SunEdison (NYSE: SUNE) had a terrible 2015. It's stock fell more than 70% and sentiment around the stock has been extremely bearish. While the company's fall was due to several factors (investors had been selling solar stocks because of falling crude prices and the worry that generous tax credits might expire), one key acquisition ignited the chain reaction. Although SunEdison has improved the terms of the acquisition and gained a major backer in the process, the move isn't quite enough to make the stock a buy yet.
Losing the markets' trust
SunEdison's troubles began when it agreed to purchase residential solar system provider Vivint Solar (NYSE: VSLR) in July in a move that prompted liquidity fears. SunEdison's fall was aggravated by management failing to do enough to calm shareholder's concerns during the early and middle stages of the decline. Rather than cleaning house and enacting liquidity raising measures immediately, management took their time to announce cost cuts and cash-raising measures. Instead of realizing that it had made a mistake in terms of classifying $739 million recourse debt as non-recourse, SunEdison disclosed the error only when its stock was in the low single digits. Rather than amend the Vivint purchase to save liquidity earlier, SunEdison waited until December to do so.
Because of those belated steps among others, management lost the trust of many shareholders. For a business like SunEdison, which is as much of a finance company as it is a renewable energy developer, losing the market's trust is a crushing blow. SunEdison depends on the market for growth capital and needs low to reasonable financing costs to be economically profitable. If the market doesn't give it affordable growth capital, SunEdison's future value isn't very promising. With SunEdison's cost of equity currently somewhere north of its captive yieldco's 16% yield, IRRs in solar projects in the low teens to single digits, and renewable energy project developer operating margins generally lower than that, SunEdison doesn't have much room to work with. Moreover, although SunEdison has positive net present value now, it might not have positive value if there is a fire-sale in a forced liquidation scenario.
Appaloosa throws a wrench
Making matters worse is hedge fund Appaloosa wanting a yieldco controlled by SunEdison, TerraForm Power (NASDAQ: TERP), to open its books. Appaloosa has complained that SunEdison has used TerraForm Power in inappropriate ways and wants to separate TerraForm Power and SunEdison. Appaloosa would like the two companies separated because a big reason why TerraForm Power's stock is so low is that shareholders are afraid SunEdison will continue using the yieldco to finance non-favorable transactions. If Appaloosa can remove SunEdison's control from TerraForm Power, TerraForm shares will be worth a lot more because the company's 16% yield will be safer . TerraForm Power wouldn't be forced to pay $799 million in cash for Vivint's solar rooftop solar portfolio, for example, in a deal where the purchased assets aren't as creditworthy as utility PPAs, and that wouldn't fetch anywhere close to the purchase price in today's market. Appaloosa has incidentally sued to prevent TerraForm Power from acquiring the said part of Vivint Solar's portfolio.
Blackstone vote of confidence
Because SunEdison and TerraForm Power's financial statements are so complicated, it's difficult for most investors to determine whether Appaloosa will succeed in its attempt to separate the two companies. If Appaloosa finds a smoking gun or if Appaloosa successfully blocks TerraForm Power from acquiring a part of Vivint Solar's portfolio, SunEdison would have further to fall. If nothing is amiss, SunEdison would gain much needed confidence and its stock will stabilize.
One big vote of confidence for SunEdison in the Appaloosa matter is the fact that a vehicle of Blackstone Group LP (NYSE: BX) is willing to take SunEdison stock and convertibles in lieu of a cash in exchange for its Vivint shares. Because Blackstone is willing to hold shares, the bull case is that despite SunEdison's high cost of capital, its large debt load, and Appaloosa's demands, SunEdison's troubles are solvable over time. It might not be as terrible as it looks.
SunEdison's core problem isn't demand driven. Solar demand is strong and will remain robust now that the ITC, which provides tax rebates of up to 30% on solar in the United States, has been extended until 2019. SunEdison's problem is on the finance side and around the trust aspect in particular. Management lost a lot of credibility during SunEdison's large decline. If SunEdison executives fail to win back trust and lower the company's extremely high cost of capital, SunEdison will continue to be a big disappointment.
Winning back the markets' trust isn't impossible and it has been done before. . Blackstone's willingness to hold shares and SunEdison's recent cash raising measures have restored some confidence in the company's liquidity situation. If SunEdison retains control over TerraForm Power and TerraForm Power's yield trends lower to the ideal under 5-8% area, SunEdison can get its mojo back.
For TerraForm Power's yield to come down to the single-digits, however, crude prices will need to rally substantially and comparable MLP yields will need to fall so there is more demand on a relative yield basis. Given that crude prices are under $30 per barrel and are still weakening, this scenario doesn't look probable for the next year.
Given the uncertainties with TerraForm Power and SunEdison's high financing costs, SunEdison isn't a safe buy until its cost of capital comes down. Until that time, there are better buys elsewhere. But for those that believe in SUNE's future, its upside is certainly bigger than its downside.