Sunday, August 7, 2011

Are prospective expenditure matching funds in Trina Solar's debt covenants?

Trina Solar buys polysilicon and sometimes wafers and sells finished solar panels. They used to talk about polysilicon processing costs and do their manufacturing at a large and impressive factory.

You can get an idea of the processes involved (but not the scale of the factory) with this YouTube promotional video:

They aim to be the largest maker of solar panels in the world.

This is a high profile company. It sponsors Formula 1 and Indy Car which gives the executives the chance to be filmed in front of fast cars surrounded by pretty young women.

My problem is that the more I look at the accounts the less I understand them.

To this end I wrote a letter to management suggesting that they were in (seemingly unnecessary) breach of their debt covenants and they wrote back assuring me they were not.

This post makes public my letter and their response. Some commentary is provided on their response.


First my letter:

Attention Terry Wang, Chief Financial Officer, Trina Solar 
by email: ***


Thomas Young, Senior Director of Investor Relations
by email: 


Puzzling over Trina's debt covenants

Dear Sirs

I am a hedge fund investor based in Australia. I am also the writer of the popular Bronte Capital blog. The blog has been associated with exposing Chinese accounting scandals but the companies discussed on the blog differ substantially from Trina Solar. Substantially they did not exist. Trina Solar clearly exists and Trina Solar panels are distributed widely.

I am increasingly puzzled over Trina Solar's accounts. The issue that puzzles me most is the high cash balance combined with strange debt covenants.

I intend on writing a blog post about this – and I seek your comments because it is almost certain there is a simple and innocent explanation of what I see and I am happy to include your response in my blog post. It is more an education in how a competent hedge fund manager reads accounts. 

Anyway the issue I am raising is how Trina funds its capital expansion.

The last 20F filing contained the following investing cash flow section:

[Click for full detail...]

The columns are for 2008, 2009 and 2010 respectively. Purchase of property plant and equipment was 165, 136 and 144 million dollars for the three years respectively.

The 20F also contains this section about a debt facility to purchase the property, plant and equipment.
In September 2009, Trina China entered into a five-year credit facility of approximately $303.3 million, consisting of RMB1,524.6 million Renminbi denominated loan and $80.0 million U.S. dollar denominated loan, with a syndicate of five PRC banks led by the Agricultural Bank of China and Bank of China. Approximately $269.2 million of the facility are designated solely for the expansion of our production capacity, with the remaining to be used to supplement working capital requirements once the capacity expansion is completed. The facility can be drawn down either in Renminbi or U.S. dollars. As of December 31, 2010, we had drawn down approximately $275.1 million under the facility. The remaining facility to supplement working capital requirements can only be drawn on or after the date of completion of capacity expansion. The weighted average interest rate for borrowings under the facility was 5.53% for the year ended December 31, 2010. Interest is payable quarterly or biannually in arrears for loans denominated in Renminbi and U.S. Dollars, respectively. Interest rate applied for Renminbi-denominated borrowings is the same interest rate stipulated by Chinese central bank plus 10%. U.S.-dollar denominated borrowings are subject to the six-month London Interbank Offered Rate plus 3%. The facility is guaranteed by Trina and Mr. Jifan Gao, our chairman and chief executive officer, and his wife, Ms. Chunyan Wu, and is collateralized by the property, plant and equipment of the project and the related land-use right. Borrowings outstanding as of December 31, 2010 are payable on a biannual basis, commencing on October 27, 2011. For purposes of the expansion, we are required to match draw-downs from the facility with an equal amount of cash from sources other than the facility. The terms of facility also contain financial covenants which, among other things, require us to maintain a debt-asset ratio of no more than 0.60, a net profit ratio of not less than zero percent and an interest coverage ratio of greater than 2. 
At first reading this is very puzzling.  This facility is “designated solely for the expansion of our production capacity, with the remaining to be used to supplement working capital requirements once the capacity expansion is completed.” However we know that Trina's purchases of property, plant and equipment were 144 million in 2010 and 136 million in the WHOLE of 2009. 

They facility is drawn to 275 million.  So it appears Trina has funded their entire 2009 and 2010 capex with this facility.  However the terms state that Trina must  “match draw-downs from the facility with an equal amount of cash from sources other than the facility”. It doesn't look possible that Trina has done that and it appears that Trina has drawn their bank facilities in excess of what the covenants would allow.

