Sunworks Could Win, But Buy Its Acquisition Partner Peck Instead


In August, Peck (NASDAQ:PECK), a solar-focused contractor, agreed to acquire Sunworks (NASDAQ:SUNW) stock in an all-stock deal. Peck shareholders would own 63.46% of the combined entity, while SUNW shareholders would get the other 36.54%.

Piggy bank in front of solar panel infrastructure
Source: Shutterstock

Mergers are usually dull ordeals for regular investors. Investment banks take their massive cuts, hedge funds nibble at the edges for arbitrage opportunities, and individual investors get a note from their brokerage that one of their stock tickers changed at some point two weeks ago.

But the Sunworks deal is different. And, as a solar investor, I NEED you to pay attention.

Here’s why.

SUNW Stock vs. PECK: A Case of EV Mania

Since the two companies announced the deal, the typically smooth merger process has gotten upended by “electric vehicle mania,” a mad dash to invest in any company that looks like Tesla (NASDAQ:TSLA).

On Sept. 24, SPI Energy (NASDAQ:SPI) announced plans to enter the electric vehicle space. As rumors swirled, investors targeted similar-sounding Sunworks as another potential electric vehicle play. Shares of the solar panel contractor jumped 275% on hopes it would create an EV battery.

The duller sounding Peck Company, on the other hand, rose by just 70% despite its similar affiliation. Yet, the terms of the SUNW/PECK deal haven’t changed – Sunworks will still get 0.185171 shares of the combined entity.

That means SUNW stock has become wildly overpriced. Any investor buying high-priced Sunworks today will have their shares converted into cheaper PECK stock once the merger closes in Q4. In other words, investors looking to cash in on the solar craze should buy Peck instead.

SUNW Stock: A Merger Arbitrage Opportunity

I know this might seem boring, but it’s critical to understand what merger arbitrage means for SUNW stock. It’s the difference between having 56% of your investment melt away or getting 130% in “free money” once (or if) the PECK/SUNW merger closes.

In a merger, the acquiring company (buyer) typically offers either its shares, cash, or a combination of both to the acquired company (target). Offer a high enough price tag, and TargetCo’s shareholders generally say “yes.”

All cash deals. Of the three options, all-cash deals are the easiest to understand. An acquiring company might offer $100 per share to buy TargetCo, which would immediately push its shares $100. The target might trade for slightly less (i.e., $98) if investors don’t believe the deal will go through. Or it could sell for more (i.e., $105) if investors believe a better deal will come along. But it will eventually settle at $100 once both boards agree to the terms and the merger goes through.

Share-based deals. Share-based transactions are a little harder to understand but follow the same principle. Let’s say an acquiring company offers 30% of its shares to the target. If the buyer’s total share value is $70 million, the target’s total share value should settle around $30 million (i.e., 30% of the combined 30 + 70 = $100 million entity). And because share prices are linked, one stock’s rise tends to push up the other.

Merger Pricing Gone Awry

SUNW Stock - Pricing vs PECK
Click to Enlarge
Source: Data courtesy of WSJ Markets

When management announced the PECK/SUNW deal, their share values largely met these guidelines. PECK closed at $4.10 on Aug. 11, while Sunworks closed at 72 cents. The agreed-upon exchange rate of 0.185171 meant that each SUNW stock valued PECK at 0.72 / 0.185171 = $3.88/share, a minor 6% difference.

But then something happened this fall: SUNW stock rocketed in value as investors rushed into solar stocks. (Perhaps they didn’t realize that PECK is also a solar company). Today, SUNW is valued at $3.05, which suggests PECK should be worth 3.05 / 0.185171 = $15.22. However, PECK is worth just $6.56 today, despite 70% of its business coming from installing solar panels. That’s a gaping hole of $8.66 per share.

Merger Arbitrage for the Regular Joe?

In theory, that means regular Joe investors could potentially buy PECK, short SUN, and earn $8.66/share in profit. That’s how merger arbitrage hedge funds make a living. (Merger arbitrage hedge funds have almost certainly stayed away since the PECK/SUNW deal comes to just $28 million, a drop in the bucket for most hedge funds).

And that leaves regular investors a grand entrance into a usually exclusive world of “merger-arb.”

So, what could go wrong? Firstly, Sunworks could still call off the deal. The $375,000 termination fee is a drop in the bucket compared to the current $28 million mispricing of SUNW stock. Secondly, SUNW shares are expensive to short. Interactive Brokers, a trading platform, quotes a 42.38% fee rate for shorted shares.

And finally, more investor mania could push SUNW stock up even further, creating massive short-term losses for those who don’t correctly hedge their short positions.

Instead of Long/Short, Go Long PECK

Those three reasons make SUNW stock somewhat unattractive to short. To simplify the process, investors looking to buy into solar contractors should buy PECK stock outright. The second-generation family company has a long history of profits and offers a way to buy SUNW stock for cheap.

PECK isn’t perfect either. For instance, it had trouble managing profitability through its IPO – EBITDA decreased 10.7% in 2019 as the company moved to acquire projects at the “notice to proceed” phase. Its localized team will also need to adjust to working nationally with SUNW’s sprawling operations.

But it’s far and away more profitable than SUNW, despite working in the same contracting industry. It’s also in an incredibly fast-growing space of solar panels. The EIA expects renewables to make up over half of all power generation by 2042, with solar accounting for almost half. That makes PECK a far better buy than SUNW, in both price and operations.

Solar investors: get all hands on deck. PECK has a long way up to go.

On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.

Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.

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