Bronte has taken a long position in Sun Edison. We did this after the first and indeed second stages of the collapse in that stock. The stock decline here is spectacular. First Solar and Solar City have had issues - but nothing like this.
Until about a week ago we were showing (small) profits on the position. Then it took yet another leg down. I know the cliche about trying to catch falling knives - but we think this is a quite good bet - and would be a better bet if the board took decisive action to fix immediate and pressing problems.
Background
Sun Edison develops huge and highly capital intensive solar and wind project where the power is largely pre-sold and where separate financing is developed for each project. These projects are then sold to [“dropped down to”] semi-captive yield companies sold to mostly to yield sensitive investors.
There are several issues. Big solar projects are massively capital intensive – think of utility scale power generation where you have to pay for the next 25 years of fuel upfront. The projects have huge debt but also reliable high margin cash flow.
Secondly there is a pretty obvious conflict of interest in the “yield co” drop-downs. We have successfully shorted a few companies where we think that overpriced assets were being sold to captive vehicles. In the end they these were good shorts - if you can't treat the investors in the drop-down vehicle fairly you will eventually wind up with fewer investors, less access to capital and less underlying profitability.
Thirdly, because of the related parties and the copious amounts of different types of debt these companies have complex and even scary accounts. At Bronte we are quite good at getting to the bottom of complex accounts. But we have a problem with these.
In a meaningful fashion Sun Edison is a “trust me” story.
Whatever, the problems Sun Edison and its yield cos have been smashed. Once fairly obscure solar developers have become a major topic of discussion on Wall Street.
It took us a while to understand why they have fallen so hard. The argument comes down to complex accounts, lots of debt and a peculiar acquisition of door to door marketing company(Vivint).
But there is also more than the usual amount of rumour and innuendo. On Twitter there are arguments we know to be wrong and arguments that are simple fear-mongering (calling Sun Edison “Sun Enron” is one such appeal). Sure the company is highly levered and complex but it is almost certain that the past deals have been good deals. Any solar farm deal you put in place 3-5 years ago has worked out. Both solar panel prices and interest rates are lower than you would have baked into your cash flow models. We would be enormously surprised if the past deals of Sun Edison did not work out.
Whether the future deals work out is however an open question. Low solar panel prices and low interest rates are not exactly a secret – and the funding cost for solar panel farms has risen with this panic. Bluntly we think unless the company repairs its relationship with capital markets it is unlikely to be able to generate good deals in the future and it will wind up in run-off.
There is a deeper problem with the way these companies [yield cos and their parents] see themselves and communicate with investors. That comes down to the fact that many have their roots in semiconductors where operating leverage is everything. You disclose your costs, your variable versus fixed, capacity expansion and so forth because if you make solar modules, wafers or chips that stuff matters a very great deal to your business. Investors use and demand that information because simply put, it matters and drives the profitability of the business.
A yield-co is a completely different business – it is a non-bank financial company.
Non-bank financials “blow up” for one of three reasons, (i) credit risk, (ii) duration mismatches and (iii) and unstable funding. If you want to assess TerraForm Power (Sun Edison’s yield co) you need to assess whether the credit risk on the projects (the counter-party) is okay, how the contract and funding is (eg floating/fixed etc) and all the ways in which project development funding is able
to roll into long-dated funding.
A friend put this to a yieldco and the management balked at providing that level of project detail. My friend's response: “well, are you Northern Rock?”
And that is the guts of the issue and the market fear. We have gone to considerable effort to convince ourselves Sun Edison is not Northern Rock with solar panels. We have talked to several people who have organised funding for these things and it seems okay to us. Specifically all construction finance automatically can be termed out as project finance (over the life of the project and linked to the project) when the construction is done.
If this is true the market fear for this company cannot cause insolvency. Given that the company is priced as if insolvency is likely this stock should produce a good return from here.
Alas we could be wrong here. We can’t see all the funding (the disclosure is complex) but the bits we have seen have this character. We checked through several sources and we don't think the company can have a “run on the bank”. The Northern Rock outcome is unlikely.
Now of course we have not seen and understood all of the finance deals. Only the ones we can find. But that is sufficient to know we are probably right. And that is the case for buying. The old projects are good and they should run off at an attractive clip.
