Description

The converts (2.75% due 2021)  at about $0.50 on the dollar seem attractive.

The objective of this write up is to assess the likelihood of the converts being worth less than $0.50.  The focus is mostly quantitative.  Hence, I would like to ask those who are well-informed to point to specific issues with the assumptions, the logic, or the calculations.  Those with a preference for a good story, written in prose, please skip to the next idea.  (Code for: only engage via comments laying out your math or logic, in short form, please.)

There is plenty of background on the name in this forum.  However, given the severe dislocation in market price of the issuer’s securities, the relatively fragmented discussions on the idea’s board, and the benefits of laying out the numbers, I thought it would be helpful to post it as a new idea.  With all this in mind, let the following serve as introduction:

• Solar and wind generation capacity will most likely continue to grow at a rapid pace for the foreseeable future

• At current and expected development costs, solar and wind generation is competitive in a lot of markets (where electricity is US$0.10/kWhr or more):

Unit economics for solar

Rev/yr = 1kW/1000W x 24 hr/d x 365 d/yr x 20% capacity factor x $0.10/kWhr

Rev/yr = $0.18/W

Opex (O&M + g&a)/yr = 0.04/W

Ebitda/yr = $0.14/W

Developed cost = $1.75/W   (Source: SUNE $1.75 in 2016)

Financing: ¼ equity ($0.44), ¾ debt ($1.31); cost of debt 4%

Annual debt service/W = 0.08 (equal yearly payments for 25 years)

CAFD (cash available for distribution) = Ebitda - debt service

CAFD/yr = $0.05/W

CAFD yield = CAFD / equity

CAFD yield = 12%

Capital structure

SUNE x TERP+GLBL and warehouse facilities

Cash at SUNE x TERP+GLBL = 2,393+697+367+265-(636+90+1,109+2+161)

Cash at SUNE x TERP+GLBL = $1,724m

(SUNE owns 62.7m shares of TERP and 63.3m shares of GLBL; but I am not including them in the calculation of net debt because SUNE can’t/won’t sell them in the near future.)

Net debt (inc pfd) = $6,429

*Most of this debt is nonrecourse, however for this analysis its impact is similar to recourse debt.

Note: The Margin loan is secured by TERP shares.  Max L/V is 40%. Due to TERP price, it required additional collateral: 3q15 $152m, Oct'15 +91m (and most likely more in Nov).  It seems to me, the best option is for SUNE to repay the loan (and save on relatively high interest expense).  Obviously this does not change the net debt balance.

Here is the important part: Cash flow analysis

(Note all references to SUNE exclude TERP+GLBL and warehouse facilities)

• SUNE has three available warehouse financing vehicles with an aggregate total (equity + debt) capacity of $6,450m, of which I estimate $5,350 is available

• In 2016 SUNE expects to:

• develop 3500MW (2600 retained and 900 for 3rd parties); I assume the same for 2017 and 2018

• sell for $1.75/W and earn $0.35/W gross profit (cogs 1.40/W); for 2015 1.85/W (and cogs 1.50/W)

• have opex (x d&a) of $600m

• SUNE provides O&M service to 5GW for a net margin of $0.01/W, which I assume is not included in the opex guidance

• SUNE will receive aprox $150m in dividends from TERP+GLBL per year

• SUNE currently owns 2200MW (x TERP+GLBL and warehouses)

Big assumptions/other key factors (for scenario above)

• Soft 3rd party market or closed 3rd party market but new WH availability

• This scenario assumes a soft 3rd party market, which is why the existing warehouses keep 2800MW beyond 2018 (and SUNE never realizes the corresponding $1b gross margin)

• However, it assumes an outlet for 2600MW in each of 2017 and 2018 into a combination of new WHs or 3rd parties

• The likelihood of there being at a minimum a soft 3rd party market and some new WH availability seems high in light of:

• The overall global market trends for wind and solar, and

• Even more favorable project unit economics (i.e. higher returns for 3rd party buyers) going into 2017 and 2018

• SUNE could add a lot of value by buying back its convertible debt at $0.50; but it’s not a defining factor

• Should the 3rd party market absorb the MW dropped into the existing WHs, SUNE would realize gross margin on 3500MW (2800+700 previously dropped at 4 WHs), which could be $1b+

• Assumes VSLR acq is just money wasted; no value generated whatsoever (BTW, good deal at TERP which is buying roof top (with contract escalators) at $1.75/W, which is well below replacement value (e.g.SCTY targets $2.50/W in 2017)

• Biggest assumption is SUNE is able to earn $0.35/W gross profit (20% gross margin)?

