Value Investing

Bronte Capital Raises Further Questions About “The Sun Edison complex”

Bronte Capital raised questions about SUNE last month – see their latest below.

Bronte Capital Amalthea Fund Investors’ Letter for August 2015

The market got into a funk this month and many funds (including funds we admire) have had a rough time.

As the results below show our performance was fine. We beat global indices by more than 4 percentage points and during a rough period the value of your holding increased by 0.88% net of all fees and charges. Although it is by no means a sensible benchmark for this global fund it is notable that the Australian market (ASX 300) index was down 7.7% over August.

Our longs did not hurt us in any unexpected way. Many of our shorts made us good money. On the big down days our funds went down but well under half the market. Alas on the big up days we underperformed somewhat. There were no big surprises. Because the gains were mostly on the shorts our leverage levels generally declined during the month and our flexibility is increasing.

Newspapers have been calling this an “historic” sell off. It is not. Market funks like this happen every few years on average. The last few years however have been benign and so people are surprised.

We do not think the sell off has been large enough to make stocks cheap and there is no substantial change to our positioning. We expect worse. We just don’t know when.

Bronte Capital – The Sun Edison complex

The markets have not fallen very far – and we do not think generally that it is time to go looking for “bargains”. In the oil space (where the falls have been large) plenty of companies we regard as frauds and promotes have not yet failed. It is unlikely there will be true bargains (particularly in the energy space) before the big bankruptcies begin.

However there is one cluster of stocks which have been hit remarkably hard – Sun Edison and its related companies. We talked about these stocks in our last letter and they are the signal collapse of this little interlude of stock market history.

Sun Edison develops huge and highly capital intensive solar and wind project where the power is largely pre-sold and where separate financing is developed for each project. These projects are then sold to [“dropped down to”] semi-captive yield companies sold to mostly to yield sensitive investors.

There are several issues. Big solar projects are massively capital intensive – think of utility scale power generation where you have to pay for the next 25 years of fuel upfront. The projects have huge debt but also reliable high margin cash flow.

Secondly there is a pretty obvious conflict of interest in the “yield co” dropdowns. We have successfully shorted a few companies where we think that overpriced assets were being dropped down. And those stocks went badly wrong but it took time.

Thirdly, because of the related parties and the copious amounts of different types of debt these companies have complex and even scary accounts. John thinks himself a quite dab hand at accounting and has trouble getting to grips with it. In a meaningful fashion Sun Edison is a “trust me” story.

Whatever, the problems Sun Edison and its yield cos have been smashed. Once fairly obscure solar developers have become a major topic of discussion on Wall Street.

It has taken a while to understand why they have fallen so hard (and hence created the opportunity in the stock). The argument comes down to complex accounts, lots of debt and a peculiar acquisition of multi-level-marketing scheme (Vivint) that invites scrutiny.

But there is also more than the usual amount of rumor and innuendo. On Twitter-surprise!–there are arguments we know to be wrong and arguments that are simple fear-mongering (calling Sun Edison “Sun Enron” is one such appeal). Sure the company is highly levered and complex but it is almost certain that the past deals have been good deals. Any solar farm deal you put in place 3-5 years ago has worked out. Both solar panel prices and interest rates are lower than you would have baked into your cash flow models. We would be enormously surprised if the past deals of Sun Edison did not work out.

Whether the future deals work out is however an open question. Low solar panel prices and low interest rates are not exactly a secret – and the funding cost for solar panel farms has risen with this panic.

We have read an enormous amount about this company lately and most of it made little to no sense. However we are not beyond plagiarism where we find good ideas well explained and where the ideas test out against facts we know. Plagiarism is a perfectly acceptable investment strategy as long as you do enough work to know you are plagiarising good ideas.

And here we will plagiarize the anonymous Nemo’s blog (by “Nemo Incognito”). Nemo has an acute and we believe accurate description of the company. Nemo analyses Sun Edison as a non-bank financial. To quote:

There is a deeper problem with the way these companies [yield cos and their parents] see themselves and communicate with investors. That comes down to the fact that many have their roots in semiconductors where operating leverage is everything. You disclose your costs, your variable versus fixed, capacity expansion and so forth because if you make solar modules, wafers or chips that stuff matters a very great deal to your business. Investors use and demand that information because simply put, it matters and drives the profitability of the business.

Bronte Capital Amalthea Fund

See full PDF below.