The fat lady may not be singing yet, but if the rumors about SunEdison Inc (SUNE) are true — and there’s likely something to them — she’s at least warming up.
Yesterday afternoon, word started to spread that the failing solar power developer was in talks with creditors, presumably as a prelude to some sort of restructuring.
It’s not a tough idea to believe. Not only is SunEdison not profitable, but after more than a year of being in the yieldco game, it’s still moving in the wrong direction.
SUNE stock is responding as one might expect, sliding 10% lower today after losing 25% of its value on Tuesday after rumors of the rumor began to circulate. SunEdison shares are now down 95% from their July peak.
The whole sordid saga begs one overarching question: What went so wrong for this promising concept?
The answer is multifaceted, but it can be boiled down to just one key mistake.
SUNE Is Scrambling
Debtwire was the first to comment that SunEdison was speaking with second-lien lenders to arrange for debtor-in-possession financing. Such a deal would effectively let the company reset the value of the collateral to their current — lower — market value rather than the value used to initially make the loans. The loans in question total a little more than $700 million. That’s only a fraction of the $11.6 billion worth of debt the company is presently dealing with, but it’s not a stretch to assume the talks mark a bigger debt-servicing problem.
Of course, the true debt situation, the lack of profitability and SunEdison’s actual liquidity can only be guessed at this time; the company is now a couple weeks late in filing its quarterly results with the SEC, disclosing to SUNE shareholders the organization’s current financial condition.
The fact that the company is being investigated (by lawyers, not the SEC) doesn’t help paint an encouraging picture. Neither does the “identification by management of material weaknesses in its internal controls over financial reporting” explanation for the delayed filing.
It’s a sequence investors have seen play out before, usually en route to an ugly end.
What Went Wrong?
So how did SUNE stock go from being the best thing since sliced bread at the beginning of 2015 to effectively being radioactive since the second half of 2015?
The steep plunge in the price of oil and natural gas is often the knee-jerk explanation; it’s presently cheaper for utility companies to power their plants with natural gas than solar power. And to be fair, that is a contributing factor.
It’s not the big one, though.
The bigger impasse was and still is a mountain of debt SunEdison can’t service given its revenue model and current market
The debt-driven/income-pass-through model isn’t flawed. Real estate investment trusts and master limited partnerships use it effectively. But SunEdison and its partner/customer TerraForm Power (TERP) are struggling to make the model work simply because the duo spent too much money for too little cash flow. TerraForm should have been seeking projects that yielded something between 8% and 10%, but in an effort to be first and biggest, it bit off projects with much lower likely returns.
Oh, the up-front payback looks good, as it did headed into 2015 when the market was going hog-wild for yieldcos. The longer investors had to study the math, however, the clearer it became the math didn’t and still doesn’t make long-term sense the way SunEdison and TerraForm were trying to make it happen.
The red flag started to wave when the TerraForm Global (GLBL) IPO turned out to be a bit of a bust; the proverbial honeymoon was over.
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Meanwhile, not only was, and still is, the value of SUNE stock largely predicated on the success of TerraForm Global and TerraForm Power (and their ability to purchase projects from SunEdison), SunEdison has taken on too much debt of its own, buying assets and developing them, then ending up being unable to sell those assets at a price that made sense for the buyer as well as the seller.
None of this is news to anyone who’s followed the SunEdison yieldco story from its inception, of course. All of it, though, should serve as a lesson to every investor.
The lesson? The series of bad decisions leading up what looks like is going to be the demise of SunEdison were ultimately based on bad assumptions that nobody questioned until it was too late … including the company’s leadership.
The reality has been that taking on a ton of relatively expensive debt to acquire lower-yielding assets on hopes the payback would improve over time was based on a bad assumption. Planning on being able to develop solar projects and then sell them quickly for a profit was based on a bad assumption of developmental effectiveness.
Indeed, assuming investors were going to line up to sponsor unproven yieldcos — when proven, better dividend payers were available — was a bad assumption.
Nobody dared question the model a year-and-a-half ago, though, because the story just seemed too darn good.
Bottom Line for SunEdison
In its defense, SunEdison and yieldcos in general are hardly the first fad to move through the boom-and-bust cycle just because the market fell in love with the premise without thinking about its plausibility. They won’t be the last, either. It’s also worth adding that SUNE stock may well be a worth speculative buy right now; the pendulum seems to have swung pretty far in a bearish direction.
Either way, looking back with the gift of hindsight, none of this meltdown and what looks to be a restructuring can come as a complete surprise. The assumptions were oddly optimistic from the onset.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
