Total Group Picks SunPower: A Watershed Solar Deal With More Upside

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 |  Includes: SPWR, TOT
by: Dr. Duru

Perhaps it is not a good idea to use the term “watershed” twice in a year when referring to solar stocks, but it seems to me that Total Group’s (NYSE:TOT) acquisition of a 60% controlling stake in SunPower Corporation (SPWRA) will shine a spotlight on the values available in the solar sector. If nothing else, it could help direct some attention away from a potential slowdown in the second half of the year to the longer-term, upside potential in solar.

On the flip side, this deal caught me flat-footed. When I wrote about SunPower’s breakout in February, I had a long position in play ahead of an earnings announcement that I concluded held high upside potential. When SunPower delivered, I took profits (as usual, I reported the trade in twitter using the #120trade hashtag)…anticipating a pullback from such a sharp move. The stock did indeed come back down, but I failed to reload even as the stock floated near support at the 200-day moving average (DMA). It was neglect on my part, not a lack of interest! Fortunately, Total Group and SunPower structured a a deal that leaves some common shares available to the market. This will allow traders and investors to continue to participate in the remaining upside potential that both companies see in the business.

SunPower gets an instant 35% premium with more future upside potential

Click to enlarge:

SunPower gets an instant 35% premium with more future upside potential

*Chart created using TeleChart

I decided to listen to SunPower’s conference call announcing and explaining this deal because I wanted to learn more about the history, background, rationale, and benefits of the deal. I was not disappointed. For example, I learned that Total Group has been considering doing a deal in solar for about two years. Over that span of time, the company reviewed around 200 solar firms. It is thus very significant and promising for SunPower that it was picked after such extensive due diligence. (SunPower will also provide additional detail in the tender documents it will file with the SEC within 10 days).

The first thing I noted in the presentation is that SunPower included its outlook for the first quarter although this information was not provided in the press release announcing the deal. The numbers are consistent with the lackluster performance solar companies have reported so far in the current earnings cycle. Like LDK Solar (NYSE:LDK), SunPower has pushed out revenues from the first quarter into future quarters:

  • Q1 2011 Revenues expected to be approximately $450 million (during conference call discussion, management indicated the prior guidance was $475-525M)

  • Italian project revenues shifted into Q2/Q3; awaiting final decree

  • Q1 Non-GAAP EPS estimated to be in line with previous guidance of $0.15 – $0.21 per share; closer to $0.15 end of range (GAAP EPS will be in-line according to conference call discussion)

While this pre-announcement could not over-ride the larger news, it is one more sign that solar companies experienced somewhat disappointing results in the first quarter. (ReneSola (NYSE:SOL) reported soft results earlier – the second straight quarter of disappointing performance). The pressure to perform in the next quarter or two will be high now.

I have summarized below my notes from the conference call. I have included some commentary as well. I did my best to record the names of analysts and their respective firms but could not catch them all.

Notes from the conference call:

Management intro and discussion

  • SunPower evaluated the deal for a year.

  • Total has been seeking a partner for a few years (later refined to “two years).

  • Deal will make available up to $400M cash on the balance sheet, releases $400M in restricted cash.

  • They have been discussing doing large-scale investments.

  • Total is the 5th largest oil and gas company in the world and is committed to becoming a worldwide leader in renewable energy.

  • The tender could be extended to allow time for American or European regulatory clearance.

  • Total has agreed to increase sub-limits based on needs of the company – financial support will help build out utility-scale business

Question and Answer

Jesse Pushel(?), Jeffries
Q: Will additional liquidity allow SunPower to accelerate project pipeline?
A: [The] immediate impact is that covenants on letters of credit will free up cash. Intend on putting it to work on large-scale commercial projects. Positive for the AEO (?) relationship.
Will accelerate cost-reduction plans.
Allows SunPower to build faster; does not need short-term project financing. Allows company to be more opportunistic.

Q: Did Total look at thin film companies as well and was higher efficiency part of the decision?
A: Total spent 2 years looking at almost 200 companies, included thin film companies.
Total’s requirements: High-efficiency, vertical integration, low-cost manufacturing, cost roadmap that is credible and gets to commercial electricity parity on Total’s horizon of interest.
Me: I think the motivation behind this question was to determine whether First Solar (NASDAQ:FSLR) could be in play for an acquisition, OR to see whether some serious competition could be waiting in the wings through an acquisition of a smaller player.

Michael Horowitz, Robert Baird
Q: You made my afternoon. Does this [deal] change the way you view volume mix between commercial and UPP (Utility and Power Plants), and do you go upstream?
A: Broadly speaking, we are in a position to be more aggressive. Total is interested in vertical integration and the company likes the downstream footprint. The company likes being vertically integrated. We have no specifics yet on how to deploy capital to get to vertical integration.

