduced.
So I think the outcome is death and our position in the stock is sharply weighted towards death.
The glory-case for Trina solar
Fast growth into declining sales does not necessarily mean death if sales miraculously turn around. A large Chinese solar subsidy might do that but the recently announced solar subsidy is set at a low level (feed in tariffs are under a third of the European equivalents). The really rich markets (Southern Europe) don't look like they are coming back soon.
The second - and more important way that they can sell the massively increased production is if they cut prices far enough that the relatively expensive capital markets of Europe can finance the projects. They will do that if they get (even-more) super-efficient and if the polysilicon costs drop far enough.
They have been very efficient in the past - processing costs have dropped but nothing like as fast prices for panels.
But the real cost drops have been driven by polysilicon which peaked at over $400 per kilogram and is down by at least 80 percent.
The main polysilicon contract is attached to the 2009 annual report. This contract specifies the way in which polysilicon prices in the contract are to drop if the spot price for polysilicon drops.
In other words they are obligated to buy lots and lots of polysilicon - they are just not obligated to buy it at the current price.
The contractual terms of their lending agreements require that they do actually process the polysilicon.
In other words if they can get their processing costs low enough and they can grow the market enough, they might be able to sell all of their obligated polysilicon by growing the market.
If this happens the company - now on a PE of 3 - will (at least) quadruple in size and get repriced as a growth stock. $50 in that case is conservative. Glory for this company is a long way up from here. A very long way up from here.
But they better start getting the costs down and selling the product really rapidly (like right now) because the current large and increasing negative cash flow will leave this company as just more road kill in the US listed Chinese space.
For thought and conversation.
John
38 comments:
How common are these purchase aggreements? LDK, JKS, STP all have similar PE's. LDK/STP have had negative press in the past.
Guess it makes sense that if one player like TSL was willing to sign long term committments then it probably forced competitors do do something similar.
Thanks for the rather large post. It was fascinating and interesting to see your thesis shift.
I would guess that the $650mln in drawn bank facilities are not actually loans but bank guarantees or LCs issued in favour of the supplier, to secure Trina's obligations under the silicon purchase contract.
If so, the banks would have recourse to Trina if the guarantees/LCs were ever called (good luck with that), but otherwise remain as contingent obligations, which would explain them not being on Trina's balance sheet.
So if your new thesis is correct, then these banks have effectively written Trina shareholders (and, ultimately, Bronte Capital) a massive option.
Could the whole business model, with the $14bln of silicon purchase commitments, be motivated entirely to exploit the banks' willingness to do so?
Its the oldest game in finance, after all.
Given the apparent about face, there is a line in that clash song that seems relevant: "I believe in this, it's been tested by research, he who f***s nuns will later join the church"....
Thanks Will, I was wondering how to keep $650m debt off balance sheet without upsetting auditor.
John,
IIRC STP in the past signed up to some RIDICULOUS poly commitments with MEMC among others.
When the poly glut duly appeared they managed to renegotiate (definitely price, not sure about volume).
I am pretty sure that any poly mfr with a contract to Trina would rather sell SOMETHING to Trina (alive) than nothing to a dead Trina.
Won't they just renegotiate and avoid death?
I thought it quite fun that (from the 2009 annual report) the name of one of their major suppliers of polysilicon is called "Hemlock Semiconductor".
Poisoned chalice...
The thesis is very interesting, but if was even more interesting to watch you change your thesis as the data points changed. This is the uncertainty many face while analyzing a company but very few post their thought process. Great post.
I think that you meant that you have a strangle, rather than a butterfly. Just FYI.
The LT purchase agreements are not as solid as you would think. Go back a few years to when silicon prices fell dramatically and look how many of these "LT agreements" were thrown out or renegotiated.
The LT contracts were negotiated DOWN in price, up in volume.
Can't pull that stunt again. But the key thing is the 650 million in drawn credit lines.
The counterparty HAS THE LINES. In other words they ALREADY have the money.
Trina's negotiating position is weak. Very weak.
The story is the old one. If Trina owes $1 milion Trina has a problem. If Trina owes $1 billion the lender has a problem unless the lender has a bank letter of credit.
If the lender has a bank LOC they just draw it.
Now the bank has a problem.
Which means Trina has a problem.
There is no reason I can see the shareholders get out of this one.
TRINA of course still exists at the end of this. But why should Western shareholders own it?
There is a bit of devil in the details. I would like to see the exact terms/form of the LCs/guarantees, and which banks have provided them.
If the supplier had a decent lawyer and the LC facility was structured as we would normally expect in a transaction of this type, then I'd say the bank(s) and thus Trina is on the hook.
But if we're not dealing with normal western commercial and banking practice then who knows? The banks have big incentive to wriggle out of payment, after all, or the terms may be so loose as to allow them to.
So who are the banks? If they were western banks then facilities this size would almost certainly have to be syndicated - and someone with current access to a decent data provider (not me at the moment) should be able to find the facilities reported somewhere.
But if they're Chinese banks then who knows?
