Friday, August 12, 2011

Four days and roughly flat

After four strange days this week we have made some mistakes (including owning a lot of Bank of America), cleverly covered some shorts and bought some longs on Monday (but limited our trading because of blind fear), made a few more mistakes, had some luck (I mean really good luck) and guess what: we are flat.

We are down low single digit for the month - but hey - I reckon there are a lot of people who would swap.

We were never "threatened" meaning there was little risk of what Warren Buffett refers to as "permanent loss of capital" but it was an altogether uncomfortable experience.

But I am going to tell you something that most hedge fund managers won't admit: the difference between flat and minus seven percent on a week like this one is three parts luck and one part good judgement.

The really big negative surprise

The really big negative surprise from the week was the extent to which we were vulnerable to general hedge-fund liquidation. Our shorts - usually higher beta than our longs - and a source of most of our profits this year - just did not give us the hedge. Hedge funds were liquidating - either to meet margin calls or just to meet large anticipated redemptions. They were selling the most liquid stocks and some were buying back higher short interest stocks (hence those being conspicuously stronger than market).

In most markets our portfolio has relatively low beta (I think about 20-30 percent) meaning if the market drops 50bps we expect to be down 10-15bps and anything different is "alpha". This week we tracked market to a much larger extent and on one day (Wednesday) we actually fell slightly more than market in the first hour. I was genuinely and unpleasantly surprised.

The luck

We had two bits of luck during the week. Firstly our put-option position on Trina Solar paid off big time even though the thesis was mostly wrong.  We covered half the position. That was worth a few points. We have a changed thesis which we are very comfortable with and have positioned differently for the changed thesis.

Second we have a large (and sometimes discussed) position in News Corp. Good results sent the A class share up 18 percent. The results were driven (yet again) by Cable TV Stations. Fox News may or may not be fair and balanced. Whatever: it is extraordinarily profitable.

Logitech: another thing we got wrong

I pretty-publicly lost a fair bit of money on Bank of America. It was for a while our biggest position and whilst we trimmed some we have not played it well.

But I am just as upset about Logitech. I wrote up our basis for shorting it. I got roundly panned as an idiot on Business Insider (see the comments). I sat with the position for a while - but the results were slightly different to how I anticipated and I thought I might be wrong and covered.

Here is the six month stock chart:

Being wrong and losing money: that is part of the game.

Being right and not making money: that is really annoying.

Now I can't even remember the reason why we covered Logitech. It seems so silly... and maybe had I had the flu that day or a sprained ankle we would not have covered it. And the fund would be slightly more profitable.


Day to day there is a lot of luck in this game. But if you avoid being stupid (owning Logitech for instance as it zoomed towards obsolescence) you will do OK over the long run.

Just make sure that there is nothing in the short run that can truly hurt you.

And be smart - really smart - but try not to be "too smart". That is a hard judgement.

Remember the difference between flat and minus seven this week is dumb luck.

And this week we were lucky and we were not too smart. Which - from the perspective of our clients - is a good thing.


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.

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. 

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:

YearIngots (MW capacity)Modules (MW capacity)

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 Trina15
Short term borrowings secured by machinery of Changzhou Energy Trina Solar Energy Corp77
Unsecured short-term borrowings24
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:
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)

March 31December 31March 31
Current assets:
Cash and cash equivalents
Restricted cash
Investment in securities
Project assets
Accounts receivable, net
Current portion of advances to suppliers
Deferred tax assets
Prepaid expenses and other current assets, net
Total current assets
Advances to suppliers
Property, plant and equipment, net
Prepaid land use right
Deferred tax assets
Other noncurrent assets

Current liabilities:
Short-term borrowings, including current portion of bank borrowings
Accounts payable
Amount due from related party
Convertible note
Income tax payable
Accrued expenses and other current liabilities
Total current liabilities
Long-term bank borrowings
Convertible note payable
Accrued warranty costs
Accumulated Other noncurrent liabilities
Total liabilities
Ordinary shares
Additional paid-in capital
Retained earnings
Other comprehensive income
Total shareholders’ equity
Non-controlling interest

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.


