Muddy Waters is short Hannon Armstrong Sustainable Infrastructure Capital, Inc. (NYSE:HASI) because its accounting is so complex and misleading that its financial statements are effectively meaningless.
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Hannon Armstrong Sustainable Infrastructure Capital: "ESG" Is For Exaggerating, Scamming, And Grifting
We are short Hannon Armstrong Sustainable Infrastructure Capital, Inc. (HASI) because its accounting is so complex and misleading that its financial statements are effectively meaningless. HASI is a prime example of how public market incentives can warp a company into relentlessly destroying value to feed a Wall Street growth narrative. Most of HASI’s income is both non-cash and unrealizable: It has little relationship with cash to be received in the future. HASI misleadingly inflates GAAP earnings three ways: 1) Through a loophole in the arcana of accounting for renewables subsidies, HASI books non-cash unrealizable income relating to third parties’ tax credits that will be reversed; 2) HASI produces non-cash income by manipulating the discount rate it applies to residual assets to implausibly low levels, thereby inflating its gains on securitizations; and, 3) HASI books interest income from non-cash “Paid in Kind” (“PIK”) interest payments, which are essentially IOUs from stressed borrowers.
Overall, we adjust HASI’s 2020 GAAP income downward by $66.3 million to $16.5 million at the midpoint of our estimate. We adjust HASI’s 2021 GAAP income down by $362.7 million to a net loss of ($235.4 million) at the midpoint. HASI’s non-GAAP “Distributable Earnings” mislead investors who believe they are a proxy for cash earnings – we estimate 2021 cash earnings as negative. HASI’s dividend is almost entirely financed through capital raises. We believe that HASI’s operating cash flow is misleadingly high – we conservatively adjust it downward by approximately 39.3%.
HASI’s SunStrong EMI is an example of how HASI engages in seemingly non-substantive – if not outright value destructive – transactions with an equity method investment (“EMI”) company to create the appearance of cash flows and earnings by roundtripping money. We count $502 million of loans that HASI made to SunStrong since 2018 without disclosure as related party transactions, indicating that the cost to HASI for such financial statement flattery is outsized risk. The gain to HASI’s executives, meanwhile, is clear: they have disposed of $22.9 million of stock in the past two years, with CEO Jeff Eckel having liquidated or gifted $17.1 million.
We adjust GAAP earnings significantly downward because HASI misleadingly inflates GAAP earnings in three ways:
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- We estimate that HASI inflated 2020 income from EMIs by $40.4 million, or 540% at the midpoint of our estimate, and turned a loss into positive income in 2021 by using an accounting loophole to book non-cash, unrealizable income when the tax incentives associated with the project are realized by the tax equity partner.
- We estimate that by manipulating the discount rate to implausibly low levels, HASI inflated gains on securitization in 2020 and 2021, respectively, by 34% ($13 million) and 60% ($25 million). HASI performs securitization of receivables from government-linked and commercial projects. HASI receives a small securitization fee, but retains a residual interest responsible for significant paper income. HASI inflates its gains on securitizations by using what HASI calls a “market-based risk-free rate” to value the residuals, rather than a comparable market rate with default and other risk considerations. By dropping discount rates on residuals to 4.3% in 2021 from 8%-10% in 2013, HASI can write up the values of those residuals significantly on its balance sheet.
- We estimate that PIK interest income inflated HASI’s reported interest income in 2020 and 2021, respectively, by 16.1% ($13.2 million) and 15.1% ($14.0 million). HASI inflates earnings by booking undisclosed, non-cash PIK interest income. When a company “PIKs”, it essentially issues IOUs for the interest payments.
- HASI’s preferred non-GAAP metric, “Distributable Earnings”, has almost no relationship with cash earnings. HASI’s Distributable Earnings is a “have my cake and eat it too” metric. As should be expected, HASI adds back non-cash expenses. Critically though, HASI does not exclude non-cash income. We estimate that in 2021, non-cash income was $362.7 million, which was 2.3x HASI’s reported Distributable Earnings of $158.7 million. Distributable Earnings is therefore significantly distorted by HASI’s non-cash income.
- In contrast to other companies that collect cash for their revenue, HASI’s revenues have a significant non-cash component, stemming from PIK interest income, gains on securitizations, and non-cash income from EMIs or non-cash HLBV income. HASI does not remove non-cash income, only adding back noncash expenses and investments to calculate its Distributable Earnings.
- HASI makes an adjustment to income from EMIs, but this adjustment does not correspond to EMIs’ actual cash generation power. HASI replaces EMI income with another non-cash metric, a so-called “Equity Method Investments Earnings”, which is projected future income based on scenarios that seem greatly optimistic based on their performances to date.
- We adjust 2021 Distributable Earnings down from $158.7 million to a loss of ($181.4 million) by removing income that is likely or entirely non-cash.
- The vast majority of HASI’s dividends have been financed by returns of capital, not returns on capital – in other words, HASI primarily pays its dividends through equity and debt raises. In the eight years since HASI’s IPO, only 9% of dividends came from internally generated cash flows on average: 91% was just recycling equity and debt investors’ capital.
