SunEdison: An Autopsy - Bezek's Daily Briefing

| About: SunEdison, Inc. (SUNEQ)


Stocks slid Tuesday as pressures mount.

What went wrong at SunEdison?

We discuss the broad lessons to take away from the failure.

Markets trembled on Tuesday. The day ahead of what is likely to be an eventful Fed minutes release, US markets all dropped pretty strongly. The Dow (NYSEARCA:DIA) was least affected on a percentage basis, but it still shed 133 points. The Nasdaq (NASDAQ:QQQ) and S&P 500 (NYSEARCA:SPY) both dropped 1%.

Oil didn't appear to be the culprit, as crude (NYSEARCA:USO) was actually higher on the day. Oil ended the pit session at 2:30 ET with a large unexplained jump. Then the API inventory numbers came out and juiced oil further. Perhaps inside info leaked. Regardless, after a long unrelenting selloff, oil bulls can finally enjoy a day of relief.

The selloff was broad. Healthcare was the only sector that bucked the trend in any meaningful way. From technology to financials, it was a pretty red affair. If I had to pin the selloff to any one thing, it would probably be European concerns.

European stocks sold off sharply, and there seems to be a general level of rising concern. Perhaps the best risk barometer there - Deutsche Bank (NYSE:DB) - is getting pounded:

DB Chart

DB data by YCharts

It's fair to say that things could get ugly in a hurry if that February low doesn't hold. Initially, the take on Brexit was that the UK might hurt itself but it wouldn't have much broader impact. Now people are reconsidering.

The initial trade - long Euro (NYSEARCA:FXE), short British Pound (NYSEARCA:FXB) - was logical. But on further reflection, some traders are taking the further step of reducing overall European exposure rather than just hedging off England. Needless to say, the UK leaving could trigger a number of similar actions from similarly Euro-skeptic member states. As US investors, this may not seem like a big deal. However, given the generally weak state of much of Europe's banking system, any widespread political risk will almost certainly cause financial consequences.

One final note before we get to today's main event. The Briefing has been Brazil (NYSEARCA:EWZ) focused lately, so I'm trying to avoid the subject. That said, Tuesday's court decision that the nation's VP must also face impeachment proceedings is a dark turn.

The VP's party had split from Rousseff and was preparing to assume power. That's seemingly off the table now. The danger of impeaching Rousseff just went up greatly, as the country now faces a power vacuum right as the Olympics arrive. There's a good chance Rousseff will survive until the summer if this decision holds, which will be strongly negative for Brazilian equities.

SunEdison: What Went Wrong? What Can We Do In The Future?

It's easy in the day-to-day investing grind to lose track of the bigger picture. When I first started closely watching the markets, Enron was in the news very frequently, as its financial condition progressively weakened and then it eventually blew up.

It wasn't until 2008, when watching the financial system of Enron itself, that the broader impact of that catastrophe revealed itself to me.

We're going to get a bunch of scintillating business books about the collapse of SunEdison (NYSE:SUNE). It's one of those larger-than-life happenings. Along with Valeant, if a bear market starts soon, those two companies will be held up as examples of everything that went wrong as a result of cheap money and excessive financialization of the economy. But while the definitive book or case study hasn't yet been written on SunEdison, we can get a good early take.

SunEdison's faults can be boiled down to at least three. While there are many specifics to SunEdison, many of the broader themes are timeless.

The first is that SunEdison was an incredibly leveraged roll-up. A roll-up is a company that relies on serial acquisitions to keep growth going and propel earnings and share price momentum. SunEdison incredibly went from less than $500 million in debt in 2009 to more than $10 billion today:

Click to enlarge

Incredibly, the company failed to show any consistent revenue growth despite leveraging the balance sheet to the hilt:

The company was so keen on growing its footprint that it entered in many marginal or outright uneconomic deals, and as such was forced into increasingly difficult financing situations to keep the structure alive.

In fact, it's fair to question how much of the business model was actually economic at all. As you can see, ever since the company started going crazy with the debt acquisition binge, SunEdison basically didn't produce any EBITDA (data from gurufocus, in millions):

Click to enlarge

2012 was the last year it produced meaningful EBITDA. While leverage and "growth" are sexy, you can see the business was actually far more consistently economic prior to the huge leveraging that began in 2009.

Since 2011, the company never once generated positive cash flow from operations, let alone free cash flow or earnings. Free cash flow ran at a clip of -$1 billion or worse four of the past five years. And unlike most roll-ups, SunEdison wasn't able to issue stock to fund this gigantic spending spree; most of this was funded with pure debt. To the extent the company issued paper, it was by spinning off its yieldcos, which is a much messier fundraising route than simply selling more of your own paper.