Tuesday, August 9, 2011

Paul Krugman vs Mr Bean

Welcome to the newer readers from Paul Krugman's blog. It is the third time (I think) he has linked me and as per usual he brings a lot of traffic.

My post on margin calls is my second most visited post in the past year.

The most visited post however is Mr Bean declaring the European Debt Crisis over.

Krugman is super-smart, has a platform at the New York Times and at Princeton and has a Nobel prize.

But Rowan Atkinson pulls a bigger crowd and doesn't have to say anything.


Who has got the margin call?

Bronte Capital tends - as this blog has said many times - to be long large cap and relatively liquid companies at 10-16 PE ratios.

And we are short the wildest range of frauds, fads and failures you can imagine.

Our shorts are small and relatively illiquid. They are also higher beta - so we tend to be 2-2.5 times as long as we are short and that is only mildly market correlated.

The strategy has been wildly profitable for the last six months and is not bad most the time but we do not like days when the market really pukes.

When the market really pukes it is the biggest, most liquid names that get sold. Why? Because you can sell them.

And they go down hardest.  Which is problematic if you are long that which goes down hardest.

So today is not our strongest day - and whilst we are down far-less than market - I can't say I am enjoying it.

But I am fascinated.

You see the desperate selling of the biggest liquid names is a sign of margin calls.

The market is not puking. Some prime broker is puking the stocks held by one or more very large hedge funds.

So lets play the game: guess who got the margin call!

Guesses by email or in the comments...


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.

Thursday, August 4, 2011

So that makes it alright then...

China Media Express (now defunct and exposed as a fraud) was once the highest conviction and highest stakes short-versus-stock-and-stock-promoter battle on Wall Street.

That mantle has now shifted to Harbin Electric a company which makes (or is that purports to make) large numbers of high-tech electric motors. The Harbin battle has become special for its vitriol and today's 15% plunge and recovery in the stock is just the latest salvo.

Harbin Electric is subject to a proposed management buyout involving the CEO (Mr Tianfu Yang) and Abax Capital (an Asian based private equity fund sometimes associated with Morgan Stanley). The proposed buyout price is $24 and the stock is trading at $17.50 so if the deal goes through holders should make 37% returns. As the deal is meant to close in three months this is an unbelievable 350 percent annualized return. Bulls point to reputable parties involved in this deal including Goldman Sachs and China Development Bank.

Citron's case is that the company is a fraud and the deal is a fraud. The company is worth something close to zero, the deal will not close and the stock will collapse to low single digits. Citron (and other shortsellers) argue the deal is a ruse to suck in unsuspecting arb funds and dumb shareholders and that - absent the deal - Harbin would have collapsed like just about every other Chinese reverse merger.

I am not going to go through the background: all I want to point to is the latest "hit-piece" from Citron Research and Harbin's response.

Harbin alleges criminal behavior by people associated with Citron:

The Company believes that Citron used doctored SAIC reports. The Company has recently reconciled its PRC tax filings on a consolidated basis with its financial statements reported in its SEC filings for fiscal year 2009 and has not found any inconsistency in any material respect. Its SAIC filings are largely in line with its tax filings in the PRC.

Suffice to say that at there is a criminal conspiracy here - either Citron and associates are knowingly peddling lies or Harbin Electric is knowingly peddling lies.  

I don't have access to the original documents and so I don't want to add to that debate. I want to focus on director conflict of interest and Boyd Plowman - the "independent director" charged with assessing the Chairman's take-private bid for the company.

The role of Boyd Plowman

When the management of a company attempt to take it private the role of non-management directors is crucial. After all non-management directors are there to protect against management stealing the company or at least buying it on the cheap.

So typically the board will set up a "special committee" of non-associated directors to assess "the deal". 

Harbin did that.

And the chair of that is Boyd Plowman.

