In this episode of Industry Focus: Energy, Nick Sciple and The Motley Fool contributor Jason Hall discuss the renewable energy sector, specifically the short report about Enphase Energy (NASDAQ:ENPH) by Prescience Point Capital Management. They go through the main points of the report and argue about whether it changes their investment thesis in the company. They also discuss why it's important to understand and analyze the thesis of a company for yourself before you dismiss it, and much more.
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This video was recorded on June 18, 2020.
Nick Sciple: Welcome to Industry Focus. I'm Nick Sciple, joining me once again is Motley Fool contributor Jason Hall. Jason, great to have you back on the podcast.
Jason Hall: What an interesting, exciting day. And I want to say, I think we're breaking a streak here, we're breaking a streak. I'm not going to be talking with you about anything to do with oil stocks.
Sciple: Yeah, I mean, well, oil is above $0 now, so I guess we clearly don't have anything to talk about. Yeah, today we'll be talking about renewable energy and, specifically, Enphase Energy, which is a company we've talked about in the past on the show. Yesterday, on Wednesday, Prescience Point Capital Management released an over 50-page-long short report on the company, which sent the stock down over 25% on the day, Wednesday. In trading today, it's back up about 16%.
Jason, before we get into the substance of that short report, you know, just high-level, when a company you own has a short report come out on it and you see the stock fall like this, what do you do, how do you respond?
Hall: So, I think it kind of gets to the core of being a successful long-term investor. One of the hardest things to do is to fight your very human nature to act, you feel like you have to do something, whether it's to sell to get out before the pain gets worse, and that happens to a lot of people, or it's time to double down. You know, you're, I'm buying, what do these idiots know? It's an emotional thing, because you own this, this is a business you own a part of. So, you feel some urge to do something. So, I think, for me, the first thing that I have to do is force myself to stop and breathe. And then start actually figuring out if there's any validity to this short, this attack, this thesis that this is a bad company, a broken stock, whatever it is. So, that's where you, kind of, have to start. That's something you and I've talked a lot about over the past 18 hours or so.
Sciple: Yeah. So, when you own stock in a company, it's like that's your team, you're rooting for them and when somebody comes out and attacks them, I see you're wearing your Georgia Bulldogs hat as we record right now, it's like when somebody comes out and says, you know, Alabama did some kind of recruiting violation. I'm like, there's no way that that could happen. And you have to fight that instinct. Because I think at the end of the day, whatever your opinion is on short-sellers, the fact that there's a group of people out there looking for information that, kind of, disconfirms a bull thesis on a company, that folks are putting that type of work in and provide some valuable information to the market that we can use. I mean, what's your opinion on short-sellers and the role they play in the market, Jason?
Hall: So, I have an opinion that's evolved over the years. As I've become a more experienced investor, I've come to believe that short-selling is a viable and reasonable and completely ethical part of the market, I absolutely do. That doesn't mean that every short-seller is ethical, just as every buyer is not necessarily ethical. There are plenty of people that are pumping bad businesses to get a short-term pump/gain, so they can then sell that business. So, there's bad actors on both sides of the ledger, on buying and selling. But in general, I think short-selling, it's an important and viable part of the stock market.
Sciple: Yeah. I think you're absolutely right. I mean, you have to assess a short thesis, just like you would assess a long thesis and determine whether that information that's getting introduced is something that's valid that you should act on or something that you can comfortably ignore. I kind of came up with, kind of, a four-step process that I would follow whenever a short thesis would come out on my company. The first step is, read it. You can't disconfirm someone's thesis without knowing what the thesis is, reading it and understanding it. And so, step two is, try to understand what their argument is? And I think it's important to know that if you're having trouble deciphering their argument that there's two possibilities of what could be going on there. Either their argument makes no sense and it's nonsense or you just don't understand something that's going on with the company. And so, that's why it's important, upfront, before you buy the stock in the first place, to really do your research so you have a framework to analyze this type of new information that comes in.
