In Spite Of The Judge's Order, SunEdison May Terminate Vivint Deal

Summary

  • Judge Andre Bouchard's ruling to deny injunction in the Appaloosa lawsuit provides major relief for beleaguered SunEdison shareholders.
  • In spite of this development, termination of the Vivint deal is a vastly superior option to all involved.
  • We look at scenarios which provide an equitable solution to all parties and considerable upside for SunEdison shareholders.

Finally, it happened! Thursday 4PM Eastern Time, Delaware Chancery Judge Andre Bouchard, as we have predicted, ruled that David Tepper's Appaloosa cannot stop TerraForm Power (TERP) from consummating its deal to acquire residential project assets of Vivint Solar (NYSE:VSLR). According to the judge, while Appaloosa raised meaningful concerns about this transaction, it could not prove the deal would cause immediate harm to TerraForm investors.

While we have long argued that the Tepper lawsuit lacked substance, investors were not so sure and have beaten down all the stocks in the SunEdison (SUNE) complex, including TerraForm Power and TerraForm Global (GLBL). For nervous investors, the threat of the Appaloosa litigation felt like Damocles' Sword that would lead to SunEdison's corporate death (i.e. bankruptcy). Short sellers, aided by short side analysts, relished the uncertainty as the prices of the stocks in the SunEdison complex collapsed.

The judge's decision, therefore, comes as a welcome relief to stockholders of all four public companies that suffered from this ordeal. However, as we have discussed in our earlier article on the subject, SunEdison still faces some significant challenges from the proposed Vivint Solar acquisition.

We believe the game has changed substantially since the Vivint deal was renegotiated in December. Several key developments that affect the deal now, compared to December, include:

  1. The residential solar market has tanked further making the Vivint assets even less valuable. Several adverse net metering decisions have come into play causing the size of the market to shrink. Concurrently, the cost of capital and the discount rates used for the assets have gone up.
  2. Due to the changes in the landscape, Vivint's 2016/17 prospects, if they were to be revisited, would be worse than what they were at the time of the revised deal. We find it highly likely that Vivint's annual new system sales peaked in 2015.
  3. Residential solar valuations have plummeted.
  4. SunEdison had an abysmal capital raise, which has substantially impacted the Company's capital structure as well as the Company's ability to raise cash in the future. SunEdison's prospects and cash situation have been hurt by the recent project cancellation setbacks in Hawaii and SunEdison's cash position has become worse due to the restructuring of its polysilicon and wafer operations.
  5. SunEdison's stock has fallen precipitously and the Company's current market cap at $450M, is only a fraction of the value of the revised Vivint deal.

Due to these developments, it no longer makes sense for SunEdison to be proceeding with the Vivint Solar merger based on the current terms. We believe it makes imminent sense for the Vivint deal to be revised and that this deal is currently being renegotiated. We see two possible scenarios from these renegotiations.

  1. The deal will proceed albeit with modified terms: The challenge under this scenario is that neither of the companies have much time to go through major revisions. Especially any changes that affect the public shareholders will cause long delays and are likely to be ruled out. Under this scenario, it would be difficult to change the valuation significantly and most of the changes would have to be in credit terms and how the assets are carried. The negotiating space in this scenario is limited.
  2. The deal will be terminated with substantial concessions from all involved: In this scenario, there is considerable scope to rearrange the deal for an exit. The core of any such transaction would likely include the following terms:
  3. Substantial breakup fees from SunEdison in the form of cash, stock and debt.
  4. Monetization of Vivint's operating assets - possibly in the form of a purchase of TerraForm Power (assuming no injunction).
  5. A lowered price assessment of Vivint's portfolio to better reflect the term sheets that SunEdison may have witnessed in the market.
  6. An option for Vivint to absorb SunEdison's residential and small commercial business so that it can gain scale and reduce per watt operating overhead (or SunEdison may discontinue that business altogether).

While scenario 1 may be theoretically possible, we do not believe it serves the interests of SunEdison shareholders. If this option were to pan out, SunEdison's other operations would suffer since the Company would be thinly stretched. We find it highly likely that SunEdison would have to shutter the Vivint operation in a very short duration after the merger. Furthermore, the dilution in SunEdison's stock to honor the current deal, as it is structured currently, will be unacceptably high and cause the Company problems with future capital raises.

