This is the fifth in a series of articles regarding the acquisition of Vivint Solar (NYSE:VSLR) by SunEdison (NYSE:SUNE) and it will focus on the potential financial impact on VSLR, SUNE and Blackstone of a theoretical termination of the Merger Agreement. This article is best read in conjunction with the prior two articles:
- SunEdison: Read Through From Solar City's Earnings Release Conference Call
- SunEdison: Valuation of the Vivint Solar Residential Portfolio Assets
The first article provides the background necessary to understand why VSLR and Blackstone may be best served negotiating a termination of the Merger Agreement if the Delaware Chancery Court, which will hear the Appaloosa Case on February 16th, enjoins TerraForm Power (NASDAQ:TERP) from closing on the acquisition of the Vivint Solar Portfolio Assets from SUNE. In summary, "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." The second article provides an estimation of the value of the Portfolio Assets that will be key to the court's decision in the Appaloosa Case and to any potential termination of the Merger Agreement.
At the close of the first article cited above, I made a termination proposal (discussed further below). It is one possible termination proposal and is certainly not the only alternative. It is designed merely to illustrate that a negotiated settlement that benefits all parties is possible, even at this late juncture. Benefit, within the context of this rapidly deteriorating situation, is a very relative term however. Blackstone and VSLR will never realize even half of the reduced financial terms of the Amended Merger Agreement because of the weakened financial condition of SUNE and the question is whether all three management teams, amidst the fog of war, will have the calm and competence to salvage the limited financial benefits that do remain available to them.
The irony of Blackstone out-negotiating and forcing such onerous and detrimental terms on SUNE on two separate occasions is that Blackstone is now in grave danger of being saddled with VSLR, a company that is burning cash, in need of a significant capital injection, and likely to remain uncompetitive under the current management if the acquisition by SUNE does not go through or is delayed by a protracted legal struggle in the courts. This reality is reflected in VSLR's closing stock price of $5.45 on Friday, February 12. The disaster that has befallen SUNE due to the Merger Agreement with VSLR speaks for itself.
If Blackstone and VSLR accept that the risks of an insolvency at SUNE resulting from the acquisition of VSLR are too great, then a termination agreement that allows Blackstone to liquidate VSLR through a sale of its assets (it has limited and ever diminishing value as a going concern) and to capture some of the price recovery of SUNE's securities makes sense. The proposal made in the first article cited above was as follows:
- VSLR retains as a termination fee the SUNE equity and convertible notes that were to be issued as part of the original 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."
So what is the financial impact of this type of termination? The table below provides an estimate of the various sources and uses of cash to VSLR in a termination followed by liquidation scenario.
|Sources and Uses of Cash|
|Termination and Liquidation Scenario|
|SUNE Convertible Debt (8% YTM)||$282,252|
|SUNE Common Stock||$63,900|
|VSLR ST Assets||$19,000|
|Working Capital Facility||$120,000|
|VSLR Shares Outstanding||116,400|
|Net Value per VSLR Share||$4.61|
The Net Value per VSLR of $4.61 is below the current stock price but it also only reflects a SUNE stock price recovery to $5. SUNE may need to sweeten the pot with additional bonds and shares of SUNE stock to push the value to the mid $5s but the value is close to what the market is currently discounting. An explanation for each line item in the above valuation table follows.
Portfolio Assets Value: A detailed explanation of the estimation of the value of the Portfolio Assets is provided in the second article cited above. Here is an excerpt of the estimation methodology:
"The valuation of the portfolio assets will equal the discounted value of the equity cash flows and the discounted value of the debt service cash flows. There are three variables in calculating these values: discount rate for the equity cash flows, advance rate for the debt service cash flows, and discount rate for the debt service cash flows. Here are the estimated present values at various discount rates.
|Discount Rate Equity CF||10%||12%||14%|
|Present Value Equity CF||$154.92||$136.39||$121.37|
|Discount Rate Debt Serv CF||5.0%||5.5%||6.0%|
|Advance Rates||PV Debt Service CF|
Recent equity research issued for SCTY and SUNE regarding the sale of portfolios of residential solar assets have discussed unlevered discount rates of 7.5%. Adding the 65% advance rate undiscounted debt service cash flows with the undiscounted equity cash flows from the tables above and using an unlevered discount rate of 7.5% yields a PV of $712.3 million. A worst case scenario in my opinion for the distressed sale of the portfolio assets to a third party would be an equity discount rate of 14%, an advance rate of 65%, and a debt rate of 6%, which would yield a PV for the portfolio assets of approximately $714 million."