The Vivint Acquisition
That said this company does not behave like a financial institution, they have been rash and callous in their treatment of capital markets. This is dumb. Capital (not solar equipment) is the main input in this business. And capital is cheaper if people trust you.
Moreover management did a really foolhardy acquisition and explained it badly.
Vivint (the target) is a door to door marketing scheme selling solar systems. Some suggest multi-level marketing scheme characteristics but I cannot find the contractual terms that indicate it is an MLM. [Contra: friends have done research on the numbers of complaints at State agencies concerning Vivint.]
Moreover the product it is selling door-to-door (financed solar systems) is not a bad deal for customers. Customers put the solar panels on their roof and their power bills go down. Whether the solar system is owned by the household or some corporate structure what is effectively going on is a loan to the householder where the householder will repay the loan by splitting the utility bill saving with the solar company. Things can go wrong in this deal – but those things are not very likely.
That said, there are good reasons why roof top solar is less attractive than utility scale solar farms. The main one is that rooftop solar gets under-priced use of the grid. The grid is essential here – unwanted solar is sold to the grid and the grid provides electricity when the sun doesn’t shine. My business partner was once a utility CEO. He has an instinctive skepticism of rooftop solar. He thinks – correctly – that people with rooftop solar underpay for grid services.
In Northern California this is becoming explicit. Pacific Gas and Electric is proposing changes which explicitly charge households with solar panels more to access the grid. Whilst we have no view on the size of the charge the direction is probably right. This will become a trend and make roof top solar less attractive in the future.
The Vivint acquisition - which looks strange - was poorly explained and was bundled with a few details that indicated that the margins on projects dropped down to the captive yeild-cos are declining caused a run on the stock. Moreover there were lots of hedge funds who had oversized positions in Sun Edison before the collapse. There clearly was a rush to the exits.
And in capital market terms those can be self-fulfilling. The equity and debt cost for Sun Edison has risen substantially and this seriously impedes the economics of the company. Its that strange thing about financials that lower prices for equity and debt reduce the future cash flows.
The current situation and the way forward
Sun Edison has lost about 80 percent of its value without the slightest hint from the management team that there is a problem. The credit default swaps have moved against them and it will be far more difficult to grow whilst the situation is like this.
There really is one issue here. Can they find and develop new solar plants and drop them down into project financed bankruptcy remote vehicles and (a) make a profit and (b) ensure the new owners of those vehicles make enough return to keep them coming back for the next vehicle? [At the moment there is a fairly strong private market for solar projects - people like large pension plans - but the same concern applies to them too. They got to trust you.]
If they can't develop and sell either growth stops dead or the company becomes a ponzi.
Alas with market distrust it becomes unlikely that future projects can meet the required return hurdles. The private market for completed projects will also have the same concerns about the management.
The best case here is that the company has become a melting ice-cube. It is worth something (I think a fair bit more than the current price) but every drip of cash that comes off in the end goes either for debt repayment or is returned to shareholders.
The whole project development team - the raison d'être of the company - ceases to have any use. They should all be fired. Yes - all of them. [If you work for Sun Edison it is your job too. And that will eventually include the board. Them are the stakes. If the current board doesn't do something about this it is eventually your job.]
There is an alternative - an alternative I think the company should take. They should pay their contrition to the market - and give the market what the market wants.
What the market wants here is a clear vision of financial control and responsibility. They want to know that Sun Edison is not Sun Enron.
Stocks don't just fall 80 percent in a vacuum. Someone has to be held responsible - and the board needs to ensure that happens to ensure Sun Edison has a future.
That person is the CEO.
Ahmad R. Chatila
Ahmad R. Chatila (Sun Edison's CEO) is a visionary. Indeed Mr Chatila is the reason for Sun Edison's success to date. I have heard managers describe him in glowing terms - amongst the best CEOs in America.
And I don't disagree.
Except that he should be fired. Pronto. Now.
Sun Edison - through the vision and drive of Mr Chatila has become a financial institution. One with a lot of run-off value. One which I think has improved the world a great deal.
Vision, drive and competence are usually great things for a CEO.
Not in this case.
I am an old fashioned kind of guy. I do not think visionaries should run financial institutions.
Visionaries running financial institutions end in disaster.
