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Summary Terraforma Power shares collapsed over the past few months. Liquidity concerns and the funding of future commitments are worrying investors. I will dig into the liquidity issue to assess whether the company is a good investment opportunity at current prices. Terraform Power: buying when there is blood on the streets? The original quote is attributed to Baron Rothschild, who apparently made a lot of money by buying assets amid the panic that followed the Waterloo battle against Napoleon. Can we apply the same concept to Terraform Power (NASDAQ: TERP )? Only one thing is certain. There is a lot of blood on the streets. The stock is down almost 80% from 40$ in July to 8.4$ at the time of writing. A bit of a background may help those not familiar with the story. The company owns and operates clean power generation assets (solar and wind in particular). In a nutshell they buy the assets, they structure the financing, they negotiate power purchasing agreements (if they do not come already with the assets) and they distribute the income once operating costs and financing costs are repaid. A very simple business model. Two things make it complicated: Liquidity: in the good old days of a stock trading between 30$ and 40$ they signed agreements for acquiring a significant amount of assets knowing that they had a lot of options to finance deals (project financing, corporate bonds, loans and equity issues). The stock decline worried investors to the point that the liquidity issue is becoming a self-fulfilling prophecy: the stock goes down, cost of equity and debt goes up, they have fewer options available for financing and therefore the stock goes down even more. Issues at Group level. TERP is partially owned by its sponsor, Sunedison (NYSE: SUNE ), a developer of solar plants whose stock price has crashed even more due to high leverage, significant commitments to buy new projects and incredibly difficult to read financial statements, with a mix of recourse and non-recourse debt and questions on the future solvency of the business. In this report I will try to assess the current situation of TERP and the future commitments in order to establish whether the market overreacted to the liquidity issues and is mispricing the stock. A good starting point is the presentation of Q3 results. On slide 17 the company shows the most recent capital structure adjusted for the latest deals announced: (click to enlarge) Source: Q3 2015 Earnings presentation The company shows cash of 796 mln and a combination of recourse debt (two bonds for 1.25bn) and non-recourse debt (project financing for 1.3bn). The net financial position including all debt is therefore 1.76bn. This debt is against a 2016 ebitda run rate for the current portfolio of approximately 400 mln with a net debt / ebitda of 4.4x and against a portfolio of renewable energy facilities valued at approximately 4bn in the balance sheet. If we were talking about real estate we would say that the loan to value is 44%, a reasonably low level. Remember that we are talking about assets with highly predictable cash flows and long term power purchasing agreements in place (average life of 16 years). The status quo shows one thing: the company is currently under levered given the type of assets they held. One important supporting factor is the recent (November 6th) renegotiation of the debt on certain assets in the UK, the results of which are in the pro-forma figures showed above. The company managed to refinance those UK assets at a 4% all-in interest cost with non-recourse debt. That figure shows how – at an asset level – TERP’s portfolio is seen as extremely high quality. Now let’s look at the commitments. Here things start to become challenging. TERP committed to buy 1,453MW of solar and wind assets from Invenergy and Vivint as part of a deal structured by its parent Sunedison. The total cost of those assets is approximately 3bn. From the 10Q we can also see that the company has commitments to buy additional energy facilities from Sunedison for a total of 1,080MW (1.4 bn). Let’s analyse how the company is thinking about those commitments. On slide 18 of the Q3 presentation the company offers a picture of the current status of the financing plan for the Invenergy and Vivint acquisitions, showing 1.7 bn completed and 1.3bn in progress. (click to enlarge) Of the “in progress” part of the financing we have three components: Vivint Term Loan or TERP bond (250 mln) Project finance debt (726 mln) 3rd party infrastructure capital (300 mln) During the Q3 conference call the management stated that they are making good progress on the financing. My personal take is that a TERP bond is not realistic (the yield would likely need to be above 10% given the sentiment around the stock) while all other options appear credible. In particular the largest chunk is project finance debt and the company showed earlier this month that they can successfully raise that kind of capital at very good terms. Infrastructure capital should also not be a serious problem in a market full of yield hungry investors. I will let you make your judgement on this but I believe we are not talking about an impossible task for the company. Remember, all assets are cash generating with 15 years plus of revenues under contract with primary standing counterparties. Moving on to the commitments to buy the Sunedison facilities the company states in the 10Q that on October 26th SUNE entered into a purchase and sales agreement with a JP Morgan fund that agreed to buy three of the assets that are part of those commitments. Upon closing, expected on the fourth quarter of 2015, TERP will have a reduction in its commitment to buy SUNE assets from 1.4 bn to 580 mln. The company intends to deal with these commitments through a combination of project finance debt, company cash, assumption of current debt and the involvement of third party infrastructure investors. While TERP is currently working on securing the financing, SUNE is also looking for third parties that may be interested in taking the projects directly. In case of a sale by SUNE the commitments for TERP would decline further. A final point that I would make on the liquidity issue is that the company currently has in place an unused revolver credit facility equal to 725 mln that is going to increase to 1 bn and can offer further flexibility in structuring the financing for the deals mentioned above. My final take on the liquidity issue: it is very scary when sudden lack of confidence hits a company. TERP’s 2023 bonds moved from 95 at the beginning of the month to current values of around 70. Capital markets are clearly closed for TERP at the moment. That contrasts a lot with what the company managed to achieve by financing at the asset level , like they did in the UK. I particularly like the fact that at the moment there is only 1.3 bn of project finance debt in place against 4 bn of assets and that suggests me that deals similar to the UK refinancing could soon take place in other parts of the portfolio. I am confident the company will work in this direction and will eventually be able to finance all the deals even though spreads will certainly be higher than a few months ago. Finally let’s look at the stock. What are you buying at 8.4$? I will make a very simple analysis here. Let’s assume no equity is issued and all commitments are paid for with new debt. Let’s also assume that the incremental debt raised and its amortization completely eats all of the cash flow produced by the assets. That’s very harsh credit conditions. Even in that case we would have a company that can sustainably keep the current dividend rate at 35c (in reality the plan is to increase it to 0.425 in 2016) based on the cash available for distribution from the current assets while building some additional equity in all those projects thanks to the amortization of the debt. That is a 16.8% yield + the build-up of some equity in the current projects. Not bad. Worst case / best case. The worst case scenario would be a bankruptcy of parent SUNE, with certainty of some messy agreements that would need to be worked through, and complete lack of financing. In this case I believe the equity would still be worth something (let’s say 3 / 4 dollars a share) based on a liquidation of all the assets owned + commitments at a 25% discount to book while repaying all debt at face value. A clear sky scenario would see the company providing for all the liquidity needs through external sources at reasonable terms. In that case the stock would rebound and, even though I believe the 30$ – 40$ range will not be reached for a long time, we would likely see TERP trade back to around 25$ (three times the current level). Conclusions: although risks are extremely high and volatility will continue to characterize the stock, I believe TERP offers a great asymmetric return profile. The downside is large in a worst case scenario and therefore position sizing should take that into account but, at least this time around, I am a buyer despite all the blood on the streets. Scalper1 News
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