Sun Edison: Read Through From Solar City Earnings Release Conference Call

| About: SunEdison, Inc. (SUNEQ)

Summary

Solar City is actively marketing the equity cash flows of owned residential and commercial solar assets but has not completed a transaction to date.

Solar City has received interest from multiple parties on the equity cash flows but declined to provide a timeline to complete a deal.

Based on Solar City comments, Sun Edison may find it challenging to find a buyer for the Vivint Solar Assets prior to the February 26th Vivint shareholder vote.

Without a Portfolio Assets purchase by TERP or a third party, Sun Edison would become insolvent if it closed the VSLR acquisition.

Latin American Power Fund won a temporary restraining order against Sun Edison in New York Supreme Court.

Solar City (NASDAQ:SCTY) released its 4Q and year end 2015 earnings after the market close on Tuesday February 9th. SCTY missed its installation forecast for Q4, lowered its forecast for Q1 2016, and appeared to lower its estimates of the net retained value of cash flows for its existing residential solar systems. The reaction in aftermarket trading was severe with the stock trading down more than 30%. The purpose of this article is to discuss the implications or the "read through" of SCTY's financial performance and Conference Call comments for Sun Edison (NYSE:SUNE) as it struggles to complete the Vivint Solar (NYSE:VSLR) acquisition. I will also make a few observations about SCTY's valuation and future prospects at the end of the article.

In a previous article, I detailed SUNE's potential sources and uses of cash if TerraForm Power (NASDAQ:TERP) is enjoined by the Delaware Chancery Court from purchasing the 470 MW VSLR portfolio of operating residential solar assets ("Portfolio Assets") as contemplated under the "Purchase Agreement" between SUNE and TERP ("Appaloosa Case"). As detailed in that article, if SUNE is unable to find a third party purchaser for the Portfolio Assets, it will likely need to use as much as $249 million in cash on hand to fund the costs of the VSLR acquisition. To put that in perspective, the very costly second lien financing announced in early January raised $607 million net of transaction fees and Original Issue Discount. 41% of the second lien proceeds would therefore be necessary to acquire a company that would not generate any economic value for SUNE shareholders and would likely consume additional capital during 2016, not a pretty prospect for an already capital constrained entity.

SCTY has also been actively marketing the equity cash flows of its commercial and residential solar assets in order to harvest and reinvest the capital back into the development arm of the business and is therefore likely negotiating with some of the same investors as SUNE. There are two likely groups of investors for these types of assets: 1) institutional investors such as insurance companies and retirement funds seeking high quality, credit worthy assets that they can use to match fund a portfolio of liabilities with similar cash flow characteristics or 2) private equity and strategic investors who would be motivated by potential equity returns or attractive expansions opportunities. SCTY is most likely dealing with institutional investors while SUNE is likely speaking with all potential investors.

SCTY management spoke several times about its effort to sell the equity cash flows during the earnings conference call. Quoting from conference call transcripts is always tricky due to transcription errors and the failure to capture the intonation of the speaker so I would encourage each reader to listen to the comments and judge for themselves. The following are the most pertinent quotes from Tanguy Serra, CFO.

"...Then what we do is, we take the assets out of those aggregation facilities and either secure tie (sic, should read securitize) these assets or what we are doing right now, as we disclosed in the Analyst Day, is monetizing full value of these cash flows. These are the two things we are working on.

Obviously, the SEC won't allow me talk about securitizations so we are not going to talk about it on this call. But the cash equity, we are positively surprised by the appetite in the market and I think there's been some press releases and research reports written about this asset class being generating significant appetite for not only us but for a number of solar players. As we received multiple churn (sic, should read term) sheets on that basis - that is a series of investors that are reasonably independent from day-to-day market movements."

"...And the appetite that we are seeing in this market is for a diversified pool of assets, which includes a mix of states, totally typical of our portfolio, a mix of commercial, totally typical of our portfolio, and there's a real appetite for that exposure."

His response to an analyst query as to the timing of a potential sale of equity cash flows is as follows:

"...you know how it is, which is when you're figuring out a new form of monetization here. The last thing you want to put on is time and pressure. That is not good for anyone. So right now, these asset are in aggregation facilities that have long term maturities.

So from critic (sic, should read credit) perspective there is not massive pressure to release these assets from there. As and when we like pricing, we negotiate terms that we like and this is going to be a landmark deal for the industry, not just for us. We won't let that happen.

Again, I really don't want to put any time and pressure on the company by announcing something here. We received term sheets. We like what we are seeing."