Mr Chatila has built an institution for which he is profoundly unsuitable to run. The market has made that abundantly clear.
Pay him out
I have mostly been unsympathetic to firing executives and leaving them with a big payout. Mr Chatila is an exception.
Mr Chatila has not done much that is wrong. He has created - from very little - a worthwhile, valid and large business. He has achieved much.
He has not done very much that is wrong except create a business which he personally is a woefully inadequate CEO for. For this he should be rewarded: as recognition of (a) what he has truly created and (b) for going quietly and constructively.
Calculate his payout, add thirty percent and fire him.
Who to appoint?
There is a core criteria on picking the new CEO.
They need to be boring and from a control culture. The idea CEO would be someone from (say) the risk management department of Goldman Sachs. What you want is a dull suit occupied by someone whose job it is to pull wings off butterflies. Someone whose job it is to ensure - and be seen to ensure - that bad projects are not funded.
The market wants someone who will get on an earnings call and talk about asset liability matching, FX risk mitigation and basically sounds like the CEO of a mortgage REIT, not a semiconductor visionary.
You want risk aversion above all other things.
And you want it for another reason. Mr Chatila has populated the senior ranks of Sun Edison with people like himself. Ambitious go-getters - people who get things done. It is notable that all of the ex Goldman hires at Sun Edison come from the banking and advisory side. They are deal people. Deal people do deals and are not happy if they are not doing deals.
The people Mr Chatila have hired have got things done. Alas if you are going to have people like this in a financial institution (and Goldman Sachs is full of such people) then you need a counter-balance. Someone who stops you doing silly things and has the intellectual horsepower to work out what is silly and what is not. There are plenty of such people around and if Sunedison can poach deal centric Goldmanites then perhaps it can pick up a few slighly more salty risk managers too.
There is an alternative of course. But that is harder. You could keep Mr Chatila. Have a visionary running your financial institution - but then you need to beef up the risk management culture of the place to an extraordinary degree. You need to sack the CFO, half the board need to resign (and be replaced by hard-headed financial types) and you need to remove about half the go-getters that Mr Chatila has installed.
Easy and difficult routes to dullness
This company has got to become dull and predictable and it has to get there fast. Anything short of dull and predictable will end badly.
There is a fast route to dull and predictable (the one I prefer). Start at the top. Sack Mr Chatila. Appoint someone who will embody the new (and boring) Sun Edison. And this guy is going to give the market the sort of information they need - that is
(a). Power purchase agreements and their counter-parties (the analog of credit risk for a non-bank financial institution),
(b). Contract terms for the above PPAs - eg fixed, floating, renewal terms and also for the debt for the projects (the analog of whether there are mismatches in funding), and
(c). The funding details (to ensure that there are not mismatches in the duration of funding).
There is the second route to dull and predictable. That is to leave Mr Chatila in place but sack half the people around him and replace them with people who will control his ambition. This is - in this case - a worthwhile option as Mr Chatila really is a visionary - someone who really has created value.
Whether you can keep the good parts of Mr Chatila (vision, drive) and also keep the market happy has yet to be seen. I have my doubts.
The third way to dull and predictable - and one which will be forced upon the company shortly if the board does not react sensibly is just to put this into a form of run-off. Fire everyone in project development. Just do it. My guess is that they have to start firing now - but a few is not going to do. In runoff they have to fire all the interesting people, leave a skeleton maintenance staff and send us (now suffering) shareholders lots of cash.
My guess is that the board will settle on the first option or Carl Icahn or some equivalently effective activist investor will buy a big stake and force the third option on them.
John
Showing posts sorted by relevance for query solar. Sort by date Show all posts
Showing posts sorted by relevance for query solar. Sort by date Show all posts
Friday, October 2, 2015
Friday, August 19, 2011
Trina Solar and the meaning of "strategic partnership"
A couple of days ago Trina Solar announced a "strategic partnership" with the well managed Australian company Origin Energy*.
I think Origin is one of the best managed companies in that space in the world (but it is not exactly cheap...)
Origin also has an Investor Relations department that in my (fairly considerable) experience is dead straight: they tell the unvarnished truth and I like them.
Anyway here is the announcement:
In other words it is not much of a "strategic partnership".
But just to make sure I wrote to the Investor Relations department of Origin.
