#UK Wall Street’s getting crushed by a form of financial engineering you’ve probably never heard of


Leon Cooperman

On August 6, billionaire hedge fund manager Leon Cooperman took the unusual step of dialing in to an earnings call for one of his fund’s holdings and asking a question.

It was a second-quarter earnings call for SunEdison, a solar-energy company that went public in 1995. At the time, Omega was the 11th-biggest shareholder of SunEdison with 8.8 million shares.

It’s a large stake, but it is still unusual for Cooperman to pick up the phone to publicly ask a question on a company’s quarterly conference call.

These were no ordinary circumstances, however. After enjoying the benefits of a classic Wall Street hedge fund pile-in, when the smartest money in the stock market wants nothing more than to buy, buy, buy, SunEdison was crashing.

Cooperman wanted to know if its executives would throw him and other investors a bone and buy back some stock. They responded, in no uncertain terms, that they would not.

Since that call, SunEdison’s stock has fallen a further 80%. Its two subsidiaries, TerraForm Global and TerraForm Power, have seen their stocks fall 64% and 73%, respectively. There have been management shake-ups at both the subsidiaries.

The stock price collapses have burned some of the biggest investors in the business, including Cooperman, David Einhorn of Greenlight Capital and David Tepper of Appaloosa Management.

And it is all because of doubts over a type of financial engineering which fueled explosive growth in the solar sector for two years, and now has investors questioning the entire sector.

What’s a yieldco?

The shift in fortunes has been brutal. At an event in October last year, David Einhorn of Greenlight Capital called SunEdison a well‐run, financially savvy company, benefiting from an open-ended growth opportunity trading at a bargain price.”

He priced the stock at $32 a share. It’s now trading at about $3.

The “open-ended growth opportunity” Einhorn was referring to is made possible by something called a “yieldco.” It’s the magical instrument that fueled SunEdison’s growth and caught Wall Street’s eye in the first place.

David Einhorn speaks at the Sohn Investment Conference in New York, May 8, 2013.  REUTERS/Brendan McDermid A yieldco is a little like a real-estate investment trust or a master limited partnership. They are created by a parent company and bundle long-term operating assets together, with these cash flows paid out in dividends.

Solar manufacturers created yieldcos as separate entities that would buy up the solar projects manufacturers built in “drop-down transactions.”

SunEdison has two yieldcos, TerraForm Power and TerraForm Global. The parent company owns a majority stake in both companies. There are eight publicly traded yieldcos in North America in total.

The appeal for the parent company is that, in hiving off the operational assets that have predictable cash flows because of long-term contracts, they reduce their own cost of financing.

The appeal for investors is in the name: These are yield companies. Having a public company with supposedly secure cash flows delivering 4% or 5% in the shape of dividends is attractive in a low-interest-rate environment.

This was supposed to be a sleepy little bet. It was supposed to be like landing on the Electric Company in Monopoly, or buying JP Morgan stock after 2012. Shareholders got fat and happy on promises of growth and consistent dividend payouts.

With this story in hand, yieldcos became the belle of Wall Street’s ball in 2014. Over the course of 2013 and 2014, 15 yieldcos went public raising $12 billion in capital according to Bloomberg. Then in early 2015, the Global Yieldco Index, an ETF, was created.

The ETF never really got a chance to shine before the crash on July 20, though. That’s when this whole entire theory was put to the test.

The accidental reveal

On July 20 SunEdison bought Vivint.

Vivint is the second-largest installer of residential solar panels in the US. SunEdison financed the deal with debt and by selling $922 million of assets to TerraForm Power.

SUNE 6 months chartThe deal marked a shift for SunEdison, which had previously focused on bigger public projects with more trustworthy counterparties. Going into residential solar panels marked a departure for the firm, and led Wall Street to start asking questions. 

“This deal sparked concerns about the quality of underlying cash flows, the premiums being paid for portfolios, and underlying discounted cash flow assumptions,” said UBS in a recent note.

