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The Fundamentals

Suntech (NYSE:STP) defaulted on a $541 million convertible note payment due the 15th March 2013. That breached terms of the company's other outstanding loans. As a result, the creditors of Suntech's biggest subsidiary, Wuxi Suntech Power Co., Ltd. ("Wuxi Suntech"), filed a petition of insolvency and restructuring against that particular subsidiary March 20th 2013.

You are probably wondering why the bondholders haven't filed a petition for bankruptcy of Suntech. That's because Suntech signed a forbearance agreement with more than 60% of the convertible note holders on March 11. The company stated the following in the press release announcing the forbearance agreement:

Under the forbearance agreement, in the event the Company does not make payments due under the Notes on March 15, 2013, the signing bondholders agree not to exercise their rights under the Notes and the related indenture until May 15, 2013, subject to certain market-standard early termination events.

That means that the convertible note holders can force Suntech Power Holdings into bankruptcy once the agreement ends on May 15, 2013.

On March 21st 2013 the court accepted the petition for insolvency and restructuring of Wuxi Suntech. The company wrote the following in the press release regarding the court acceptance:

The primary goal is to restructure Wuxi Suntech's debt obligations, while continuing production and operations.

That means that the creditors of Wuxi Suntech aren't interested in liquidation, but a restructuring. A restructuring usually results in creditors getting transformed into equity holders, while the old equity holders get nothing.

An interesting question is how big a proportion of Suntech Power Holdings Wuxi Suntech is. Suntech Power Holdings answered that in its November 2012 bondholder presentation. The following slide is copied from the presentation:

(click to enlarge)

Note what is written under note 2:

The above chart is not a full corporate structure chart of the group. It shows all consolidated entities within the group that had outstanding bank debt and guarantees of bank debt as of August 31, 2012, (ii) their respective parent companies, and (NASDAQ:III) GSF. The above chart does not reflect intra-group payables.

The company highlighted in the bottom of the slide that "$1.4 billion of bank debt at PRC subsidiaries holding vast majority of operating assets". Wuxi Suntech is holding $1,23 billion of debt and is guaranteeing $223 million of bank loans at several subsidiaries and a Joint Venture. One can derive from that Wuxi Suntech holds the vast majority of Suntech Power Holdings Co., Ltd. operating assets.

As Wuxi Suntech is under restructuring, and Suntech Power Holdings is probably is going to lose its equity stake in the company, one has to value the remaining subsidiaries of Suntech Power Holdings in order to determine the intrinsic value of the company.

The following is another slide copied from the November 2012 bondholder presentation:

(click to enlarge)

As you can see in the chart above, Wuxi Suntech held most of the company's cash as of August 31, 2012. I have derived from my calculations that the company has negative equity. You can download the calculation, which is within this research note here.

What is left are:

  • Suntech Power Holdings Co., Ltd. , which had $42.6 million in cash as of August 31, 2012. A default notice on $541 million convertibles notes, $50 million convertible loans, $66.2 million guarantees of bank loans and financial leases at subsidiaries, €493 million loan guarantee to GSF and Downstream guarantee of domestic bank debt
  • Suntech Power (Hong Kong) Co., Ltd., which is based on the British Virgin Islands. The subsidiary had $0.4 million in total cash and cash equivalents as of August 31, 2012
  • Suntech (NASDAQ:CHINA) Investment Co., Ltd., which is based in PRC. The subsidiary had $0.7 million in total cash and cash equivalents as of August 31, 2012
  • Power Solar Systems Pty., Ltd. (Australia) has no cash and has been under liquidation since the company filed its latest 20-F filling. The following is a screenshot from page 56 from the fillings: (click to enlarge)
  • Suntech Power (Cyprus) Co., Ltd. (Cyprus) has no cash, but a "direct or indirect controlling interest" in:
  • "Various US Subsidiaries" which had a total of $6.3 million in cash as of August 31,2012
  • "Various PRC and European Subsidiaries" which had a total of $19.5 million in cash as of August 31,2012
  • Suntech Power Investment PTE., Ltd. (Singapore) has no cash, but a "direct or indirect controlling interest" in:
  • Various PRC subsidiaries, which had a total of $54,9 million in cash, $158.1 million in short-term bank loans and $13 million in long-term bank loans as of August 31,2012
  • Various Asian and Australian subsidiaries, which had a total of $4.5 million in cash as of August 31,2012
  • Suntech Power Japan construction (Japan), which had a total of $18.5 million in cash as of August 31,2012

The companies that will be left after Wuxi Suntech will be restructured are primarily holding companies and sales companies (entities that Suntech uses to make its sales through in different jurisdictions). The remaining subsidiaries can only move their cash up to Suntech Power Holdings Co., Ltd after they have paid their liabilities to its creditors. The default on the $541 million convertible notes also triggered cross-defaults on the companies other outstanding loans. The company stated the following in the press release announcing the default:

Such event of default has also triggered cross-defaults under Suntech's other outstanding debt, including its loans from International Finance Corporation and Chinese domestic lenders.

As the default triggered cross-default on Wuxi Suntech's debt, one could expect that the companies PRC based subsidiaries, with loans from Chinese domestic lenders, will be forced into bankruptcy. The company's remaining PRC based subsidiaries had a total of $171 million of short-term bank debt as of August 31, 2012 and only $54.9 million of cash and cash equivalents as of August 31, 2012.

When the forbearance agreement ends on May 15th 2013, the more than 60% of bondholders who entered into the agreement can initiate legal proceedings that will force Suntech Power Holdings into bankruptcy if the company doesn't pay them. I don't think that it's realistic to assume that the company will pay back its bondholders due to the company's financial condition. If its bondholders force the company into bankruptcy the stock will get delisted from the New York Stock Exchange, and the current shareholders will lose ownership of the company's assets.

The market is valuing the company at a $110.51 million valuation as of May 12, 2013. The trade is obvious.

Disclosure: I first announced I was short STP back in February 2013. I'm still short STP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Suntech: A No-Brainer Short

Additional disclosure: I am short the disclosed stocks by being long put options. Abdalla Al-ayrot is not an investment advisory service, nor a registered investment advisor or broker-dealer and does not purport to tell or suggest which securities customers should buy or sell for themselves. Abdalla Al-ayrot may hold positions in the stocks or industries discussed here. You understand and acknowledge that there is a very high degree of risk involved in trading securities. Abdalla Al-ayrot has no responsibility or liability for your trading and investment results. Factual statements on the Company’s website, or in its publications, are made as of the date stated and are subject to change without notice.