Like most other solar stocks LDK Solar (NYSE:LDK) shares have dropped over concerns on pricing pressures in the solar industry. These fears have sent investors fleeing and shorts have piled on to create some deep values in these stocks. LDK shares now trade at a fraction of the book value which is about $9.40 per share. LDK also has nearly $4 per share in cash on the balance sheet.
This company trades for a ridiculously low P/E ratio of about 2.5 times earnings. The bargain valuation has not gone unnoticed by management, and recently they authorized the company to buy back $110 million worth of LDK stock. Based on a market cap which is just under $1 billion, this would repurchase about 10% of the outstanding shares at current prices, and more importantly it would buy about 30% of the float.
The CEO said:
We believe our ADSs (American Depository Shares) are currently grossly undervalued. We believe our share buyback program not only represents a good investment for our company, but also demonstrates our commitment to enhance shareholder value.
You can read about the share repurchase plan here. This probably won't be the last action from the CEO who calls the shares "grossly undervalued", and he has many options before him.
This could be just one of the first steps management plans to take in response to the current bargain level valuation of this stock. When you evaluate any stock investment, it must usually be judged primarily by the earnings yield. A stock trading at a P/E ratio of 20 has an earnings yield of 5%, a stock trading at a P/E ratio of about 2.5 has an earnings yield of about 40%.
When a company like LDK has this type of earnings yield (very high), it no longer makes sense to remain publicly traded, usually because it is worth more as a private company or it is worth more to private equity or an acquiring company as a takeover target. There are very few investments yielding 40% returns annually and chances are some event will take place to capitalize on this. If the shares remain at these low levels for much longer, there are a few options that management is likely to take in the near future.
One very important fact that some shorts and analysts appear to be missing on LDK Solar, is that it appears to be backstopped by none other than the Chinese Government, similar to how the US Government has backstopped certain industries and companies. This type of backstop just about guarantees access to financing, contracts, government subsidies, etc. No other solar company in China appears to have this backstop.
The China Development Bank is basically an arm of the Chinese Government and it has invested multi-millions of dollars in LDK and given it a multi-billion line of credit. According to this statement, China Development Bank (CDB):
Is one of the three policy banks of the PRC (People's Republic of China), primarily responsible for raising funding for large infrastructure projects, including most of the funding for the Three Gorges Dam and Shanghai Pudong International Airport. The bank was established by the Policy Banks Law of 1994. Debts issued by CDB are fully guaranteed by the central government of the People's Republic of China. CDB is one of the biggest issuers of bonds in the PRC.
Read that quote here.
Here are just a few scenarios which either on their own or by combining them, could spark a major rally in LDK shares and easily cause them to double:
- Management makes a concentrated purchase of LDK shares and sparks a major short squeeze. There are about 35 million shares short and if management used even a portion of the $110 million authorized to buy shares within a few days it would likely spark major short covering rally due to fears that the stock could continue higher. A major buying program would leave shorts guessing as to how high the stock could surge and cause them to rush for cover, sending the shares even higher.
- LDK has discussed the possibility of spinning off their polysilicon division in an initial public offering (IPO) on the Hong Kong Stock Exchange sometime this year. This event would transform LDK's balance sheet and stock price as it will raise an estimated $1.3 billion. Amazingly, the IPO of just the poly division is projected to be worth more than LDK's current market capitalization which is under $1 billion. You can read about this IPO plan here. An analyst at Needham said: "The company is also likely to spin off its polysilicon business through an initial public offering, which will unlock hidden value in the stock..." That analyst also said that LDK margins are better protected compared to other companies. You can read both of these comments here.
- LDK could announce plans to go private. When valuations do not justify the expense and legal risks of being a public company, many companies choose to go private. LDK has access to a massive line of credit in the amount of nearly $9 billion. You can read about that here. Since LDK has a market capitalization of less than $1 billion, it could use just part of the credit line (or other financing from the bank) to initiate an offer for the shares not already owned by the founder who already owns about half the company.
- LDK could announce a plan to list their stock on the Hong Kong stock exchange. In Hong Kong, Chinese companies are valued at much higher levels, often at 12 to 15 times earnings or more. With US markets valuing China based companies at record low valuations, it makes much more sense to list companies where stocks are fairly valued. There is little doubt that LDK shares would achieve a much higher valuation in Hong Kong. Even if they jumped to $12 per share, they would still be trading for only about 5 times earnings. Read more about signs that may indicate LDK Solar could be planning to list in Hong Kong here.
- The China Development Bank recently invested $240 million in LDK Solar. Also, note in the same article, the analyst at Trefis puts a $12 price target on LDK shares. This is significant because it implies Chinese government support for the solar industry and in particular for LDK Solar. It also could mean that CDB could (in addition to investing directly in LDK) provide bond financing that would basically be backed by the People's Republic of China. The Chinese Government has set clear goals to lead the world in solar power and other green industries, and this investment clearly shows government support for LDK Solar. If LDK and the China Development Bank were to announce a larger investment into LDK at a premium to the current price, this would also cause the stock to rise substantially. If I was the founder of LDK and the CEO of the China Development Bank, I would offer LDK shareholders in the USA a nice premium, take the company private and then in a year or so, float the company on the Hong Kong Exchange for three or four times the current valuation. This transaction could make billions for the founder, and the bank.
I am confident that at least one of these scenarios will play out in the next few months if LDK shares stay at bargain levels, and ultimately when it does, the shares will trade much higher.
Disclosure: I am long LDK.