If you haven’t been living under a rock you probably know that the solar industry isn’t doing very well despite rapidly growing sales. Thanks to massive subsidies from the Chinese government production is growing even faster than demand, and prices have plunged downward. PV Crystalox Solar, headquartered in the United Kingdom, hasn’t been unaffected and posted big losses in 2011 and the past six months. Management has responded sensible to the negative developments by decreasing production and preserving cash. It had a €122.4 million net cash position last June while it currently has a €54 million market cap, and recently Crystalox announced that it would return excess cash to shareholders. Enough ingredients for a potentially interesting situation.
Before diving deeper in the company, some quick stats:
Last price (Mar 12, 2013): 11.25p
Shares outstanding: 416,725,335
Market Cap: £46.88 (€53.55M)
P/B (mrq): 0.28x
P/NCAV (mrq): 0.53x
Based on asset value the company looks cheap, but those numbers are at the moment pretty old since the company reports twice a year and the latest interim report was for the period ending 30 June 2012. So we need to answer a few key questions:
- What’s the current financial condition of the company?
- What kind of future performance should we expect?
- How much excess cash is left on the balance sheet?
Current financial condition
Figuring out how much money the company is currently losing is a bit messy with multiple moving parts, but a rough estimate is better than no estimate.
Onerous contract
Crystalox has a long term contract that requires it to buy polysilicon at above market rates. This is represented on the balance sheet as a €50.7M onerous contract provision. What this means is that the company has already recognized the loss related to this unfavorable contract, but it hasn’t finished paying it. Looking at reported earnings as a way to figure out what will happen with the cash balance is therefore a bit tricky, especially since this liability is also a moving target because it depends on the polysilicon market price. At the same time the earnings also include non-cash expenses such as depreciation and amortization.
A rough estimate of the cash burn can be made to start with the EBITDA for the six months ended 30 June, minus the utilized onerous contract provision in this period, minus currency gains and an adjustment for changes in polysilicon prices. EBITDA minus currency gains was negative €7.9 million in the first six months of 2012.
The adjustment for the onerous contract provision is a bit more tricky. Crystalox used €4.1 million of the provision in the first six months, but the size of the provision also increased from €17.8 million to €50.7 million. On the balance sheet €12.6 million is recognized as a current liability, meaning that it has to recognize ~€6.3 million the next six months. Combine this with the adjusted EBITDA and it seems Crystalox is on track to burn €14.2 million in the second half of 2012.
This isn’t the whole story yet, prices have continued on a downward trajectory. Spot prices for polysilicon have declined from roughly $25/kg in June to $18/kg today. This means that the onerous contract provision will increase in size again and that more money will be wasted on overpriced polysilicon. I do think the impact will be fairly limited though. Spot pricing was at $70/kg at the beginning of 2011, so what ever happens: the biggest drop in absolute terms is behind us. The price can’t drop below zero :).
Deferred grants and subsidies
Another liability on the balance sheet that deserves some attention are the deferred grants and subsidies. The company recently decided that it will discontinue its polysilicon production facility in Bitterfeld, Germany. While it’s not clear from the balance sheet why the company got grants and subsidies in the past a large part of the 23.8M liability is probably related to the Bitterfeld facility. These liabilities increased significantly on the 2008 balance sheet after the facility got build. With Crystalox discontinuing it I assume there is a high probability that a large part of these subsidies need to be repaid. No idea how this exactly works though! There could be room for an upside surprise.
Adding it up
Admittedly this is a bit rough, but lets assume that the company burned through €20 million the second half of 2012. This number is significantly higher than the €14.2 million estimated above, so we have plenty of room to account for lower polysilicon prices and possible one time restructuring costs related to shutting down facilities and firing employees. I do think this estimate is on the pessimistic side because Crystalox has been reducing production and cutting costs, so while spot prices have gone down I would actually expect that EBITDA before exceptional items has improved. If we also assume that the company needs to pay back the majority of its subsidies it would have roughly €80 million in net cash at year’s end.