Given these factors, we believe the management will favor scenario "2" above - in other words, move to terminate the deal. A major factor that comes into the calculus for termination is the deal structure. Given the dramatic deterioration in SunEdison's stock price to levels that cannot be justified by any valuation principles, we believe it is unwise for the Company to pay a significant part of the termination costs using stock as consideration.

We believe SunEdison stakeholders will do much better if most of the compensation is paid in cash and debt. Once the deal is terminated or consummated, we believe SunEdison can see a big jump in the stock price. To the extent SunEdison needs cash, floating a secondary post termination would result in a lot less dilution.

However, given the tenuous financial position of Vivint Solar, and its need for capital to continue operations, this deal cannot be terminated unless there is a way to provide financing to Vivint Solar in the near term.

So, how can SunEdison achieve this termination given Vivint's needs?

We believe the answer to this lies mainly with TerraForm Power. One of the effective ways this can happen is if TerraForm Power absorbs Vivint's residential solar portfolio in spite of the deal termination. Even a take-or-pay agreement for assets that Vivint is going to build in the future, assuming they are done at market prices, would not cause much of a downside to TerraForm Power and would help immensely in SunEdison's ability to terminate the transaction. In parallel, any cash that SunEdison can contribute in the form of deal termination fee would be helpful to Vivint to right its ship.

Some will argue that making TerraForm Power take on Vivint Solar's assets is not fair to TerraForm shareholders given that these residential assets are not as valuable as what TerraForm will likely be paying for them. While we violently agree with the assessment that Vivint Solar assets are overvalued per previous deal terms, we note a few things:

  1. SunEdison and TerraForm have jointly committed this hara-kiri of Vivint Solar's transaction. If anything, it appears that prior management of TerraForm was one of the main culprits of the financial engineering that led to the current series of misadventures.
  2. Even though SunEdison and TerraForm likely share the responsibility for this misadventure, the price has been largely paid for by SunEdison stockholders. A little bit of share in the misery for TerraForm shareholders would be apt.
  3. While the Vivint assets will certainly degrade TerraForm's asset quality, the near-term implications for cash flow are positive due to the fact that residential assets have a much higher CAFD/invested$.
  4. To the extent that TerraForm can take on these assets to help seal the deal, the uncertainty surrounding the SunEdison complex will be lessened and as a result the stock prices of all three companies would rise. TerraForm would certainly benefit from a stronger sponsor.
  5. SunEdison can work with TerraForm in the future to get rid of these assets. While TerraForm may take a loss on these assets at that time, it would be doing so from a position of financial strength instead of the current distress situation. There can even be a mechanism for TerraForm to share any losses with SunEdison

It should also be noted that, in negotiations, it is not difficult to find a "shared pain" solution as long as the long-term outcome to the involved parties are favorable. In this context, to the extent that TerraForm finds the near-term pain burdensome, SunEdison could alleviate such pain with longer-term agreements. A fair solution would also reduce Tepper's ire and reduce the threat of ongoing litigation sinking the current deal.

In summary, while the judge ruling is a matter of great relief to shareholders, we believe the real challenge for SunEdison is ahead of it. The best outcome for all parties would be a termination of the deal. Consummating the deal on revised terms would be a distant second best outcome.

The motivation for the parties to negotiate and settle is tremendous in spite of the injunction being denied and we expect a settlement will be reached in a matter of days. We believe management understands the tradeoffs and will work hard to terminate the transaction. Unfortunately, investors have to face continued uncertainty until SunEdison closes or terminates this transaction.

This article was written by

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Author of Beyond The Hype
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Beyond the Hype is different because it is dedicated to cutting through management and Wall Street commentary and providing fresh and insightful perspectives on companies and investments. We see through hype, show the true value of companies, and make investments safer. A lot of views tend to be controversial, against the grain, and remarkably accurate.

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Disclosure: I am/we are long SUNE, TERP, GLBL. 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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