Rob Stone, Rowen and Company(?)
Q: Question on the strategic rationale on just 60% and to keep the stock as a currency. Why not acquire all of SunPower?
A: It shows the homework Total has done for a couple of years. Total likes the entrepreneurial pace of SunPower, like Silicon Valley headquarters, and the worldwide footprint. Total want to accelerate that. Total wants SunPower to be even more successful with those attributes. The company wants a structure to allow fast, nimble entrepreneurial decision-making, at the same time capitalizing on [a] top 20 in the world balance sheet.
The structure is very similar to our relationship with Cypress semiconductor that was very successful. Nimble and quick and innovative and yet have scale.
Me: This sounded like a long-winded and obtuse way of saying that the equity upside of a mature, integrated oil & gas company with a $144B market cap is much more limited than that of a solar company with a $1.5B market cap (pre-deal). The growth rates in solar are higher than oil & gas. If SunPower were fully acquired, the stock option component of compensation would be a lot less attractive, potentially making it more difficult to attract the kinds of entrepreneurs SunPower still needs to drive its business to the next level.

Q: Back to the utility scale business – having deeper pockets now and the potential now to leverage capacity with concentrator technology, do you see acquiring additional project assets or development pipeline as a key part of the strategy going forward?
A: This power UPP business is a strategic push for the company. Let’s not underestimate the position where concentrator technology works particularly well.
One of the big synergies is that Total is in the project business. They [sic] understand it well and understand strategic value. They have presence in over 130 countries. Synergy with project development, pipeline acquisition, expand concentrator system in parts of the world where Total is present.
We will be disciplined.

Kelly Dacquiri(?), Maquarie
Q: Can you tell us some of the key valuation metrics Total used?
A: Total is very much in this for the long-term – 5-10 years, decades. The CEO has commented on clean energy as [a] key part of the mix. Of course, 40% of the stock will continue to trade so the market can judge as well.
Total certainly used discounted cash flow (DCF) value given the global footprint, long-term perspective on where solar power is headed. [It] has more to do with how can Total help SunPower grow faster in markets where we are not yet in.

Q: Help us think about the magnitude of the acceleration, so we can get our head around what went into the valuation.
A: At some point we should let Total speak for themselves. When you think of accelerating, it will not be instantaneous. It will be well-thought out. Primarily 2012 and beyond for acceleration: Capacity, cost, and markets. The ability to use the concentrator product in a worldwide footprint of markets has real upside.

Q: Seems more focus on UPP business, understandably. Any change on owning the projects yourself?
A: Basically, no. Commercial business is doing great and is expanding very rapidly. We can deploy capital in that business. European feed-in tariffs are moving to commercial and residential business. Doing a great job offering value in that market. This is not just a UPP play, but a company play.

Working on some financing structures in the commercial and residential markets where the financial institutions are looking at the credit worthiness of SunPower. Now with our affiliation with an AA- rated company, that is only going to enhance our ability to get more financing for the commercial and residential market.

Steven Chen, UBS
Q: How did the partnership come about? Were you considering any other financial partners in addition to Total in this strategic relationship?
A: A year ago we presented at a conference and Total had a bank contact us, mid-stream in their two year process. SunPower over the course of the last year spent time considering the future with plans of installing 10GW of power over the next five years and thought about how best to accomplish and finance that. That included capability and balance sheet. We did an extensive search of all possible viable options. Total came back a clear winner both strategically and financially. Once tender documents are filed with the SEC in the next 10 days, we will provide extensive detail on these activities.

Q: You mentioned conditions that need to be met to purchase additional shares. Do those conditions mean some sort of revenue targets or customer wins or cost/watt targets?
A: No. Customary closing conditions and standards.

John Hardy, ? Company
Q: I was wondering whether you could talk about the sensitivity on UPP operating margins without having to pay that high cost of construction financing and some longer-term financing capital. Do you know anything about Total tax(?) appetite in the U.S. And if you do, how do you think that will help speed up that development timeline.
A: We will be working closely with Total’s project finance team and other institutions that we don’t have relationships with now. [We] may decide to fund smaller projects off the balance sheet.
Tax(?) appetite: Several different operations in the U.S. and that is not something they have explored yet but on the list to talk about.

Sean Kumar, Jeffries?
Q: Do you currently have any projects you are working on with Total?
A: Several opportunities in very early stages. Long-winded yes. Some clear complementary opportunities. Very hard to predict.

Q: Can you provide some color on Total’s poly business?
A: Total has a 25% interest in a company that just started production in poly. Very interesting. Have a couple of strong partners that they will continue to do business with.
Entity is in Pennsylvania. Called APP.

{END OF CONFERENCE CALL}

(Click here for archived commentary on SunPower)

Be careful out there!

Disclosure: I am long LDK, FSLR.