But once you understand the short thesis and the claims that they are making and if you've done your analysis and determined the validity of it, then you need to incorporate that new information into your thesis. If you think it's valid but it doesn't change your long-term thesis for holding the stock, then maybe you continue to hold. If you think, oh, this is, you know, all the sudden this company is a fraud and maybe I should change my exposure. After you've incorporated all that information you need to choose on what action to take. I think in most cases, and I think Jason kind of alluded to this, the best course of action is probably to do nothing. But without considering the information in the first place and really trying to assess it for yourself, you really can't determine whether it's something to act on or not. So, it's really important to understand and analyze the thesis for yourself before you dismiss it.
Hall: Yeah. And I think, in a way, it's kind of, it's a little more of a distilled version of the way that you need to treat every stock that you own, right? And anytime there's new information, you have to work that information into your thesis and act accordingly. So, when the information changes, sometimes that means your thesis changes. I mean, that doesn't have to be a short, it could just be the fundamental opportunities change or the business is not executing. There's plenty of reasons that your thesis can change. And it's data, not dogma, right? It's so easy to fall in love with your investments and anchor on that investment as a great investment and refuse to even consider new information. And that's a great way to fail as an investor. So, yeah, so, absolutely.
Sciple: Sure. So, in that light, when it comes to considering new information and evaluating the validity or not of a short report, let's get into this short report on Enphase Energy from Prescience Point Capital Management. Jason, just high-level, what are the main points of this thesis, this argument that they're making about Enphase?
Hall: So, at its core, Prescience Point is saying that they've actually done private investigations on the grounds in India where a large portion of the company has some of its finance operations set up, is that, as much as $200 million or a little more than $200 million of revenue and gross margin expansion over the past several years is fabricated. I mean, they're point-blank saying that it's not real revenue. And they're underpinning it to the offshoring of a lot of their accounting to India at the end of 2018, which is when their current CEO came in and made some changes in the organization.
Part of their argument is, a lot of other executives and middle management that were brought in by these new executives from prior organizations they worked with, claiming that they are "yes men" and that they're loyal to one another. Even going so far as to say that the former CEO of -- help me out here, SunEdison?
Sciple: SunEdison. Yes, Sir.
Hall: -- is basically pulling the strings [laughs] in the background and coordinating a lot of what's happening. So, there's a lot of innuendo, a lot of rhetoric behind it. They're using data, like, looking at market share gains from a big industry analyst that follows the solar industry, to try to demonstrate how it's impossible that the revenues that they're claiming are legitimate. I think that's kind of the main thing. Those are basically the underpinnings of their argument for a target price of delisted. [laughs]
Sciple: Right. Certainly, when you say you think the company is going to be delisted, that a large portion of their revenue is allegedly fictional, I mean, they're essentially arguing that they're going to follow a similar path to what folks think is going to happen to Luckin Coffee, where a large subset of their revenue was allegedly fake and then the company is now in the process of being delisted.
I do think it's worth driving into the basis of that allegation of inflated revenue. You mentioned this idea of third-party market share reports, that the short-seller cites a report from Wood Mackenzie, who is widely recognized as the leading third-party analyst when it comes to this industry and specifically Enphase's industry, the solar microinverters' main competitor is SolarEdge. And so, if you look at market share numbers reported by Wood Mackenzie over the past several years, particularly the past couple of years, SolarEdge has been gaining market share while Enphase's market share has remained relatively flat.
So, over the last year Enphase roughly doubled its U.S. sales every quarter, but its market share, if you look at the market share data, remained roughly flat. And so, if Enphase isn't gaining market share and its revenue is doubling, then maybe you think the overall solar market is growing. However, if you go back to that Wood Mackenzie data over that same time period, the solar market only grew 12% over the period.