Call me a cynic, but getting banks to lend money to a solar cell producer obligated to buy raw poly-Si seems like a great way to transfer wealth from the capital markets to the owners of the poly-Si company...even with the actual end markets in complete chaos.
Could TSL merely be the conduit in such a scheme? A real company, but when the writing was on the wall, and the solar bubble began to burst, perhaps TSL management, already proven incompetent by surrounding themselves with such luminaries as Peter "King Kong" Mak and Crocker C. made a deal with the devil?
TSL management are either crooks or morons, and neither option makes them good stewards of shareholder value.
Of course, they could just get lucky, but it will take a miracle.
would the polysilicon supplier have an incentive to maintain the health of their customers/industry? and hence they might look to the long term and go easy on trina?
Someone above made the comment that GCL would rather - if/when Trina is unable to meet its purchase obligations - renegotiate rather than settle for the $750mm cash+LC and whatever business remains from Trina, and I've got to think that's the case (to a point, of course).
Without knowing the (advance) payment schedule, we can't really know for sure, but the PV of keeping Trina alive as a customer with relatively small concessions from the existing agreement has to be higher than taking 1/20th the value of the contract in cash today + some totally unknown remainder of it down the road, no?
Agree with comment that management seems at best stupid and at worst somehow complicit.
Great post as always, much appreciated.
I know Trina would want to secure low poly cost by agreeing to a long term purchase agreement but this raises several questions?
1. Why would a bank be willing to extend credit to Trina, knowing that this cash could be claimed by the Poly makers if Trina blows up, sounds like a risky proposition?
2. Why would Trina sign an agreement that forces them to purchase $14 billion worth of poly, without a contingency if sales started collapsing?
3. In the event that Bronte analysis is true that the stock is either going most likely to 0 or 50, Would the poly maker knowingly put Trina out of business to grab the cash, I bet they would renegotiate the contract instead to prevent a long term customer from declaring bankruptcy...
Not sure I can agree with your analysis. My experience is that when push comes to shove there is no such thing as a take or pay contract - It is pragmatic to draw things out in the legal system - who knows your supplier might even go bust and drop the case. With a glut in the polysilicone market - Trina can draw legal proceedings out and get new supply under better terms from someone else.
As for low digit P/E, as a genrral priciple, if a company overstates its earnings a low P/E can be a high P/E on estimated real earnings eg 4x P/E on a 10X overstatement is 40x. Same as low P/B often being correct valuation of those parts of the assets that are real/unimpaired/unliened.
The critical point here is that the poly supplier has
(a) some prepayment - see the $94 million advanced to suppliers
and
(b) 650 million in LOCs written by the banks.
If Trina defaults they have $750 million of cash in hand which gives them a better-than-average negotiating position.
They may chose to keep Trina alive - but only if Trina is worth more alive than dead.
Its worth 750 million dead.
If it dies the bank owns it.
Trina does not cease to exist. Just the bank owns it.
The bank will want to run it.
Who they going to buy poly from?
It is the poly suppliers interest to keep Trina alive if it can raise more money from Wall Street - AKA suckers.
But there are scenarios where this lives - and if it lives $50 is probably conservative.
Very rarely have I seen such fat-tailed outcomes.
J
This is a great post, thanks John for taking the time to write out the whole saga.
According to the purchase obligation schedule, more than 50% of the 14 billion is to be be paid in year 6-7. Seems unsual.
The contract with GCL is 7500MW poly/wafer 2011-2020 which is much more reasonable. So I guess the bulk of obligations are to Hemlock and Wacker?
Could it be that most solar equipment manufacturers produce a lot of inventory in Q1 while selling close to nothing,
since this Q tends to fall in the winter period of the northern hemisphere - the lion share of their markets?
Q2-Q3 sales in Germany could be better than anticipated,
with the government subsidies still in place (they were not cut on 1 July, contrary to threats made earlier in the year).
what a pleasant read
offtopic perhaps -- you told us recently you liked some french banks; could you explain briefly why?
thanks!
Off topic indeed. It is French regional banks - and they are small cap - so no I don't pass the analysis out except to larger clients when they ask.
This does not seem good for FSLR.
First off great work. Fun read.
"This does not seem good for FSLR."
Jim Chanos publicly denounced FSLR on May 25. Share prices have fallen since then from $125 to about $100 (although they are up 1.42% today). This would be hard to attribute to Chanos though since the price was at 117 before the nice "correction" weve had recently. Prices actually rose to about 133 a month after the comments because they secured nearly $4 billion in loan guarantees
One of Chanos reasons for shorting FSLR was the insider selling that was going on. Well today a director named MICHAEL J AHEARN sold about 68.5 million dollars worth of shares (link at bottom). Not a reason to short but defiantly a red flag.
I'm assuming (total guess, havent researched) that First Solar has very limited exposure to Trina. So why is this bad news for them?
http://www.insiderinsights.com/insider/1381112/ahearn-michael-j
Do you think there's any risk that the Chinese government might become a big purchaser of panels? Compared to building empty cities, solar farms stimulate GDP, reduce pollution, generate at least some RoI, support jobs, support a struggling high-tech industry, and build goodwill with global environmentalists. If the government offers a low but reasonable margin, a sideways scenario could become the most likely.
