Beleaguered solar company SunEdison Inc. SUNE and its YieldCos – TerraForm Power Inc. TERP and TerraForm Global Inc. GLBL – witnessed a sharp rise in share prices yesterday. SunEdison gained 9.4%, while TerraForm Power and TerraForm Global surged 32.6% and 9.4%, respectively.
The rally came after SunEdison and TerraForm Global canceled a deal which would have had a severe impact on their finances and led to a massive dilution of SunEdison’s shares.
Per the deal, TerraForm Global would have gained control of 2,200 megawatts of generation assets from Brazilian renewable energy company, Renova Energia SA. For the past few months, the company was in discussion to take over Renova’s assets for $3.45 billion via a share swap deal. Both the companies cited adverse market conditions as the reason behind the decision.
TerraForm Global pulled out after SunEdison decided to cancel the $250 million deal to buy a 16% stake in Renova from its owner, Light SA. Per the deal, Nov 30 was the last day to decide to proceed with the deal, after which both parties have the right to terminate it without penalties.
This is the second evidence in the past two months of SunEdison scaling down its South American ambitions. In October, the company terminated the deal to buy Chile’s Latin American Power.
Why Investors Cheered the Move
We believe that the deal cancellation was the right decision as SunEdison had decided to finance the deal by issuing new shares, which would have diluted its earnings. Meanwhile, in a report, Credit Suisse analysts Patrick Jobin, Maheep Mandloi and Jennifer Ky stated, “Per disclosure, this also extinguishes SUNE's liability to acquire 2.5 GW of Renova's backlog projects (total consideration of $4b for deliveries in 2017-2020).”
The company’s current market price is down nearly 90% from its 52-week high of $33.45 attained on Jul 20 this year. This is because of a tremendous rise in debt due to the string of acquisitions, such as First Wind and Solar Grid Storage completed over the past one year. Moreover, the company has agreed to buy Vivint Solar in a cash-stock deal worth $2.2 billion.
The acquisitions have taken a toll on SunEdison’s balance sheet with total outstanding debt (including current portion) nearly doubling to $11.7 billion at the end of third-quarter 2015 from $6.3 billion a year ago.
Additionally, in the first nine months of 2015, $1.14 billion of cash was spent on operational activities. The negative operating cash flow indicates that SunEdison has been unable to generate enough cash to cover operational costs and, so, had to raise more debt.
Furthermore, the disappointing third-quarter results by SunEdison’s YieldCos have raised investors’ concerns. A YieldCo is a publicly-traded company formed to own operating assets that produce cash flow, which is then distributed among investors through dividends.
In other words, YieldCos buy finished projects developed by the parent company, thereby freeing up capital for the parent company to spend on more projects. A parent company with a highly leveraged balance sheet has difficulty completing projects, while a cash-strapped YieldCo has difficulty paying off its financers. SunEdison is facing trouble on both fronts.
TerraForm Power reported loss per share of 3 cents comparing unfavorably with the Zacks Consensus Estimate of earnings of 28 cents. On the other hand, despite incurring narrower-than-expected loss, TerraForm Global’s revenues of $29 million missed the Zacks Consensus Estimate of $34 million.
Both the YieldCos lost over 47% and 39% value, respectively, since the results were released. Moreover, on Tuesday, shares of TerraForm Power and TerraForm Global were trading at a discount of more than 78% and 68% to their respective 52-week highs of $42.66 and $14.10.
As both the parent company and the YieldCos are trading at a significant discount, it has become difficult for these companies to sell shares in the open market at attractive valuations and raise funds.
The prospect of a near-term interest rate hike by the Fed is a further negative for the YieldCos. Higher interest rates make such high-yielding stocks less attractive and raise the cost of financing projects.
YieldCos need to issue new shares (generally at higher prices than their IPOs) from time to time to raise capital for new investments as most of their cash flow is used up for dividend payments. However, SunEdison’s YieldCos are facing difficulties on this front due to plummeting share prices.
Conclusion
Although backing away from the Renova deal was a positive step taken by SunEdison, we believe that much needs to be done to improve its liquidity position. We do not expect this Zacks Rank #3 (Hold) stock to gain much in the near future.
Investors may instead consider a well-performing stock in the alternative energy industry such as SunPower Corp. SPWR, which carries a Zacks Rank #2 (Buy).
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