I have puzzled further over this – maybe some old property, plant and equipment debt was rolled into this facility.  But according to the latest 20F filing the long-term borrowings outstanding at the end of 2008 were only $14.6 million so the strangely-large draw-down of this facility cannot be the result of long-term debt rollover.

So unless I am mistaken (and I would appreciate you telling me where I am mistaken) Trina has drawn this facility far in excess of what is allowed under the facility terms and is currently in breach of its debt covenants.

This is peculiar because Trina showed free cash in excess of $750 million on their balance sheet as per December 2010. There would appear no reason why Trina would be in breach of the debt covenant. Moreover it is a pretty harsh covenant – it involves a pledge of most the property of Trina and personal guarantees by Mr Jifan Gao and his wife.

Anywhere but China I would consider this as an innocent mistake – one easily fixed by taking cash from the balance sheet and making good on the 50 percent rule. In China you have to question cash balances. I have spotted other companies with fake cash balances. But those were substantially fake companies and Trina is clearly a very large manufacturing concern.

So – I am writing to ask (a) whether my analysis is fundamentally wrong and if it is not (b) why are you in breach of your debt covenants, (c) how much of the cash on-balance-sheet will be used to make good that breach, (d) have you sought a waiver of those covenants and (e) whether that waiver has been made good.

I hope to hear your answer.

I intend on blogging on this in about five days – and I will incorporate your answers in the blog post.

Thanks in advance.

John Hempton

Now their response:

Dear John,

Thank you for opportunity to address debt covenant inquiries centering on the statement:

For purposes of the expansion, we are required to match draw-downs from the facility with an equal amount of cash from sources other than the facility.

First and foremost, and in contrast to your comments received, Trina Solar is not in breach of its facility debt covenants.

Related to this fact, at a high level:

I.  Some capex in 2008 and 2011 are also under (matched) capacity project financing
II. We matched the project financing under agreement through our equity offerings and some contribution from two-year positive operating cash flows.

More specifically,

1. Timing of matching funds:
The Company made significant disbursements for subject expansion project prior to 2009, the year in which the loan facility was finalized. Such payments are common and can be linked to both project infrastructure development (engineering design and construction) as well advanced payments for technology hardware (facility EHS and production line related).  Such ‘early disbursements’ should be included as matching funds.

2. Project completion status:
Though initial phase was commissioned in late 2009, this ultra-large scale facility has yet to be 100% completed in terms of capacity additions. As such, related 2011 expenditures would also qualify as matching funds.

3. Source of our matching funds:
Fund sources include proceeds from our 2008-issued senior convertible notes, our 2009 and 2010 follow-on offerings, and a portion of our operating cashflows.

We trust you find the above helpful and thank you in advance to confirm receipt.

Best Regards,

Thomas W Young
Senior Director, Investor Relations


I showed both the letter and the response to one of my better friends (someone highly familiar with the nuance of debt covenants) and he drolly replied that "prospective expenditures are not exactly matching funds".

The usual notion of "matching funds" is that if you spend $100 on plant and equipment the loan may be drawn to $50 and the other $50 has to come from somewhere else.

According to the company the loan is drawn to $275.1 million as of year end and Mr Young tells me the project is not finished.  $275.1 million is way in excess of half of capital expenditure in 2009 and 2010.

Trina Solar say that some 2008 capital expenditures should also be included. The total investment in property, plant and equipment in three years 2008, 2009 and 2010 was (165 plus 136 plus 144 million equal to) 445 million. If they had only drawn the loan to 50 percent of the last three year's capex they would have only drawn 222.5 million rather than the above-mentioned 275.1 million.

Trina tell us that they can match funds with future expenditures. I find that unusual but as this blog is a fan of Fox News I will answer with the usual rejoinder: I report. You decide.


Post script: I think Jeffrey Rothstein's comment below - and my reply to it - are important parts of this story - so I encourage reading of the comments. I am not sure the 20F filing disclosure accurately reflects terms of the loan agreement.


Anonymous said...

Assuming they are in compliance with their covenants because of the reasons they list, it becomes a pretty meaningful insight into differences in the lending standards of the PRC banks versus the rest of the world.

Anonymous said...

Maybe there are some nuances between "maintenance and expansion capex" as well

Jeffrey Rothstein said...