Now we can rephrase the Trina Solar press release more accurately: Trina has sold some solar panels to Australia's Origin Energy. No details as to price were announced. Trina is one of a number of suppliers used by Origin Energy. This deal is material to neither party.
Chinese Companies and Strategic Partnerships
The phrase "strategic partnership" has come to mean customer - often small customer. But it is genuinely confusing as it sounds important.
When I was looking at Longtop Financial Technology (a company now trading on the pink sheets in pennies) I came to the conclusion that much of the company did not exist. Certainly there were large claimed businesses that just could not be found.
But we were confused by Microsoft (on their website no less) listing Longtop as a "partner". You can still find the listing here. This relationship was of course hyped by Longtop but when I checked "partner" just meant "customer".
And I write this only as a warning: be very wary of any Chinese company claiming to have a "strategic partnership" when what they mean is small commercial sale. It is yet another sign of an over-promotional management team.
John
*In my past career I purchased (for clients) almost 5 percent of Origin Energy at under $2 a share. It was cheap. I sold it for just under $4 a share and thought I was clever. The stock price is now $13.72. That was not my best decision and I had full understanding of how good this company was.
I think Origin is one of the best managed companies in that space in the world (but it is not exactly cheap...)
Origin also has an Investor Relations department that in my (fairly considerable) experience is dead straight: they tell the unvarnished truth and I like them.
Anyway here is the announcement:
CHANGZHOU, China Aug. 17, 2011 /PRNewswire-Asia-FirstCall/ -- Trina Solar Limited (TSL) ("Trina Solar" or the "Company"), a leading integrated manufacturer of solar photovoltaic (PV) products from ingots to modules, today announced that through its subsidiary, Trina Solar Australia Pty Ltd, it has signed a strategic partnership with Origin Energy Australia ("Origin"), the leading Australian integrated energy company.
Under the terms of the agreement, Trina Solar is expected to supply Origin with approximately 22 MW of PV modules over the next twelve months starting from the third quarter of 2011.
"We are delighted to initiate our relationship with Origin, Australia's leading energy retailer and the country's largest green energy retailer with significant investments in renewable energy technologies," said John Susa, Trina Solar's Country Manager of Australia and New Zealand. "We are confident that this long-term partnership with Origin will bolster our ability to expand and strengthen our market position in the residential segment."
"Origin, which is one of Australia's leading solar retailers, has closely reviewed the capability and quality of a number of solar module suppliers in recent months in order to offer its customers quality solar solutions. The high efficiency, scale and long term strategic positioning of Trina Solar has impressed us and we look forward to a long term relationship," said Mr. Dominic Drenen, Origin's Solar and Home Products Retail Executive.The first thing that jumped out at me was the small-scale of this relationship. 22 MWs of panels over twelve months is about 1 percent of Trina's output - and they are selling that to a major distributor in a country where the sun almost always shines, solar subsidies are still common (albeit reduced) and where the only local factory has just closed.
In other words it is not much of a "strategic partnership".
But just to make sure I wrote to the Investor Relations department of Origin.
Hi John,
Origin has not put out a release as it is simply part of our ongoing supply arrangements and not material in its own right. Trina is one of a number of suppliers we use.
Cheers,
Angus
Angus Guthrie
Group Manager, Investor Relations
Now we can rephrase the Trina Solar press release more accurately: Trina has sold some solar panels to Australia's Origin Energy. No details as to price were announced. Trina is one of a number of suppliers used by Origin Energy. This deal is material to neither party.
Chinese Companies and Strategic Partnerships
The phrase "strategic partnership" has come to mean customer - often small customer. But it is genuinely confusing as it sounds important.
When I was looking at Longtop Financial Technology (a company now trading on the pink sheets in pennies) I came to the conclusion that much of the company did not exist. Certainly there were large claimed businesses that just could not be found.
But we were confused by Microsoft (on their website no less) listing Longtop as a "partner". You can still find the listing here. This relationship was of course hyped by Longtop but when I checked "partner" just meant "customer".
And I write this only as a warning: be very wary of any Chinese company claiming to have a "strategic partnership" when what they mean is small commercial sale. It is yet another sign of an over-promotional management team.