To be clear, yes, there are ways to run businesses that are unprofitable on both an EPS and EBITDA basis. If you have assets where depreciation is accelerated on the balance sheet compared to the rate at which they actually deteriorate, you can arbitrage. This is the idea behind many pipeline companies. But as Kinder Morgan (NYSE:KMI) demonstrated last year, even that model is no sure thing.

SunEdison appears to have been running a growth pyramid. Since the assets weren't producing much if any economic profit, it had to keep growing to maintain investor confidence. Once it couldn't do more deals, the structure collapsed. The Vivint (NYSE:VSLR) deal seemed crazy at the time, since Vivint came public as a seemingly ridiculous company with little chance of ever returning capital to shareholders. Take this article from back in 2014 that assigned a $0.60 price target to Vivint and has been dead right thus far.

But, put in a hard place, SunEdison bet the company on being able to make one more huge deal. When that deal went down, it was lights out.

SunEdison suffered from tremendous hubris and/or a delusional business plan, depending on how you looked at it. The company's strategy appeared to be to collect as many marginally profitable assets as possible, and then hope some combination of subsidies, renewable energy mandates, and high prices for fossil fuels would make its hodgepodge of stuff it acquired work. SunEdison blew through a stunning $1.5 billion in subsidies and loan guarantees.

At the time that SunEdison started investing heavily in India - a graveyard for foreign utilities - I figured it might go and Enron itself. Enron, of course, was a pioneer in wasting billions of dollars on Indian white elephants.

If you go back and read articles on SunEdison from last year, when the stock price was still in the 20s, it was long on allegory and short on numbers. Green energy is a great concept, and a popular one. Everyone loves it; at least until their expensive electric bill arrives.

But these bullish articles did little to work through the challenging economics or the incredibly arcane structure of the various SunEdison yieldcos and merger deals. Is it any surprise that SunEdison allegedly stole from its yieldcos? The structures were so complex and opaque - again like Enron - that only a professional accountant could hope to fully understand it.

They also failed to account for the collapse in the price of oil. Like in the 1970s, low oil and natural gas (NYSEARCA:UNG) prices are still poison to the alternative energy sector. Yet, through mid-2015, SunEdison shareholders fully avoided acknowledging the renewed fossil fuel competition.

As a shareholder, you need to make sure you understand the math of how your investment works. If your business doesn't make positive earnings, that can be okay, but then you need to be extra careful. If there's consistently negative EBITDA and negative operating cash flow as well, be even more concerned.

If everything had broken properly for SunEdison, perhaps it could have kept the pyramid growth stage going long enough to get to a point where its assets produced enough cash to service the debt. With low enough interest rates, many things are possible.

It's difficult to tell, but maybe it would have worked. The $10 billion equity value last year was harder to explain - I was short the stock during much of 2015 due to the obscene valuation. In talking to bulls, I was frequently surprised by how confident they were in the company, despite having so little fundamental understanding of the business' economics.

In looking at future hot story growth companies, look for the same telltale signs; long histories of questionable acquisitions, failure to convert a bigger asset base into earnings or EBITDA, a confident and "visionary" CEO who shows little ability in managing detailed day-to-day things, huge investments in questionable overseas markets where other peer companies have spectacularly flamed out in the past, and so on.

As for SunEdison, the stock is worthless. If you still own shares, sell for whatever salvage value you can still get. As for TerraForm (NASDAQ:TERP), there's a good chance there's value there. If it manages to avoid any responsibility for shared expenses with SunEdison due to poorly-written contracts, the stock could be worth $16-20. It's not a risk I want to run, but I can see the appeal.

If you're a subscriber to my service or SA Pro, please see my article on Abengoa (NASDAQ:ABGB), a Spanish solar firm that blew up in similar fashion. As was the case there, the parent company has little value, while there's a decent chance the yieldco - in that case - Abengoa Yield (NASDAQ:ABY), will maintain its value. Since the article, Abengoa is down substantially, but the yieldco has posted gains.

And finally, I reiterate my call to avoid the whole solar industry unless you really know what you're doing. With oil, coal, and natural gas all this cheap, solar power is in a very disadvantaged place generally. Yes, there are specific cases where it works, but in general, it's uneconomic, and investing in it will bring you more headaches than it's worth.

Disclosure: I am/we are short EWZ.

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.

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