- We adjust HASI’s 2019-2020 Operating Cash Flow (OCF) down by -39.3%. We believe this is conservative.
- Non-cash HLBV income enables HASI to inflate OCF. HASI discloses that it accounts for any cash distributed from EMIs as OCF, up to the amount of income booked on each investment. In this way, HASI’s paper income also inflates OCF.
- We estimate that HASI used non-cash, unrealizable HLBV-related income and returns of HASI’s own capital from EMIs SunStrong and Buckeye to inflate OCF. We adjust 2019-2020 OCF downward by -39.3%, or -$39.4 million.
- HASI’s SunStrong EMI is a prime example of how HASI uses its EMIs to manipulate earnings and cash flows through multiple aggressive roundtripping mechanisms and without appropriate disclosures.
- HASI paid only $10 million for its 49% equity interest in 2018. We estimate that from 2019 to 2021, HASI has booked non-cash, unrealizable HLBV income of $15.3 million, for a paper IRR of 10.2%.
- HASI has made $645 million in mezzanine loans to SunStrong since 2018, of which $373 million were still outstanding at year-end 2021. These loans appear to be related party loans in substance, yet HASI has failed to make related party transaction disclosures regarding loans totaling $502 million. We see the failure to disclose as an attempt to obscure from investors how HASI uses SunStrong to manipulate its financials. HASI has generated $20 million - $30 million in annual interest income from these loans, of which ~40% is non-cash PIK interest that is settled by converting interest to additional loan principal.
- SunStrong has incurred millions of dollars in losses from inception to date. At the same time, HASI has refinanced certain of its loans to SunStrong twice with at best cosmetic benefits to the interest burden or loan maturity. These refinancings give the misleading appearance of healthy mezzanine loan repayment activity.
- PIK loans enable HASI to keep increasing interest income from SunStrong, even though SunStrong’s debt burden is extreme.
- We suspect that HASI’s sale of HA Helix to SunStrong, which was essentially for a payment of money borrowed from HASI, inappropriately inflated HASI’s operating cash flow while giving the misleading appearance that it collected cash on accrued PIK interest and principal.
- We view HASI’s misleading governance practices as obscuring the non-cash, circular nature of its business.
- HASI shows HLBV income from EMIs that is one-time, non-cash, and unrealizable. HASI is not obligated to show this income. To eliminate the significant amount of non-cash HLBV income it has recorded and properly apply accounting rules, HASI should take impairments or use realizable book values under HLBV. However, HASI chooses to continue reporting inflated non-cash income.
- HASI’s EMIs have experienced approximately ($449 million) in losses from hedges and other causes that remain poorly explained by the company. Yet, HASI reports record income from EMIs due to non-cash unrealizable HLBV income.
- HASI executives have cashed out $22.9 million of stock in the last two years, led by CEO Jeff Eckel. The company’s misleading non-cash “Distributable” metrics drove $8.6 million in 2021 executive bonus payments.
- After estimating HASI’s income inflation, we adjust HASI’s 2021 GAAP income downward by $362.7 million to a net loss of ($235.4 million).
- We adjust HASI’s 2020 GAAP income downward by $66.3 million to net income of $16.5 million.
HASI is a renewables-focused financial company that today operates three main income streams. The largest source of reported income is its Equity Method Investments (EMIs) in renewable energy projects. Most of these are minority investments in wind, residential solar, and utilityscale solar projects. HASI accounts for EMI income through “Hypothetical Liquidation at Book Value” (“HLBV”), which creates significant non-cash and unrealizable income. The second key segment is securitization of receivables from government-linked and commercial projects. Historically, HASI’s securitization-related income was largely a fee equivalent to a small percentage of the securitizations. However, HASI increasingly retains residual interests in these receivables, which as explained infra, generates significant paper (non-cash) gains. HASI’s third major income source is interest income from commercial and government loan receivables. HASI regularly books non-cash PIK interest from such receivables, even when the entity guaranteeing the receivables appears highly levered and generates little profit. All three business areas have significant non-cash income components that allow HASI to report unrealizable income.
HASI illustrates the perverse market incentives that can warp a business once public. Before HASI became reliant on largely unrealizable, non-cash gains, it was a boring, cash-based business. For 32 years before going public in April 2013, HASI was 100% fee-based, primarily generating fees from loans, land leases, and securitizations. Before its 2013 IPO, HASI’s managed portfolio consisted of fixed rate amortizing loans or direct financing leases, with ~99% of the portfolio consisting of U.S. federal government obligations, the majority of which were energy efficiency financing. HASI only began investing heavily in EMIs post-IPO, in 2014. HASI’s investment portfolio has changed significantly since then. As of year-end 2021, EMIs were HASI’s largest asset class, equal to 42.4% of HASI’s asset value; investments in receivables, both commercial and government, combining for ~34%, of which commercial receivables are 91.3% of the receivable balance.
Read the full report here by Muddy Waters.
