On CNBC’s Fast Money last night we had a discussion on solar stocks following SunEdison’s (SUNE) $2.2 billion deal to buy Vivint Solar (VSLR) for a 50% premium. I think it is important to note that VSLR is expected to have $60 million in sales this year and expected earnings losses for as far as the eye can see. SUNE is also drowning in red ink on the bottom line, sporting double digit sales declines every year since their peak of $3.3 billion in 2011. But all is good in the hood, as SUNE’s stock is up 60% on the year, having made a new 6 year high yesterday on the news, and up 140% from the 52 week lows made last October. The company is saddled with debt of $9.1 billion, nearly equaling its $10 billion market cap, with only $790 million in cash.
Obviously, solar is a future source of a massive portion of the world’s energy. But from where I sit, this sector is already an investment bubble. I am not foolish enough to try to call a top. But last night on the program I got a little heat from my fellow panelists when I said that these stocks will be cut in half at some point. Obviously, I don’t know from exactly where. But given what we are seeing in industrial commodities and the continuing decline in crude oil, I am hard pressed to see continued investor interest amidst these headwinds in a sector that has such poor financial standing.
Last fall I took a look at the latest trend to ‘unlock” value in a money losing solar businesses, “YieldCos”, and stated that this was some good old fashioned bull market financial engineering, from Nov 25th:
Interestingly, the space has garnered some attention lately having little to do with the solar projects themselves. Rather, interest has increased since SUNE’s decision to create two “Yieldcos”, publicly traded entities that essentially strip out cash flow from their most reliable solar projects. Here is a succinct description of the entities and reasons why other players may pursue similar strategies, from RenewableEnergyWorld.com:
Here’s why SunEdison and the rest of the industry is so keen to pursue new finance options. Back in its 3Q13 financial results SunEdison calculated its current business model of building and selling solar projects yields about $0.74/Watt — but those assets’ true value could jump as high as $1.97/W if the company can find ways to enumerate and apply various methods: lower the cost of capital, apply various underwriting assumptions, and factor in residual value in power purchase agreements. That’s a startling 2.6× increase in potential value creation that SunEdison thinks it can unlock, and creating a yieldco structure to attract interest from the broader investor community is a big part of the answer.
In its 4Q results SunEdison puts more numbers to that value-creation equation: in the fourth quarter it captured an additional $158 million by retaining projects vs. simply selling them off. And by applying most of the 127-MW on its balance sheet with an estimated $257 million in “retained value” to this yieldco, the company says it has sufficient scale to unlock the true value of those solar assets.
Is this the equivalent of slicing up tranches of mortgages and repackaging them and selling a more complicated version of the underlying? It’s hard to create something from nothing when all you’re doing is financial repackaging. I’m not totally sure what’s going on here but it is either a very gimmicky financial engineering (at a time when investors were getting worried about the health of the underlying), or it is a way for the companies to take advantage of low rates and high investor demand, and the trend is just getting started.
The current valuations make little sense. And if crude oil were to re-test the lows I suspect solar projects will be less attractive and the stocks will be re-rated.
If you are a true believer and your time horizon is long, then have a ball. I know the 2008 highs for these stocks look like attractive targets. But it’s important to remember that crude oil went to $140 at that time and investor interest in solar was in an all out panic. I am not suggesting to sell your solar stocks in a panic now. I’m merely highlighting the goofy m&a and financial engineering in the space at a time where certain correlations could be signalling an inflection point. If you own any of these stocks just be aware of what’s going on and what point in the cycle it typically signals.