John
*In my past career I purchased (for clients) almost 5 percent of Origin Energy at under $2 a share. It was cheap. I sold it for just under $4 a share and thought I was clever. The stock price is now $13.72. That was not my best decision and I had full understanding of how good this company was.
Friday, December 2, 2011
The extent of Chinese solar subsidies and their implications
Chinese solar makers are facing a countervailing tariff case essentially arguing that the Chinese Government (through state controlled banks) are subsidizing them. The CEO of Trina Solar (Jifan Gao) was party to a statement (also made by three other solar CEOs) that:
(Unfortunately you need to click this image to see the axis)...
Suntech is at 78 percent. LDK is 53 percent. Trina is "only" at 22 percent - but the Trina debt piece is a convertible and was recently trading way above par as this bond price chart shows:
(Click the image to see the axis.)
Which shows the price of the Trina piece coming down from well over 100 as the "convertible" bit lost its value.
Trina has recently expanded its loans by several hundred million dollars at low rates. But Jifan Gao says those rates are not subsidized. He is wrong and the solar makers should and will lose their case. There is a robust market telling us what the "free market rate" is and it does not look like the subsidized rate the Chinese banks are providing.
The Solyandra case
The Chinese solar makers will - with righteous indignation - point at the subsidized loan that the US Government gave Solyandra - a loan that has now gone solidly into default. They have a point - but not a good one in a court. Their problem is that the WTO agreements have a specific exemption for government loans to develop new industries and new products. The most famous recipient of these loans is (of course) Airbus who gets subsidized loans to develop every new plane. Boeing can't win that trade case because the subsidy - like the Solyandra subsidy - is international trade law compliant. (If you want a decent history of that subsidy read John Newhouse's excellent book on Boeing versus Airbus.)
The reality for solar makers
The reality for the solar makers is bleak - maybe not for the solar business - but certainly for the shareholders and debt holders in the companies. The American solar makers will win the trade case. There will be a countervailing tariff. Europe will almost certainly follow. The products will have no markets at tariff included prices and the subsidized loans that the Chinese banks gave the solar companies will not be repaid.
The banks will wind up owning the companies anyway, selling products facing crippling countervailing tariffs. When the most potent argument that the Chinese solar CEOs can come up with is that their interest rates are high (almost 10 percent) but are really 30-60 percent below market their position is clearly weak.
There is an alternative. The alternative is for the Chinese to simply agree to provide no more subsidized loans and to roll all funding as it matures into long-dated non-subsidized loans. Then the whole countervailing tariff argument just evaporates.
Of course the solar companies - every single one of them - goes bust. And quite rapidly.
But it doesn't matter - after bankruptcy the Chinese government - through their banks - owns them. They become state owned enterprises and the Chinese Government can amalgamate them as they see fit. Indeed as SOEs they can seemingly subsidize them as they see fit too - because those subsidies are much harder to argue against in a trade case.
The losers are of course shareholders and western debt holders of the Chinese solar stocks. But I see no reason why should the Chinese government should give subsidies and enter into a crippling trade dispute to protect them.
It is time for Jifan Gao and the other CEOs to have their subsidies - and their businesses - removed from them just as the CEO of Solyandra had his business removed from him. The Chinese banks will learn - as people have been learning since the advent of capitalism - that when you lend a business too much you either own it or are going to spend a lot of time collecting.
John
PS. I do not wish to enter into the morality of the trade dispute. For instance I don't wish to argue that the loans to Solyandra were moral and the loans to the Chinese companies were immoral. I just want to argue what is - and why it is from an investment perspective. The loans to Solyandra were legal. The loans to the Chinese makers are not legal. Morality does not enter into it.
Moreover a countervailing tariff will hurt some people in the US (eg residential solar installers). That is a fact - but it won't enter into the legality of the dispute.
J
China’s solar industry had to pay higher interest rates for bank loans than U.S. and European competitors, and paid market rates for loans. With the appreciation of the yuan, “the loan rate we are paying is probably equivalent to over 10 percent,”Ok - lets see what the interest rate the market (as opposed to the Chinese banks are charging the solar makers):
(Unfortunately you need to click this image to see the axis)...
Suntech is at 78 percent. LDK is 53 percent. Trina is "only" at 22 percent - but the Trina debt piece is a convertible and was recently trading way above par as this bond price chart shows:
(Click the image to see the axis.)