Just a brief look at the loan agreement (think I have the right one) and I don't see any mention of "equal" or "matching" funds...

The closest thing I could find is "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,"

but that doesn't seem to mean what the company has said in its response to you (eg 50% from the credit facility, 50% from other sources).

There does not appear to be anything resembling the language the firm uses in its 20-f nor in its response to you in the credit agreement. Curiously, if such was the case, I would expect to see "matching funds" (or something along those lines) in the "Definitions" section quite clearly explained, but I don't see anything of the sort. Either way, I find it a bit hard to believe that if such clause(s) do somewhere exist, they consider uncertain future capital (equity funding/cash flow) as eligible matching contributions.

Perhaps I'm just that over-tired/worked that I'm reading the wrong document or I've repeatedly glossed-over the section(s) that detail 50% debt/50% other sources clause(s)...

If that is the case, I apologize for the idiotic and ignorant comment. If not, er, um, well, I am very, very confused...

John Hempton said...


I was forwarded the loan agreement last night - and I agree with the cut. There is no obvious mention of matching funds.

BUT - there is something else - which is that the company had to separately capitalize the subsidiary with USD200 million -

And that $USD200 million effectively gets captured permanently by the subsidiary - and as far as I know it was done with cash.

So the $750 million of cash on the balance sheet at year end was in part ESCROWED in this separate subsidiary available essentially only for capex.

The disclosure in the 20F filing is thus misleading on two accounts

(a) matching funds does not appear in the loan agreement BUT

(b) Some considerable part of the cash is escrowed as effective collateral for this agreement.

I spent about six hours going through whatever nuances I could find in their loan agreements. The whole thing is alas more tricky than it looks.


Anonymous said...

Well, according to this very recent article, I don't think those future earnings they were counting on are going to materialize, either. Then again, is a covenant really a covenant if no one notices?

Mokwit said...

I was taught by an Asian bank credit analyst that a subsidiary company is to be regarded as a fund siphoning vehicle until proven otherwise.

John Hempton said...

Mokwit: I think you were taught well.


Epicurious said...

As I have some experience reviewing credit documentation, thought I'd spend a couple of hours on this as well. After reviewing the loan agreement, John's original post and the follow-up posts by Jeffrey and John, I can't help but agree that the 20-F disclosure is terribly mistaken/poorly worded.

Based on the disclosure regarding the entirety of the project financing, ~50% of the project will be financed by the company through US$200MM in existing capital and a further US$94MM raised by the enterprise. This appears to be the unfortunate nuance of "matching" that is referred to in the 20-F but frankly misstates how the facility actually works.

Reviewing the loan agreement CPs, it is clear that US$200MM in cash had to be contributed to the project by the company upfront and appears, as John stated, to the extent that amounts remain unspent, are included in the company's cash balance but not separated out as funds in escrow. I would also note that the loan facility now appears to be fully (or nearly fully) drawn, as the remainder of the facility is for working capital loans, which requires the project to be substantially completed prior to drawdown.

On a side note, I find it peculiar that the additional contribution of US$94MM does not appear to be a condition for drawdown in anyway and, barring the ~US$30MM working capital loan, is frankly the last dollars to go into funding the project.

Anonymous said...

I write a blog about solar energy called No More Naked Roofs ( and I was wondering if anyone could explain why these solar companies trade at such low, single digit p/e multiples. In an industry where there is definitely room to grow (whether that happens is another story) why is that potential growth discounted the way it is? What am I too stupid to figure out?

Anonymous said...

Anonymous @ August 9, 2011 8:24 AM:

Solar companies are getting squeezed. Prices for their products have been dropping steadily for quite some time. And just recently the price of the "non-alternative" energy they compete with (eg, oil, etc) has dropped sharply, likely in anticipation of low economic growth or double dip.

Anonymous said...

Solar companies generally depend on large govt subsidies to make money, especially for the downstream companies further down the chain you go. Spain, Germany are the kinds of places that offer large subsidies and drive the industry. On the upstream side, there is massive competition and I believe that it takes more energy to make the silicon than the solar cell will actually generate over its life. Solar is great for the consumer but I am not at all convinced about its large scale efficiency yet. I looked at the Chinese solar industry some years back and was not enamoured at all with the fundamentals.
- KC

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