My interpretation of these comments is mostly subjective and another individual listening to the same comments can reasonably reach different conclusions. When viewed through the prism of longer-term implications for the financing of the residential solar industry, the comments were generally positive.

  • Investors are interested in looking at asset pools with good credit and high quality cash flows and at least a few term sheets have been submitted.
  • The asset pools will need to include commercial assets but the percentage mix of retail and commercial assets that will be needed to complete the first deal is unclear.
  • SCTY is negotiating with potential investors but has yet to achieve pricing and terms that it finds acceptable relative to other finance alternatives. The process is going slowly.

The short-term implications for SUNE as it tries to close a third party Portfolio Assets sale on or shortly after February 26th, the date of the VSLR shareholder vote, are not encouraging. SCTY has been marketing its equity cash flow for about the same time SUNE has been marketing the Portfolio Assets and there was nothing in the comments by the CFO that suggested that they are approaching a deal with institutional investors that could be completed during the next couple of months.

SUNE certainly has much higher cost and term thresholds than SCTY since it is severely capital constrained and residential solar will be a minor portion of its business post the VSLR acquisition. It is more concerned about survival than setting a bad financing precedent that it will be burdened with in the future. Still, based on SCTY's comments, SUNE is unlikely to complete a deal with institutional investors before February 26th. Perhaps it can pull a rabbit out of a hat by selling to private equity funds, who may be willing to accept greater risk for greater yield. A purchaser of equity cash flows or even a private equity buyer of the Portfolio Assets, however, would still need SUNE to operate, maintain, and manage the assets in the near-term, if not for the life of the assets in the case of insurance and annuity companies or pension funds. The liquidity and bankruptcy fears surrounding SUNE could be a factor limiting investor interest.

Additional Sources and Uses Analysis

SCTY's conference call comments regarding the sale of its equity cash flows were discouraging with regards to SUNE's own efforts to sell the Portfolio Assets so another look at SUNE's liquidity is warranted. My prior article analyzed SUNE's Sources and Uses to acquire VSLR in the scenario that TERP was enjoined from purchasing the Portfolio Assets. The analysis was based on information provided in the VSLR Definitive Proxy and the January 5th Business Update ("Business Update"). In the table below I use only the information provided in the Quarterly Cash Flow Projection on page 15 of the Business Update with three adjustments to project a QE 3/31/16 Cash Balance.

Sun Edison    
QE 3/31/16 Cash Balance Projection (millions)  
     
Cash Balance 3/31/16   $1,119
Less: Committed Cash   $-
Less: Equity Issuance to VSLR Sellers (1)   $(456)
Less: New VSLR Convertible Bonds (2)   $(350)
Less: Proceeds from Asset Sales (3)   $(64)
     
Adjusted Cash Balance 3/31/16   $249
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  1. Equity Issuance to VSLR Sellers is a non cash item and should not be used to calculate the cash balances. SUNE does not receive any cash in return for issuing these shares. It is part of the merger compensation paid to 313 (the Blackstone investment vehicle) under the Amended Merger Agreement.
  2. New VSLR Convertible Bonds is a non cash item and should not be used to calculate the cash balances. SUNE does not receive any cash in return for issuing these bonds. It is part of the merger compensation paid to 313 (see above footnote).
  3. SUNE does not identify the source of these Asset Sales proceeds but I believe they relate to the $67.2 million net of any payables owed due upon the completion of a JV agreement between the noteholders involved in the first debt to equity swap and 8 Minute Energy for the Mount Signal 2 and Mount Signal 3 solar projects. The parties recently agreed to extend the date to complete this JV agreement so I am skeptical that these amounts will be realized during the first quarter.

Using SUNE's numbers but adjusting for non cash items and items unlikely to be realized leaves a miniscule cash balance of $249 million at Quarter End 3/31/16. This assumes that there are no operational misses or unexpected legal issues such as this. For Q2 2016, SUNE is forecasting that its EBITDA will increase to $314 million but that its "cash delta" will be a negative $187 million (page 15 Business Update). That would leave SUNE with an adjusted cash balance of just $62 million at June 30, 2016, $126 million if the JV agreement on the Mount Signal 2 and 3 projects is completed.

So what does all of this mean? If TERP is enjoined from purchasing the Portfolio Assets and SUNE cannot find a third party acquirer, the ineluctable conclusion is that SUNE does not have the financial capacity to close the acquisition. If VSLR tries to force the close, it would raise thorny issues regarding the enforceability of the Merger Agreement since SUNE management could argue that the act of closing the acquisition would leave it insolvent and adversely impact its existing creditors. When a company is insolvent, the fiduciary obligation of the board of the directors migrates from the equity to the creditors.

