Shares in LDK Solar (LDK) have spiked up to $0.86 in recent days on news that it has raised $23 million at $0.86 a share by issuing new shares to a Chinese investor. The deal looks an odd one and the math for LDK still look very poor indeed. I first advised shorting this stock at $1.38 on August 30th and reiterated that advice on September 19th at $1.25 warning then that shareholders equity will disappear by Christmas. It still will and the spike is another opportunity to go short.
The new investor, which will own 19.9% of LDK is Heng Rui Xin Energy Co. Ltd., a PRC company invested by privately owned and state-owned funds. The shares traded at $0.71 prior to the news. We will come to the reasons why this new investor made the investment later. But does it alter the financial position of LDK greatly? No.
Let us look at the last reported balance sheet which is June 30th. It showed current assets of $2.016 billion however most of that comprised inventories - which in a market in turmoil will be hard to turn into cash - and monies owed by customers who appear to be taking ever longer to pay. Free cash was just $296.2 million with another $523.4 million cash pledged so unusable. Short-term (i.e. repayable within a year) borrowings were $2.431 billion and current liabilities were $4.518 billion. Total liabilities were $5.94 billion and net assets (shareholders funds) were down to just $192 million.
The net loss in the second quarter was $254.3 million or $2 a share versus $185 million or $1.46 a share in Q1. And the business will almost certainly have made a loss in the third quarter. The company admitted when releasing Q2 numbers on September 17th that
"Turning to the third quarter, our outlook remains cautious as we expect to see continued near-term challenges facing our industry. We remain closely focused on managing costs and operating expenses through streamlining manufacturing operations, reducing production costs and improving utilization."
With further major write-downs against property, plant and equipment and also land use rights inevitable as LDK struggles to generate cash and further write-downs against inventories and bad debt provisions also likely, shareholders funds will almost certainly be negative by Christmas, if they are not already. I await third quarter numbers with interest.
When the $23 million is received it will make no material difference to LDK's position. Shareholder Funds will still be negative very soon and unless there is a miracle - or some large scale asset disposals - the free cash balance will also be exhausted. As such shareholders equity is essentially worthless.
So why did HRX make its investment at this stage and why pay a premium to the then prevailing price? The investment looks all the more peculiar given news that came out on 2nd October from LDK New Energy Holding Limited ("LDK New Energy"), the controlling shareholder of LDK Solar which agreed to pledge its stake in LDK Solar (52%) as collateral with its lenders because it, itself, is in default on some of its loans. The lenders have agreed not to sell that stock for 12 months but the fact that the parent company is in trouble hardly helps the case for LDK Solar, the Nasdaq listed offshoot.
HRX is partly owned by the Chinese State. And this is your clue. I have written here before about how part of China's problems, which are causing its economy to crash, is that private banks have been forced to massively increase lending in recent years and some of that lending has been driven into sectors the State determined to be growth sectors. Solar is one of those sectors. Of course this massive capital injection into solar is a major reason why the industry now has so much overcapacity.
The Chinese Government knows that its banks face massive bad debts. LDK Solar is potentially one of them. As such it is now "encouraging" state backed investment funds to keep the show on the road. HRX is as aware as you and I that LDK will be out of cash within months, needs a mammoth refinancing and as such the equity is worthless. But it is following orders.
Assuming that the $23 million arrives LDK will have a market capitalisation of $143 million. At some stage before Christmas shorters will receive an early gift from Santa when the company posts vast losses for the third quarter - I suspect that ignoring (inevitable) asset writedowns and bad debt provisions the number will be c$150 million. The key figure to watch is the net free cash position. I suspect that this will be far lower than the underlying quarterly loss and that all investors can thus reach an inevitable conclusion.
The only question now is how the company's (Chinese) banks respond. They could offer more debt to LDK so throwing bad money after good. They could go for a debt for equity solution. Or they could take it on the chin and call it a day. I suspect they will not be allowed to go for option three but a loss making company, bleeding cash and with debts that can never be repaid and a net asset position that will becoming increasingly negative offers no intrinsic value for shareholders at all.
The shares remain an outstanding short with a target price of 1 cent.