The future
At the end of the last year, at the same time when the company announced that it would return cash to shareholders, it also announced the following:
The Group intends to adjust its operations to align with anticipated sustainable short term market demand so that the ongoing business will be broadly cash neutral in 2013. As part of this programme the Group i) will discontinue its polysilicon production facility in Bitterfeld, Germany; and ii) will reduce substantially its production output at its UK ingot and German wafer operations. Regrettably these actions will lead to very significant job losses both in the UK and in Germany.
Given the current cash balance and market cap my main worry is the future cash burn of the company. Buying 50 cents on the euro doesn’t do you any good if the company burns though it like a wildfire. While management expectations need to be taken with a pinch of salt I do think these expectations are reasonable credible. They are taking concrete action by reducing production significantly, and they should be in a reasonable position to estimate the profitability of the remaining business (selling solar panels on long(er)-term contract basis). It’s not some vague turnaround story where you have to trust management that a new strategy will suddenly be profitable.
A significant factor that will be outside management control will be the pricing of polysilicon and wafers. The price of polysilicon seems to be stabilizing and looking at some industry publications it seems that this is the consensus expectation for 2013. This article mentions for example an average price of $23/kg in 2013, and iSupppli also expects the drop to end.
Excess cash
Now that we made some wild guesses on what has happened with the company’s cash balance and what will happen in the near future we can move on to the next guess: how much cash will be considered excess cash and will be returned to shareholders? If the company expects to be cash flow break-even in 2013 I don’t think it would need a huge cash balance. So if there is indeed roughly €80 million left it could potentially pay out it’s whole market cap is cash and leave the company with a nice €30 million cushion.
Upside optionality
With a bit of luck an investment in Crystalox could turn in a free-roll at today’s prices, and you also get an option of the outcome of two arbitration cases. When Crystalox entered a long-term contract to buy polysilicon it’s also entered in multiple long-term contracts to sell wafers. One former customer settled their contract in May 2011 for €90 million in cash, and it also explain how Crystalox ended up with the cash-rich balance sheet despite being in a troubled industry. Two other customers were unwilling to settle at acceptable terms:
We have been unable to reach a satisfactory agreement with two long-term contract customers who have been amongst the industry leaders in recent years and we are seeking resolution under the jurisdiction of the International Court of Arbitration. While successful judgements in the Group’s favour are anticipated there is increasing uncertainty as to whether one of these companies will have the financial resources to fully settle its claim.
While it’s uncertain if Crystalox will get a ruling in their favor and even more uncertain if the companies are able to pay I do think the net present value of the option could be significant if the expected size of the judgments are in the same ballpark as the first €90 million settlement. You need just one company paying €50 million and you can double today’s market cap.
Insiders
Having a management team with incentives that are aligned to mine is important in my opinion. The CEO owns 10.6% of the company while insiders as a group own 13.9%. Their equity is valued at €7.2 million while they got a salary of €1.1 million in 2011. They have more than six year salaries locked up in the company, so that should provide a good incentive to preserve value. Another large shareholder, owning 10% of the outstanding shares, is Dr. Barry Garrard who seems to be some kind of ex-insider. I would have preferred that management owned a larger part of the company, but it’s a decent stake.
Conclusion
The solar industry is an ugly business these days, and I’m actually short one of their biggest Chinese competitors (STP). The big difference between PVCS and STP is that the latter has a crushing debt load while PVCS has a large net cash balance. That doesn’t mean that an investment in Crystalox is without risks: the company might return less cash than expected this year, it might continue to burn through cash and/or it might not receive anything from their former customers.
Despite this I think the risk/reward ratio is quite favorable at current prices. When things go wrong I probably recoup a significant part of my investment, and I don’t need many things to go right to make a great return. One of their former customers settling their long-term contracts could provide plenty of upside already, and the core business returning to profitability would be even better news.
Rating: on a scale of one to five I’m going to give this idea three stars. It’s risky, and I’m not going to make Crystalox a huge position, but the upside potential is also great.
Disclosure
Long PV Crystalox Solar
Nice write up.
I’m also in this.
We’ll have a better idea on the lay of the land in a couple of weeks when their results are presented.
MCN
Yes, hopefully they also announce how they want to return cash and how much cash they want to return. The latest trading update said that they wanted to offer shareholders an “element of choice”.
sounds like a tender offer.
Possibly. It’s not the only option, could for example also be a dividend where you can choose between cash and/or shares. We’ll see how they do this.