Bankruptcy law is clear that a transaction (in this case an acquisition) that is a causal factor in the insolvency and bankruptcy of an entity can be reversed and/or damages can be sought by the bankruptcy estate against the other party. The legal question becomes whether these legal arguments can prevail in a court other than bankruptcy court, i.e. can SUNE refuse to proceed with the acquisition without filing bankruptcy and then prevail in the lawsuit that VSLR would undoubtedly file seeking damages.

SUNE is clearly in a financial straitjacket but Blackstone is also facing a dilemma. Blackstone needs to consider the following:

  • SUNE management and the board of directors have exhibited questionable competency in agreeing to the VSLR acquisition initially and then agreeing to a poor amendment to the initial Purchase Agreement. Despite obvious financial issues SUNE could close the acquisition and then suffer financial collapse shortly afterwards.
  • If SUNE files bankruptcy after the close of the acquisition, VSLR and Blackstone would be legally and financially exposed in the bankruptcy case.
  • VSLR is financially very weak and would need to source additional capital to operate if Blackstone is forced to sue SUNE to close the acquisition. This would require a renegotiation of existing credit agreements or an injection of equity capital that would adversely impact existing stockholders.
  • VSLR is uncompetitive at its current installation costs and additional capital may not increase the economic value of the company.
  • Since VSLR has to cooperate in the marketing of the Portfolio Assets (it still owns the Portfolio Assets until the close), Blackstone knows the status of the process and possible market value of the existing Portfolio Assets. It may not want to invest more capital in VSLR based on that knowledge.
  • VSLR's stock price will be hammered if TERP is enjoined and SUNE refuses to close the acquisition or files bankruptcy. It is already trading well below the cash value of the merger compensation.
  • SUNE can abrogate the merger agreement in bankruptcy.

The point of this litany of considerations for Blackstone is to illustrate that they are not in an impregnable contractual and financial position. The situation is fraught with risk for them as well as SUNE and next steps are difficult to predict for all parties. So here is a recommendation. It is one possibility and certainly not the only alternative.

Blackstone should allow VSLR and SUNE to terminate the Purchase Agreement. The termination should include the following:

  • VSLR retains as a termination fee the SUNE equity and convertible notes that were to be issued as part of the merger compensation.
  • SUNE and VSLR sign a maintenance and administration agreement for the Portfolio Assets.
  • SUNE receives the portfolio of signed but uninstalled contracts for commercial and residential solar systems and is assigned the undrawn portion of existing tax equity partnership agreements. SUNE is allowed to hire certain individuals from VSLR.
  • VSLR retains ownership of the Portfolio Assets and sells them to a third party. VSLR liquidates upon the sale of the Portfolio Assets and distributes the cash proceeds along with the SUNE common stock and convertible debt to its current shareholders.

Various benefits would be realized by the parties:

  • All parties would avoid the time and cost of protracted litigation.
  • SUNE's cash flow projections would improve and liquidity uncertainties would subside.
  • VSLR shareholders would retain the upside of any improvement in SUNE's credit profile (through the price recovery of the convertible notes, not the value of the underlying stock) and stock price (through the common).
  • Since the cost of origination of the signed but uninstalled contracts has already been incurred, SUNE should be able to realize positive cash flow from the completion and commercial operation of these assets.
  • SUNE, through the VSLR hires, the uninstalled contracts and the assigned tax equity partnerships, would have the elements that it desires to expand into the residential solar business.
  • VSLR would have the maintenance and administration agreement needed to facilitate the sale of the Portfolio Assets and liquidate subsequently.

The following table calculates the cash balance at 3/31/16 assuming that the VSLR acquisition does not close. There is clearly sufficient cash for SUNE to survive into the second half of 2016, when it is projecting positive cash flow.

Cash Balance 3/31/16 (Millions) $1,119
Plus: Vivint Acquisition $1,058
Less: Committed Cash   $-
Less: Equity Issuance to VSLR Sellers (1)   $(456)
Less: New VSLR Convertible Bonds (2)   $(350)
Less: Proceeds from Asset Sales (3)   $(64)
Less: Vivint Term Loan   $(258)
Less: Vivint Blackstone Loan   $(244)
     
Adjusted Cash Balance   $805
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Conclusion: There are too many risks and unknowns associated with owning SUNE common stock. As events unfold over the next several weeks, SUNE could continue to experience stock price volatility. Longer-term, SUNE could potentially be a very attractive investment assuming it survives this liquidity crisis. For now however, I consider the stock uninvestable except for individuals with extremely high risk thresholds.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in SUNE over the next 72 hours.

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.