Which shows the price of the Trina piece coming down from well over 100 as the "convertible" bit lost its value.
Trina has recently expanded its loans by several hundred million dollars at low rates. But Jifan Gao says those rates are not subsidized. He is wrong and the solar makers should and will lose their case. There is a robust market telling us what the "free market rate" is and it does not look like the subsidized rate the Chinese banks are providing.
The Solyandra case
The Chinese solar makers will - with righteous indignation - point at the subsidized loan that the US Government gave Solyandra - a loan that has now gone solidly into default. They have a point - but not a good one in a court. Their problem is that the WTO agreements have a specific exemption for government loans to develop new industries and new products. The most famous recipient of these loans is (of course) Airbus who gets subsidized loans to develop every new plane. Boeing can't win that trade case because the subsidy - like the Solyandra subsidy - is international trade law compliant. (If you want a decent history of that subsidy read John Newhouse's excellent book on Boeing versus Airbus.)
The reality for solar makers
The reality for the solar makers is bleak - maybe not for the solar business - but certainly for the shareholders and debt holders in the companies. The American solar makers will win the trade case. There will be a countervailing tariff. Europe will almost certainly follow. The products will have no markets at tariff included prices and the subsidized loans that the Chinese banks gave the solar companies will not be repaid.
The banks will wind up owning the companies anyway, selling products facing crippling countervailing tariffs. When the most potent argument that the Chinese solar CEOs can come up with is that their interest rates are high (almost 10 percent) but are really 30-60 percent below market their position is clearly weak.
There is an alternative. The alternative is for the Chinese to simply agree to provide no more subsidized loans and to roll all funding as it matures into long-dated non-subsidized loans. Then the whole countervailing tariff argument just evaporates.
Of course the solar companies - every single one of them - goes bust. And quite rapidly.
But it doesn't matter - after bankruptcy the Chinese government - through their banks - owns them. They become state owned enterprises and the Chinese Government can amalgamate them as they see fit. Indeed as SOEs they can seemingly subsidize them as they see fit too - because those subsidies are much harder to argue against in a trade case.
The losers are of course shareholders and western debt holders of the Chinese solar stocks. But I see no reason why should the Chinese government should give subsidies and enter into a crippling trade dispute to protect them.
It is time for Jifan Gao and the other CEOs to have their subsidies - and their businesses - removed from them just as the CEO of Solyandra had his business removed from him. The Chinese banks will learn - as people have been learning since the advent of capitalism - that when you lend a business too much you either own it or are going to spend a lot of time collecting.
John
PS. I do not wish to enter into the morality of the trade dispute. For instance I don't wish to argue that the loans to Solyandra were moral and the loans to the Chinese companies were immoral. I just want to argue what is - and why it is from an investment perspective. The loans to Solyandra were legal. The loans to the Chinese makers are not legal. Morality does not enter into it.
Moreover a countervailing tariff will hurt some people in the US (eg residential solar installers). That is a fact - but it won't enter into the legality of the dispute.
J
Friday, April 30, 2010
First Solar – a follow-up post the result
Such is the life of a short-seller. The biggest short in our fund (First Solar) came out last night (Australian time) and – again to use the Australian vernacular – hit us around the head with a bit of 4 by 2.
It was ugly. The stock was up almost 18 percent and was the best performed stock in the S&P. Moreover it has been up for a few days prior to the result. This has not been a profitable position.
On the plus side we run a portfolio – and somewhat unbelievably the customers performed about with market despite this blow. Obviously Bank of America – our biggest long – was up 5 percent – and that position is more than double the size of our First Solar short. Also – and less obviously – our next biggest short (which I will refrain from naming) was down hard. Those two more than offset First Solar and the rest of the portfolio was merely OK. [Even the Spanish bank short – also a largish position – did not hurt us despite Santander’s blowout results.]
If you just looked at the aggregate you would not even notice the “First Solar Pain” – but I don’t look at the aggregate – and I am hurting – if only via wounded pride. So it is time to have a re-examination – a look at what went wrong or did not go wrong. After all I need to know whether to persist in this loss-making position. As I introduced you (dear reader) to my initial thoughts I will introduce you to my continuing thoughts.