And so, by the analysis that the short-seller is saying that, there's no way Enphase's revenue could have grown as quickly as they're saying. But, Jason, there is a caveat to that, as you mentioned.
Hall: A little one. Yeah, just a small one. Back in 2018, I think, Enphase reached a deal with SunPower to acquire -- at the time SunPower had an in-house microinverter business, it was making its own microinverters. The company made the decision, as part of its broader strategy, to kind of shift away from a fully integrated model to being more focused just on the panel business, and sold its microinverter business to Enphase. And Enphase, in return, became SunPower's exclusive provider of microinverters.
For people that don't know SunPower, I think they might be, if they're not the largest, they're certainly one of the largest suppliers of solar panels to the U.S. residential and commercial solar market. They are a major, major installer. So, that is a substantial portion of market share that they have and that Wood Mackenzie excludes; it's not included in that market share data, it's a massive, massive portion of Enphase's business and could easily make up a substantial portion of its growth.
Sciple: And so, this isn't something the short-seller addressed in the short report?
Hall: No, because it was completely absent. As a matter of fact, it's something that I noticed going through the company's, the short-seller firms' Twitter, they had a long Twitter thread that they dropped the same time they dropped this report. And one of the tweets was this data. And I looked at them, like, well, hang on a minute here! [laughs] and then, it's actually right there on the screenshot of the data, it specifically says, Wood Mackenzie says, they exclude SunPower insulations from that market share. And I mean, that's an outsized portion of -- that's not a majority of their sales, but it's certainly a plurality, it certainly is the single-largest source of microinverter sales that the company has.
Sciple: Yeah. So, you mentioned that issue when it comes to the SunPower part of the business. I think another thing that I was surprised by, in the short report, is that one of the main parts of the growth thesis or the bull thesis that you hear, folks, will point out for Enphase, particularly over the past couple of years, has been there, there's been a change in the electrical standards that have changed the requirements of just the number of inverters you need relative to solar panels that you install, which has really provided a tailwind for Enphase's business as well as some of its competitors. They didn't really bring that up in the short report, either.
Hall: No, it wasn't that they didn't really bring it up, they didn't mention it. I mean, it was completely unmentioned. As a matter of fact, if you look at the timeline that they laid out as the foundation of this thesis, it was tied to their CEO, when their CEO came on board. And the thing is that that timing corresponded to the change in U.S. electrical code that essentially made Enphase and SolarEdge, for all practical purposes, a duopoly in supplying the U.S.-distributed solar market. So, residential solar and commercial rooftop solar. I mean, they're the two companies that provide, I don't know, maybe 90% of the panel-level electronics. And between the two, SolarEdge has been the largest for five years in terms of total revenues and it has more market share.
So, they completely ignored the single greatest factor behind their revenue growth over the past several years and painted a picture of it being directly tied to the CEO coming in. And that's a huge gaping hole in something that is the foundation of their thesis.
Sciple: Right. I tend to agree with that. That doesn't invalidate these other claims. I think when I when I look at some of the claims they make around market share and the Wood Mackenzie data, and when you compare Enphase's revenue to what SolarEdge has been able to achieve over the past year, I do think there are some inconsistencies that do look a little funny to me, and I think definitely merit further investigation. But I will say, when I look at how this short report was drafted, it wasn't drafted in a way that was as convincing to me as it could have been, I think for a couple reasons. One, you mentioned there are some of these, I think, worthy, bullish counterarguments that just aren't addressed that I think could have been.
And then I think as well, if you look at their short report, I think it's only about 40 pages in that the report really gets into the substance of some of these accounting allegations and a lot of the front part of the report is front-loaded with a lot of these questions around management and around the offshoring of their accounting staff, and a lot of this character evidence. And so, it's like a good 20 pages of character evidence before we get into the substance of the argument. Which for me, as a reader, when you don't lead with your best argument and you don't address counterarguments, it's not as convincing as it could be otherwise. That's not to say that these allegations are invalid and don't deserve further investigation, but that is something that raised my eyebrow a little bit as to how much I should trust this report or not.