• If it is able, then no problem:

• Net debt = $5b

• CashFlow/yr = $600m+

• TERP+GLBL stake worth $1.5b+ (10x+ div received)

• If gross profit ends up being $0.25/W (i.e. 30% lower):

• 2016 CF lower by $150m,

• 2017 CF lower by $90m (smaller reduction b/c already accounted for 0.25 gross profit in the sale To new WH/3rd pty @1.75 while cost was 1.50)

• 2018 CF lower by $350m

• Cumulative negative effect $590m:

• Net debt = $5.5b @ face value

• CashFlow/yr = $265m (x debt principal repayment)

• FCF/yr = $50m

• TERP+GLBL stake worth $1.5b+ (10x+ div received)

Clearly not a sustainable capital structure; needs restructuring:

• Equity is worthless

• Pfd is worthless

• Sell TERP+GLBL stake:

Debt post-restructure = 6,285m - 650m pfd - 1,500m terp+glbl stake

Debt post-restructure = 4,135m at face value (of which 1,910m converts)

Net debt post-restructure = 4,135m - 725m

Net debt post-restructure = 3,410m

Ebitda = 875m gross profit (@0.25/W) - 500m opex net of O&M gross profit

Ebitda = 375m

Seems manageable, but probably not investment grade.

Exchange converts for half debt and half equity.

Debt post converts restructure = 4,135m -1,910m / 2

Debt post converts restructure = 3,180m

Net debt post converts restructure = 3,180m -725m

Net debt post converts restructure = 2,455m

CAFD available to restructured equity = $141m/yr

CAFD yield = $141m / ($1,910m / 2)

CAFD yield = 15%

Review of downside case

• WHs maxed out and unable to sell (and therefore SUNE can’t access $1b+ gross profit)

• Limited market for 3rd party or new WHs (despite attractive unit economics)

• Gross margins 30% below guidance (and no opex improvement beyond 2016)

• VSLR platform worthless

• TERP+GLBL worth only 10x dividends

Under these non-optimistic assumptions, the converts are still worth at least face value.

Conclusion

The business model of SUNE has evolved twice.  Originally it was a DevCo assembling projects for sale to 3rd parties.  With the advent/frenzy of yield vehicles, it transitioned to a DevCo assembling projects to drop into its own YieldCos.  With the collapse of the yieldco market, it is being forced to transition back to a DevCo assembling projects for sale to 3rd parties.

SUNE has to execute this transition at a much larger scale (and complexity) and with a lot more debt.

Two key issues

• Is there a problem with the 3rd party market?

• Can SUNE execute within its constraints?

On the first question, as I mentioned previously, I don’t think so because of the global trends and the attractive unit economics.

The second question is harder.  There are a few data points that are positive:

• Management has not wasted much time to acknowledge the change and reframing the strategy

• Major restructuring to reduce opex by 40% (from $1b run-rate to $600m 2016)

• Stop growing (among other things smaller backlog and pipeline 3q15 vs 2q15)

• The business and the operations are relatively straightforward despite being in many countries with wind and solar (utility, C&I, and RSC)

• 3q15 3rd party sales came in at almost 2x guidance (small numbers and could be sandbagging) and 4q15 guidance is for 330MW

MW Sold to 3rd parties

*This was offered in their business strategy update call on Oct 7, 2015, but the 3q15 call on Nov 10, 2015 did not specifically addressed it.

Can they sell 3.5GW/yr (into a growing 120GW/yr market)?  Yes? How soon can they ramp up?

In a ZIRP world, how hard is it to place US$6b/yr worth of investment grade projects with unlevered IRRs in the range of 7-13%? I can think of a lot of institutions who would not think that is problematic...

Catalyst

The converts at current prices offer plenty of upside and seem to have limited downside, even under a stress scenario.

Key items to track:

• 3rd party sales

• Opex

• Unit gross profit