Here is what Citron said about Boyd Plowman's independence:
Mr. Plowman is both head of the audit committee of Harbin, as well as the appointed head of the special committee to take the company private.  This committee is at the center of the requirement that the interests of shareholders be defended.  It is under his watch that we are to trust both Harbin’s financials, and the fairness of the process by which the “takeover” transaction proceeds.  
However, the July 13, 2011 proxy statement filing is the first time investors are informed of the following :
  • “Shortly after Abax filed a Schedule 13G with the SEC on December 9, 2010 announcing its greater than 5% ownership of the Company common stock, Mr. Plowman, the Special Committee Chair, brought to the attention of the other members of Special Committee, as well as to Gibson Dunn, the fact that he was then serving as a director of several Abax-controlled entities including Abax Global Opportunities Fund, Abax Arhat Fund, Abax Claremont Ltd., Abax Jade Ltd., Abax Emerald Ltd., Abax Lotus Ltd., Abax Nai Xin A Ltd., and Abax Nai Xin B Ltd. (the “Abax Companies”).”

Citron then made obvious comments about whether this relationship was appropriate or not. 

Harbin replied:

The allegation that Mr. Boyd Plowman is a Director of Abax is simply not correct. Mr. Plowman resigned as a Director of Abax on December 16, 2010, just a few days after Abax acquired 5% of the Company on December 9, 2010. This information has been disclosed in the preliminary proxy statement filed with SEC on July 13, 2011. Mr. Boyd Plowman confirm that he is not a director of Kilometre Growth either as alleged by the Report.
So that makes it alright then?

Seriously though it took from 9 December 2010 to 13 July 2011 to disclose that to the public.

That is 216 days.

But it was disclosed, and I guess within the letter of the law that does make it alright then.

The only problem is that Abax and Harbin have been dealing for some time. For instance the last 10K provides this disclosure:

On July 28, 2010, the Company entered into a Loan Agreement, dated July 28, 2010 (the “Loan Agreement”) with Abax Emerald Ltd., a Cayman Islands limited company (“Abax”), pursuant to which Abax agreed to provide the Company with up to $15,000,000 in loans (“Abax Loan”). The Abax Loan was to be  made pursuant to one or more borrowings (each, an “Advance”) from time to time from the Closing Date (July 28, 2010) to the date falling on the expiration of five (5) months after the Closing Date upon delivering a notice from us to Abax. In lieu of payment of interest in cash on each Advance, the outstanding principal amount thereof  accreted in value for the period commencing on the Borrowing Date (the date on which any Advance is made from us to Abax) for such Advance and ending on the day on which such Advance is repaid, at a rate equal to 10% per annum, computed as described in the Agreement. The Loan Agreement provided that we could  voluntarily prepay any Advance (or portion thereof in an integral multiple of $100,000) at its accreted value at any time upon written notice to Abax. On the Maturity Date (six months after the date of the Agreement), we were obligated to  repay the remaining outstanding loan not theretofore paid, together with all fees and other amounts payable under the Loan. On July 29, 2010, the Company received the $15 million loan from Abax. The Abax Loan was used to pay down certain debt and to support our capital expenditures and working capital.
So the company borrowed at 10% from Abax. Nowhere in the annual filing is this disclosed as a related party transaction. Management were (as we are now told) informed by Plowman that he was a director Abax entities on 9 December 2010 - three months before the 10K was filed.

I guess that would be sort-of-OK if Harbin really needed the money. But Harbin claim to have had almost 100 million of cash sitting on the balance sheet the whole time that they borrowed 15 million from Abax.

This is very perplexing. Harbin borrowed from an undisclosed related party at a high interest rate whilst sitting on lots of cash.

And Harbin disclosed the fact that it was a related party 216 days after management were informed of the conflict.  And they did not disclose it in the 10K.

But it is now disclosed. And we know that that makes it alright then.


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The content contained in this blog represents the opinions of Mr. Hempton. You should assume Mr. Hempton and his affiliates have positions in the securities discussed in this blog, and such beneficial ownership can create a conflict of interest regarding the objectivity of this blog. Statements in the blog are not guarantees of future performance and are subject to certain risks, uncertainties and other factors. Certain information in this blog concerning economic trends and performance is based on or derived from information provided by third-party sources. Mr. Hempton does not guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. Such information may change after it is posted and Mr. Hempton is not obligated to, and may not, update it. The commentary in this blog in no way constitutes a solicitation of business, an offer of a security or a solicitation to purchase a security, or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author. In particular this blog is not directed for investment purposes at US Persons.