Hall: Yeah, I tend to agree. Again, to your point, and I'll repeat it, it doesn't invalidate it, but it certainly calls into question how much energy and effort they really put into really researching the industry, researching the company, researching its results, when they don't even mention the single two biggest catalysts to Enphase's results, real or otherwise, over the past two years, and that's the change in the U.S. electrical code and their landing, you know, one of the largest solar panel manufacturers in North America as their largest customer.
When you don't even bring those two things up, it really calls into question all of the other things, because there's such a lack of clear evidence to really support the short thesis that they present. Again, it doesn't say that they're wrong or that there's nothing there, it's just a lot harder to have any credibility when there's a lack of even being ready to talk about those other things.
Sciple: Right. So, what it comes up away to me as, is a lot of allegations of things that look funny, but it's hard for me to pull a through line that ties it all together, that, you know, fundamentally makes sense in the context of the rest that's going on with the business. And like I said, that doesn't mean that there's not a valid argument there, and I'd really -- [laughs] you know, if the folks from Prescience Point are here listening, and you know, [laughs] I'd love to engage with you all and get some more feedback on your thoughts there.
So, all that to say, I would say for listeners, definitely read the report, this is a 50-page report that we cannot cover in its entirety on this podcast. So, we tried to cover the main points.
Moving on, Jason, I know you're a shareholder in Enphase, how are you responding to this report as someone who owns the stock? Obviously, we have trading rules, so you're not going to be able to [laughs] transact in it in the near term, but as you're allowed to, how will you respond to this report as a shareholder?
Hall: Yeah, it's interesting, you know, one of the things you and I've talked about is, you know, I follow the market pretty closely every day because it's my profession, because I write about these companies and I cover it. But I'm on the West Coast, so my day tends to start after the market has opened. And I actually discovered this when I was logging on to my brokerage account, because I've actually been considering lightening my Enphase position a little bit, just because the valuation has gotten so incredibly, so incredibly stretched. So, you look, this stock is up, I don't know, 800% or something like that over the past couple of years, I've done incredibly well by it. But there are some things that have kind of gotten me wanting to create a little more cash in my portfolio, some other ideas that I'm really interested in. And this one just happened to be on my list of ones that I was thinking about just lightening a very small amount.
When I saw this, when I saw the stock was down 25% at one point, I did some quick reading and found this report, I immediately decided to do nothing for the time being. I needed to back up, I needed to read the report, I needed to study it, I needed to give the company some time to respond, if it indeed even chooses to respond, and then just kind of reevaluate the whole thesis.
So, I'll say this. So, anyone who has invested any substantial portion of their money in Enphase and done incredibly well over the past [laughs] couple of years, it's just about hard to have not done well. I mean, I could understand somebody lightening a little -- like I said, I was considering doing it myself. But with that said, yeah, it's incredibly richly valued by just about every valuation metric you could find.
But even though I'm considering doing it myself, my experience, in the past is, it's almost always been a mistake for me to sell a stock simply based on valuation, if it's a stock that I intend to hold for the long term. So, I think the key thing to remember with Enphase, and the thesis that underpins it for me as a long-term investor, is not the fact that right now it's a duopoly with SolarEdge in the U.S. and that it has this great position to make a ton of money and be very, very profitable in this market while it has minimal competition. You know, that's going to change, that's not a permanent competitive differentiator. It's just not a permanent competitive advantage, but what it's allowing the company to do is accelerate its investments in, like, energy storage. So, it's able to, kind of, start diversifying its business and create some optionality into another major, major growth market that's going to drive renewables over the next decade.
But again, looking beyond North America, companies expanding into Europe, expanding into Africa. There are tons of places in the world where these panel-level electronics are going to be really, really important. So, it really -- you know, even after reading this report, I'm leaning in toward my long-term thesis being really unchanged. Again, pending obviously what the outfall is from the company and if they're able to give us any more information, the SEC decides to investigate.