When to persist with a loss making short
There are three reasons for covering a short – and only one of them is a happy reason.
The first reason is that the thesis has played out and you have made your profit.
The second reason is that your thesis is wrong. At Bronte Capital we have a strict “no broken thesis” rule.*
The third reason for covering a short – one that happens all-too-often – is that the short poses too much risk and must be reduced for risk control. This happens with shorts but not longs because when a long goes against you (that is down) it gets smaller and hence does not threaten the fund. When a short goes against you (up) it gets larger and hence often must be reduced for risk control reasons. This is the main practical difference between shorting and traditional long investing. Positions on which you are wrong shorting hurt a lot because they get larger and you wind up wrong on larger positions. (Leveraged long investing – which we do not do – requires risk management similar to shorting.)
Anyway – there are only two reasons I will cover the First Solar short after this beating. One is risk control – and that is more-or-less automatic. If the position is too large we will trim it. The other is that our thesis is wrong.
I am not going to tell you about the risk control process (unless you want to become a client). I will tell you about the thesis.
Our thesis – and the the First Solar results
Our thesis for First Solar – run through in detail in the two earlier posts [here and here] has a few parts.
Part A - is that crystal silicon modules (c-Si) are becoming cheaper to manufacture because the Chinese are getting good at producing them and that the most expensive ingredient (polysilicon ingot) is becoming substantially cheaper as the market has become competitive and glutted.
Part B – is that the Chinese c-Si producers are competitive and that over time the price of modules will come – through normal competitive pressure – down to near the cost of c-Si cells – that is costs will determine prices.
Part C – is that the lower price of c-Si modules will compress First Solar’s margins (First Solar uses a thin-film CdTe technology) and competes almost entirely with c-Si manufacturers. Moreover First Solar will not be able to reduce its costs because it is so efficient already – essentially that FSLR’s “roadmap” to lower costs is nonsense.
Bluntly – it is Part B above that I am wrong on. The price of modules received by FSLR was very good and margins remained fat (and indeed got fatter). In the original thesis Part B was the bit without a time-frame – and I might be right or might be wrong on it in the long run – but I am most certainly wrong on the basis of the last quarter.
Lets deal with the bits I am right on so far -
Part A: There is no doubt that c-Si cells are becoming cheaper to produce. First Solar said “the low end of guidance has resilience to $40/kg poly and c-Si processing cost of 75c/watt by Q4 for non captive demand”. (See p23 of the results presentation.)
I am going to come back to that sentence because I think it is central to what has happened – but for the moment note that these are assumptions about competitor costs that were unthinkable only 18 months ago.
The cheapest of the competitors (say YingLi) will be below 75c/watt by Q4 – but it is unlikely the average Chinese manufacturer can get to that target. As for the poly price I think it will be below $40/kg – but it is not there yet. That said – it is obvious that they need to deal with competitors with much lower cost structures than previously. The first part of my thesis is not broken.
Part C: The company has an aggressive plan (“the roadmap”) for reducing their costs per watt by the end of 2014. This plan was illustrated in the following (not to scale) picture:
![[image9.png]](https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi3flsXG2ayc8ArmLywuvFDm5SffCVUAESKHWr-z3kKiRzGy8p_s7fexEJGARcVx8hI-UY1sYOXFzX0I_YC-8FVMXN8h5R0Mpb4xhZmFpwWcNRYOcbsOHuzRFXsI3CDhXk4BQktPL51sXY/s1600/image9.png)
Note – the vast bulk of the cost-saving (18-25 percent) was to come from “efficiency”. Well the conversion efficiency of the cells remained unchanged at 11.1 percent (see p.28 of the results presentation). They need – as my last post explained – to improve the conversion efficiency by approximately 15bps per quarter over four years to meet their target. They are behind schedule.
The company states its cost per watt each quarter. Usually they cite “core costs” (that is not including “stock compensation” and “ramp up penalty”). Those costs were stable at 80c/watt. This quarter they cited “total costs” in the conference call as those dropped 3c/watt to 81c/watt.
They can’t meet their targets by dropping non-core costs to zero – they have to improve their core costs – and the main way that they plan to do that is via increasing conversion efficiency – and they are not on target. The third part of my thesis is thus not broken.
