SunEdison's Results Show the Flaws of New Business Model

Solar project built by SunEdison. Image source: SunEdison.

SunEdison (NYSE: SUNE) and its family of companies can't seem to do anything right in the market's eyes these days. After reporting earnings on Tuesday, SunEdison and its yieldcos TerraForm Power (NASDAQ: TERP) and TerraForm Global (NASDAQ: GLBL) have gotten crushed on the stock market, and there seems to be no end to the torture for shareholders.

SunEdison's decent top line, which came in at $476 million, was overshadowed by the company's whopping $284 million net loss, highlighted by a whopping $214 million in interest expenses in a single quarter. When added to $296 million in general and administrative expenses, there's not a lot of hope the company will be profitable any time soon.  

The bad news 
If you remember back to earlier in the year, SunEdison was a market favorite because it had built a massive backlog of renewable energy projects and launched two yieldcos that would buy a seemingly endless supply of new projects from the company. These sales would lead to high margins for the parent company and increasing dividends for the yieldcos. Everybody wins. 

But this is predicated on being able to sell stock from those yieldcos at decent valuations to buy new projects. As yieldcos have fallen their dividend yields have increased (now over 10%), it's become nearly impossible for the yieldcos to buy projects from SunEdison. So, the whole model falls apart. 

SunEdison responded to this dislocation by saying it would sell more projects to third parties. There-in lies the problem. If you want to see why SunEdison investors were excited about yieldcos and why they punished SunEdison when yieldcos suddenly went out of favor and the company transitioned to primarily third-party sales, you don't need to look any further than the table below.  

Source: SunEdison.

The Renewable Energy Development group in SunEdison is the segment that builds and sells systems to third parties. Clearly, it's not as profitable upfront as selling systems to TerraForm Power and TerraForm Global, which is why investors are no longer excited about SunEdison.

To be fair, Renewable Energy Development results are muddled by a $39 million gross loss in the Materials/Poly business, but even after accounting for that, third-party sales generated gross margins of just 15%. At that margin, system sales would have to be $9.7 billion a year just to pay for interest and operating expenses. 

To put further evidence behind how the yieldcos may have been overpaying to the benefit of SunEdison, drop downs to TerraForm Power and TerraForm Global generated $99 million in sales on 34 MW, a sale price of $2.91 per watt. Third-party sales generated $37 million on 15 MW, or $2.47 per watt.

The captive yieldcos were not only overpaying for projects from SunEdison upfront, they were providing high-margin cash flow on the back end as well. A strategy shift to third-party sales will have a negative impact on the business at a time when SunEdison needs to pay down debt just to survive. 

Solar project built in Chile. Image source: SunEdison.

The good news
If you want to take a silver lining from third-quarter results, you'd have to look at management's projections for the future. Management said cost-cutting measures should lead to cash flow break-even sometime in mid-2016, and operating expenses are expected to be down to $150 million per quarter by that time as well.

Meanwhile, 2.9 GW of renewable energy projects are under construction, so there should be cash coming in from selling many of those projects in the coming quarters. Time will tell whether that's enough to make a profit.

More questions than answers
In a common theme for SunEdison, the company seems to be full of more promises than it is execution. Until the company can prove its ability to make money being a boring project builder and yieldco manager, it will be out of favor with the market.

What makes that more challenging than ever is that the drop in TerraForm Global and TerraForm Power renders them virtually powerless to buy projects in the future. They're relegated to the projects they own and can finance on their own. That means less value for SunEdison and less growth in dividends for both yieldcos long term.

It's a terrible downward cycle SunEdison is on, but that's what happens when you build a company on financial engineering and not a solid foundation. The big unknown now is whether or not SunEdison can survive long term. It may be running out of options as investors sell off stock in its family of companies.