Government launched FiT for solar August 1st. Project IRRs estimated at 8%. Wind sector doubled installed capacity four straight years under similar conditions. China now has more installed wind power capacity than any other country.
However, wind FiT is roughly half of solar FiT, so it's unclear how much appetite government will have for solar until costs come down further.
But regulatory generation of demand domestically has been held in reserve until such time as European demand wanes, which appears to be 2011. Solar FiT came ahead of schedule - many in government wanted to wait until solar was as affordable as wind. Share prices are at 52-week, or even historical, lows for China solar vendors.
Coincidence?
Interestingly, today, I was offered a job opening for Trina in the European HQ :)
Let me see if I've got this straight:
Trina is committing FRAUD...unless they're not;
Trina is going BANKRUPT...unless it's profitable;
Trina's stock is going to ZERO...unless it shoots to the moon first;
Trina has all kinds of off balance sheet financial trickery going on...except, oh wait, maybe they dont.
I have another theory: the markets will be up today. Or down. Or largely unchanged. You have been warned.
Look at the margins and returns on capital of the major poly producers. To me it seems like there will be renegotiation simply because the economics on the poly end are way too good relative to the rest of the chain. The poly guys can renegotiate lower, keep their customers from bankruptcy, and still enjoy reasonable returns.
For some background on enforcement about these poly contracts,
I would advise you to read about the Q-Cells and LDK fight which took place.Also read China Sunenergy and REC.Its not easy to recover the money that easily.Also what would these poly producers will do with these massive plants of polysilicon if they have no customers.If Trina which is the lowest cost goes bankrupt so would 90% of the industry.Then what would Wacker,Hemlock,GCL which have massively expanded capacity do ? They would go bankrupt as well.It would make more sense to drastically reduce the price rather than bankrupt the customer industry.
The story does not add up in the death option
Oh, I should worry about what happened in the Q-Cells case?
The contracts were renegotiated to keep Q-Cells alive - but if this chart is life...
http://investing.businessweek.com/research/stocks/charts/charts.asp?ticker=QCE:GR
Then I think as a short I can handle it.
John
More to the point Q-Cells has gone from 75 euro to under 1 euro.
I think - as a short seller I could cope with that sort of outcome.
If that is what a renegotiated silicon contract looks like then hey - my thesis is effectively right.
John
More to the point Q-Cells has gone from 75 euro to under 1 euro.
I think - as a short seller I could cope with that sort of outcome.
If that is what a renegotiated silicon contract looks like then hey - my thesis is effectively right.
John
In China, they say, "If you can't list in HK, try SG, if you can't even list in SG, do a US reverse merger!"b
Thanks for the informative piece
If the poly silicon producers have to (a) re negotiate and (b) depend on government subsidies (ultimately in the chain) to survive , they too should be in bad shape sooner or later
Very soon most governments *including* the Chinese would think well before spending and at today's prices this solar energy seems out of wack (on a price per KWH basis)
Until real commercial demand comes up (and other energy becomes prohibitive) ..or... till governments get back on their green binge poly silicon producers should be in trouble [I'm not just talking of the solar panel guys]
These are the poly silicon producers I know of
Hemlock Semiconductor (USA)
Wacker-Chemie AG (Germany)
Renewable Energy Corporation (REC) (Norway)
Tokuyama Corporation (Japan)
MEMC (USA)
Mitsubishi (Japan & USA)
Sumitomo-Titanium (Japan)
............
How many of these are listed ? and where ?
How big are these and what part of their revenue / profits today is polysilicon sales ?
thanks in advance for all who reply
regards
Subu
Your bear thesis rests on the LT poly supply contract which sounds like a big burden.
But it now buys lots of poly and wafer from GCL, which is very flexible on contracts. Given the huge poly capacity coming on line in 2012 and 2013, Trina is in a good position to get bargain contract poly price, and the poly price should fall further to $35 or below.
Just give an example on how good these contracts are: SOL announced it is full booked for Q1 and Q2 2011 at the end of last year. However, during its recent conference call, its CEO said it chose to stay with its clients instead of contracts - suggesting contract price has been negotiated down by 30%.
Another point is China's new FIT, it works very well for western provinces which has 3000 hours sunshine and plenty of 0 cost of land. It means the same PV farms can generate more than twice the electricity that a PV farm in Germany. And all the media said there would be a boom soon. Of course, it will be slow in the beginning for the gov/grid management/developers/banks to sort things out, but the growth and be rapid once the phase passes.
Trina is the best-run panel company out there. If it starts to lose money, then it is safe to say that no other panel makers is profitable except for FSLR (which has better margin).
Using Q-cells as an example for continuous down-slide after wafer contracts modified is a bad choice. Q-cells' downfall is rooted in its inability to compete. On the other hand, Trina is a clear winner in the PV space - just look at its chart and charts of others. Whatever the sector, one should not use losers to justify shorting the winners.
@Subu: You might find some useful information here:
http://www.editgrid.com/user/odyd12/Capacity
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