The problem part of my thesis
The problem part of my thesis is pricing. And boy is that broken.
In the fourth quarter of 2009 – a quarter that disappointed – First Solar had operating profit of roughly 145 million and production of 311 MW. Some of the profit is for their development business – but – at a first approximation it is reasonable to think of this as operating profit of 47c/watt.
In the first quarter they had operating profit of 191 million and (nicely increased) production of 322 MW. This is – at a first cut – operating profit of 59c/watt.
Now operating costs per watt only changed 3c/watt (and all of that was “non core”). Operating profit changed 12c/watt. The company shot-the-lights out on price received.
Unless there is something peculiar about First Solar this will probably apply to every solar producer – including the marginal Chinese. But whatever – competition has not driven down prices at least yet.
Competition and prices
It is a core part of my world view that competition tends to squeeze margins – but it has not happened here. There are short-term reasons that are easily identified. The most obvious is that Germany has a concessionary feed-in-tariff regime which will be adjusted (down) from the end of June. There is massive demand in Germany for panels to be installed by the end of the second quarter. First Solar is sold out.
That sort of demand pressure (sudden, urgent) is enough to delay what (I hope) is the inevitable reduction of prices to reflect lower Chinese costs.
However whilst it is part of my world-view that competition tends to squeeze margins it is not universal. Some things just don’t have much competition – I never notice margin squeeze at Microsoft. Also some things that are ostensibly competitive (beverages) seem to maintain fat margins for very long times (for example Coca Cola). I don’t see any particular reason why the third part of my thesis won’t be right eventually but I am open to persuasion otherwise.
The prices received
I said I would get back to the mathematics of the guidance – in particular the comment that: the low end of guidance has resilience to $40/kg poly and c-Si processing cost of 75c/watt by Q4 for non captive demand.
Now c-Si cells use about 6.5 grams of poly per watt (a number that is reducing). This means that the guidance is resilient until the c-Si makers have costs of (75c plus 0.0065*40c)/watt = $1.01 per watt.
Now c-Si cells should (and do) sell for more per watt than other cells (such as amorphous silicon) because c-Si cells are cheaper to install due their higher efficiency. I thought that difference should be about 15c/watt – but I have seen numbers as low as 9c/watt and as high as 30c/watt. The usually accepted number is about 25c/watt – but – to make the case as favorable to FSLR as possible I will chose a low (10c/watt) penalty.
If we get to prices being set by C-Si costs at $1.01/watt (plus say 8c/watt profit for the Chinese producers) then we should get to 99c/watt (including profit) for FSLR. FSLR’s costs are at 80c (core costs) and for the moment look pinned. This implies margin at FSLR at 18c. This could be higher if FSLR reduces costs – but is unlikely to be dramatically higher.
FSLR’s margin in the first quarter was 59c/watt. Bluntly – if the Chinese get to the costs on which the FSLR’s guidance is based then FSLR’s profit crashes if FSLR has to match the Chinese prices.
It would be hard to see how FSLR can maintain its guidance under these conditions. Except that FSLR gives us an out – they say that they are resilient “for the non-captive demand”. FSLR can maintain higher selling prices because it has “captive demand”.
FSLR has captive demand because it is also a project developer and it purchased another project developer (Next Light Renewable Power) very recently.
The question is – is it sustainable to be selling to internal or captive power developers at prices substantially above Chinese costs? Obviously it is in the short term because the solar panel market is “sold out”. It is not so obvious in the long term.
In the long term either (a) the prices at which First Solar sells to “captive demand” has to match the Chinese prices or (b) First Solar is investing its balance sheet in high cost (and hence uncompetitive) captive projects.
Obviously this can continue for a while – whilst prices remain high for solar panels. But I think it will end – and FSLR’s earnings will crash when it ends. I think Part B of my thesis is only temporarily wrong. So I will (subject to risk management) keep my position.
The market of course has a different view – and that difference is painful. Having a short go up almost 20 percent on a result is – to put it mildly – unpleasant.
John
*The no-broken thesis rule was detailed in David Einhorn’s book on Allied Capital. Its funny but in a book about a more-than-average difficult short the thing I most benefited on was some (very) wise words on portfolio management.
Wednesday, August 10, 2011
Trina Solar: Somebody got lucky, but it was an accident
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
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