$100m cash in dec – $70m liability = $30m left for you
$50m poly est is rosy. long way from $23/kg to $0. pvcs capacity is <2% of total. no impact on mkt.
poly is not the whole story. you'll be left with loss-making wafers plant for "optionality".
but at least you got your fx right, not like the original guy who brought this up and mixed gbp with euros.
I don’t think it makes sense to take the cash and subtract all liabilities to figure out how much is left. They might have an accounts payable liability, but their accounts receivable asset is bigger. They have accrued expenses, but they have twice as much prepaid expenses as assets. Even the onerous contract provision is balanced by a decent amount of inventory.
About the poly pricing: I certainly expect that the current E50 million provision is not big enough, but I don’t expect that it will increase a lot (this year at least). If pricing goes from $75/kg to $25/kg and this results in a E50 million provision, then I would expect that if prices would drop from $25/kg to $12.5/kg (way lower than industry expectations) that the liability would only grow from E50 million to E62.5 million since this drop is in absolute terms just 1/4 of the first drop. At the same time the provision should shrink every quarter since the company is paying down the ‘debt’, and it’s getting closer and closer to the end of the contract term.
Re return of cash, another possibility would be a B-share distribution, where you can choose to take the cash as dividend (taxed as income) or capital return (potentially taxed under CGT).
That’s what I’m guessing they mean, but it *is* just a guess.
Guess you are right: they are going to “issue of B and C shares providing the shareholders with the option to take payments as either income or capital.” Any idea what the tax implications are for foreign shareholders?
I don’t think the UK withholds tax on dividends.
Meant to add: great writeup – many thanks.
PVCS announced results today.
Haven’t fully analyzed the results, but seems to me that:
1. A bit more cash has disappeared than expected: 95 million left (and they haven’t repaid the subsidies yet)
2. I was right to assume that they have to repay the subsidies, unfortunately everything (23 million).
3. They don’t expect that the settlements with the other customers will result in a significant amount of cash
4. Cash will be returned this summer (amount: still unknown)
5. Outlook is positive cash flows in 2013 (although “broadly cash neutral” is also mentioned)
They have written down the Bitterfeld plant to €8m, scrap value, from an original cost just a few years ago of €100m!
Sounds like €8 million in upside to me 🙂
AV,
You may also be interested to know that Quantum Partners (Soros’ investment vehicle) hold ~3% of the shares via CFD if I remember correctly.
I’m also long here essentially for the reasons you’ve outlined. There’s a hell of a lot of pessimism in the price (essentially a -ve NPV for the operating business… harsh!) but it looks like they aren’t that operationally geared and can run at cash-neutral until the solar market fixes itself. Interestingly, it looks like the EU are investigating the chinese firms for anti-dumping practices and if so might end up introducing tariffs as ‘punishment’. If so this would help the spot price in the EU at least potentially helping the situation here. Even if this doesn’t happen, the usual market forces should over time hopefully move supply and demand back in to some reasonable balance as factories get mothballed/run at reduced rates whilst demand carries on growing. My concern here is that there’s a lot of supply that could get reintroduced at relatively short notice due to the heavy overinvestment in the supply side and this will prevent the industry as a whole from making any kind of reasonable profits for a long time.
But oh well, I’ve essentially got a free option on that happening anyway! If the operating business has an NPV of £0 then it’s still cheap. I just hope they elect to return a good chunk of that net cash in June!
I wouldn’t expect healthy profits in this industry anytime soon, but certainly think the worst is behind us. STP going bankrupt, consolidation expected in China -> more rational pricing in the future. Anything above cash flow break-even is fine with me! Also hope on a good return of cash in June, but they will probably retain a sizable chuck of cash as well.
PVCS pay out will be 7.25p/sh (~€8.5c)
Not as much as I hoped it could be, but it does take most of the downside away :).
Apart from the tax aspect, do you think there are any other possible implications of choosing the B or C shares?
I don’t think there is any difference worth mentioning besides the different taxation. Just a way to allow shareholders the choice between dividend withholding taxes or capital gains taxes. Not quite sure yet what’s for me the best option as a foreign holder of the stock. Think that both options should be tax free for me 🙂