That’s when the stock started to swan dive.

It was around this time that SunEdison took TerraForm Global public. The IPO disappointed. The market priced 45.5 million shares of TerraForm Global at $15 a share, rather than the 56.6 million shares priced at $19-$21 a share SunEdison had sought.

And then a few weeks later, third-quarter earnings disappointed as well.

One key thing to realize here is that it is the parent solar manufacturers that are most vulnerable.

That’s because, as Marathon Capital LLC argued in a recent report, yieldcos have their power purchase agreements and 15 gigawatts of power plants worth $35 billion. The parents, on the other hand, have lots of costs and not much revenue.

“SunEdison still believes in the value of the yieldco model,” a representative told Business Insider by email. “The long term contracted cash flows with no fuel risk and strong creditworthy counterparties are attractive to our investors.”

solar energy panels

The SunEdison stock kept falling through September. Then in October the company called an off-cycle conference call and lowered guidance. It also said it was going to stop making drop-down deals through 2016 and would focus on cutting costs. Investors clamored for third-party sales outside the yieldco structure.

November was chaos as more information about SunEdison’s financials hit the Street. Cash commitments were disclosed. Third-quarter earnings showed thinning margins. Things started happening really fast.

  • Analysts at CreditSights noted that SunEdison changed the classification of $700 million worth of debt from “non-recourse” to “recourse.” That meant that lenders could seek financial damages if SunEdison defaults on the debt.
  • SunEdison and Terraform Power did a major conflicts committee board shakeup, and TerraForm Power’s CEO and CFO were replaced with executives tied to SunEdison. Specifically, former SunEdison CFO Brian Wuebbles became CEO of both yieldcos and a SunEdison board member, Peter Blackmore, became Chairman of the companies.
  • SunEdison entered into a transaction with its Global YieldCo and paid off some money it owed to TerraForm Power.

But none of it helped. The stock is still trading below $4. Investors are still asking questions. UBS recently cut its price target from $14 a share to $6 a share. And now SunEdison has gone back to saying that it will in fact do drop-down transactions in 2016.

When asked about this reversal from a strong commitment to seeking third-party deals, a SunEdison spokesperson pointed Business Insider to a statement from Emmanuel Hernandez, SunEdison’s executive chairman.

He said that “the company would focus on the organic development opportunities that lie ahead in order to deliver value for shareholders.”

Good to know.

It also good to know that two TerraForm Power board members resigned three days before SunEdison announced the yieldco’s board and executive shakeup.

Both letters had basically the same language:

I am resigning from the Board of Directors of both the above referenced companies effective immediately.

The respective Conflicts Committees, as constituted before today, together with independent advisors, had been working hard and in good faith to protect the interests of the stockholders of the two companies.

As a result of today’s actions of each of the Boards, I don’t believe I will be able to do so going forward and therefore resign.

The letters were dated November 20, and disclosed in a government filing on November 27. That was the day after Thanksgiving, or Black Friday.

Make someone (un)happy, and you’ll be (un)happy too

On Tuesday, billionaire investor David Tepper, who has a stake in TerraForm Power (TERP), sent out a rare public letter to the company’s board. In it, he accused SunEdison of unloading low-grade assets onto TerraForm Power, and stacking the board with loyalists who would do its bidding.

David TepperHe cited the Vivint acquisition, among other deals, as proof of the former. His closing statement may or may not have been a warning.

As previously suggested, substantial further disclosures are incumbent on TERP so that investors can assess the full impact of the pending transactions, the relationship between TERP and its ‘Sponsor,’ and the circumstances surrounding the changes in TERP’s management and Board,” Tepper wrote in closing.

“We look forward to such disclosures and stand ready to meet and discuss any of the issues raised by this letter. In the meantime, we expect the Board and the Conflicts Committee to respect and defend the integrity of TERP’s corporate identity and the interests of its stakeholders. We reserve all rights accordingly.”

In other words, do your job protecting shareholders or we’ll do it for you.

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