Sunedison is a financial mistake

The saga around Sunedison is entertaining. First it gets bid up by hedge funds, then it collapses and now it’s subject to activists claiming they broke some serious corporate governance rules. The key to Sunedison is not that management are crooks or hedge funds driving them to make illegal decisions. The Sunedison story can be summarized as a case study for what happens when you miss price investments. It’s a simple business finance 101 situation where adults with lots of degrees neglected basic fundamentals.

Sunedison has been a financial engineering company from the get go. They were an equipment manufacturer for solar cell components, a market which got commoditized. Then they decided to become a project developer for solar power projects. The problem with this business is that it is not hard and many players are crowding the space. Margins are tiny.

So Sunedison CEO Ahmad Chatila decided to go further up the value chain and actually build and own projects. This way he could make money both ways. He collects some tiny margin when building and then puts the project on his books and collects the returns. This is a noble strategy if, and only if the project is priced correctly. If not, it turns into a nightmare.

Sunedison did not price projects correctly.

They must have been under pressure to lower prices for the projects to a point where they became economically difficult if not impossible to execute. However, Sundedison needed growth to justify a high stock price, so they piled in on more on more projects .

Chatila was in effect doing what Wall Steet calls capital cost arbitrage. He was able to raise money for low rates and invest it in projects with higher returns. For example, let’s say you raise money in the US at 5% and invest it in a project in the US at 6%, you make 1%. Now, let’s assume you raise USD at 5% and invest the money in China at 12%. Even better.

The problem with this is that projects in Emerging markets should have been priced a higher returns because they are much riskier than Chatila assumed. But he didn’t stop investing because Wall Street kept funding him. Now Wall Street stopped funding and Sunedison is in trouble.

It is not surprising that now you hear stories about Sunedison allocating capital and assets among it’s subsidiaries to benefit the mother ship. If you sit on bad assets it is only natural to try to move them around in the hope investors don’t notice.

The interesting thing about this situation is that the market has tolerated this for a long time. Now, all of a sudden it doesn’t. It’s a good lesson for both, longs and shorts. Houses of cards, ponzis and other market manipulatin schemes hold much longer than they should. When they crack, they crack.

For people interested in investing in Sunedison or its subsidiaries (yieldcos) Terraform Power or Terraform Global the key questions is, what are they paying for the projects which are on the books of those companies. That is a hard question to answer. The market thinks that the asset value is lower than the debt, i.e. the company is bankrupt. In that case it really doesn’t matter what you buy or short.

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