Just again, I see a little bit of smoke, but mostly steam from the hot air. But again, my long-term thesis really hasn't changed and I expect that Enphase will probably remain a substantial part of my portfolio going forward.
Sciple: Jason, you mentioned that duopoly with SolarEdge, you know, that these are the two predominant ways that you can invest in the growth of this trend. At least in the U.S., I'm sure there's other opportunities to do so elsewhere, does this change your calculus of whether you'd prefer one over the other, if you just wanted exposure to this trend, this growth area?
Hall: If I was going to buy today, I would certainly buy SolarEdge before I bought Enphase. Again, it's based on -- so, it's easy to look at as two coins and there's one side and there's the other side, like it's obvious. Well, if the stock is overvalued, you should be selling, right? Why would you want to own it if it's overvalued? Again, because my sell point isn't today, like I'm not -- my investments are meant to pay for my retirement, right, they are to pay for my kids' college, those are things that are 15, 20, 25 years in the future. So, I'm thinking about it more from the perspective of just when I'm acting as a buyer, I will hold a stock that's overvalued. But it doesn't necessarily always make sense to pay today's price for that company.
Between the two, I would buy SolarEdge today. No. 1, the valuation, I think is better, but also, I think it's a little bit stronger business in terms of their history of generating profits, their history of generating positive cash flows. They have a few more irons in the fire. They're also getting into the energy storage business, but they're also getting into the vehicle electrification business, so they own an EV powertrain business that makes some components for powertrains, they make EV recharging stations. So, they do several other things. They do battery backup; so, not just energy storage, but also, like, think about remote battery backup and that kind of thing too. So, it's a little bit more diversified business, so I like the optionality a little better and I like the valuation. If I'm buying today, I would buy SolarEdge first.
Sciple: Alright. So, it's a big takeaway then. If you own Enphase today, this short report doesn't look like a reason to sell right now, but if you're investing new money as between Enphase and SolarEdge, SolarEdge is the winner.
Hall: I think so. That's fair. Yeah.
Sciple: Absolutely. Well, Jason, thanks as always, for hopping on the show and sharing all your knowledge with us.
Hall: You're welcome, Nick. I notice you're skipping the most important part of this entire conversation, right?
Sciple: What is that?
Hall: So, you know who Greg McElroy -- you know who that is, right?
Sciple: Your National Championship winning Alabama quarterback.
Hall: Yeah, he said Georgia has a better quarterback.
Sciple: Well, that's OK. We got the better everything else. So, we'll make it. We got the better head coach, so we'll figure it out. Hey, you know, I just hope we get some college football this year. You know, it looks like the SEC is all-in, you know, come hell or high water, we're going to play. You know, whether you think that's smart or not, it's certainly part of the culture down there. And you know, I'm ready for some college football. I need sports, period, but college football most especially.
Hall: Agreed wholeheartedly. How about this, let's see if we can get our bosses to approve you and I doing a special edition Georgia-Alabama week. Let's see if we can't do a special SEC Industry Focus.
Sciple: Let's do it. I need to get down to Athens, I've only been there once, so.
Hall: That would be fun. Onsite. Yeah, onsite. Maybe we can set it from the Tate Student Center, so then we can record it.
Sciple: Alright, folks. Write into IndustryFocus@Fool.com to command the powers that be at The Motley Fool, send Jason and I to the Alabama-Georgia SEC Championship game, hopefully, this year.
Jason, well, I hope to have you on again sometime soon.
Hall: Make it happen. Sounds good.
Sciple: As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against the stocks discussed, so don't buy or sell anything based solely on what you hear.
Thanks to Kyle Carruthers for making us sound so nice. Jason Hall, I'm Nick Sciple, thanks for listening and Fool on!