Convertible Debt Value: based on the convertible debt that was to be issued as part of the Merger Compensation:
- $350 million face value
- 4 year term
- 2.25% interest, paid semi-annually
- Yield to Maturity of 8%
Although the 8% YTM is well below current YTMs for SUNE convertible debt, the termination of the Merger Agreement should relieve the liquidity and bankruptcy concerns and result in YTMs declining precipitously. The following table provides a sensitivity analysis.
SUNE Common Share Value: The number of SUNE common shares issued as part of the Termination Fee is based Merger Agreement:
- 106 million VSLR shares
- .12 SUNE shares issued per VSLR share for a total of 12.78 million shares
- $5 value per SUNE share
The $5 per SUNE share is significantly above the closing price of Friday, February 12. The first table is a sensitivity analysis based on price.
|SUNE Share Value||51.12||63.9||76.68|
The second table is an estimation of SUNE per share valuation based on the January 2016 Business Update page 6 with adjustments based on SUNE financial constraints. The assumptions in general are conservative, particularly relative to management's projections.
|Estimate of Share Value|
|TERP Stock Value||$771,200|
|GLBL Stock Value||$696,300|
- Services business is $200 million EBITDA estimate times an 8X multiple.
- TERP stock value is equal to 48.2 million shares at $16. This share price estimate is significantly above the current market price. The termination of the merger will relieve balance sheet pressure on TERP, eliminate the negative impact of overpaying for the Portfolio Assets, and resolve the lawsuit. At $16, TERP would trade at an 8.8% yield based on the current dividend rate of $1.40 and would trade below book value.
- TerraForm Global (NASDAQ:GLBL) stock value is equal to 63.3 million shares at $11. At $11, GLBL would trade at a 10% dividend yield based on $1.10 dividend rate. It would also have significant uninvested cash to purchase additional income producing projects.
- Other: per Management estimates
- Solar Backlog: 40% of management estimates. Reflects the financial constraints of SUNE and likely slower growth
- Wind Backlog: 40% of management estimates. Reflects the financial constraints of SUNE and likely slower growth
- Recourse Debt: per page 7 of the Transaction Summary dated January 7, 2016.
- Preferred Stock: per page 7 of the Transaction Summary dated January 7, 2016.
- SUNE shares outstanding: SunEdison Dilution Overview Presentation
VSLR Short-Term Assets: Per the VSLR 10Q for the quarter ended September 30, 2015. Comprised of Restricted Cash required under the Working Capital Facility and Accounts Receivable
Working Capital Facility: Based on the VSLR 10Q for September 30, 2016, balance of $70 million plus two quarters of $25 million per quarter cash burn.
Aggregation Facility: Based on the VSLR 10Q for September 30, 2016, balance of $183 million plus two quarters of $20 million per quarter drawdowns due to reduced installations.
Short-Term Liabilities: Based on the VSLR 10Q for September 30, 2016, balances of $150 million for payables and accrued expenses
Liquidation Expenses: Based on 2300 employees (per 2014 10K) and $10,000/employee of severance and other costs plus $27 million of costs related to facilities, legal expenses, and administrative expenses to liquidate the company.
Sune remains in a very dangerous position with its future in the hands of the Delaware Chancery Court. If the court enjoins TERP from purchasing the Portfolio Assets, SUNE must negotiate a termination of the VSLR acquisition or face dire financial consequences. SUNE remains uninvestable except for speculators with extreme risk tolerance.
Miscellaneous: At Friday's closing stock price of $1.42, SUNE would need to issue an incremental 62.1 million shares to satisfy the $.75 of fair market value of SUNE shares required under the Amended Merger Agreement. This number will continue to increase if SUNE's price drops further. It represents another 15% of dilution and is another reason that SUNE management needs to hold its nerve and negotiate a termination of the Amended Merger Agreement.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in TERP, GLBL 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.