Monthly Archives: March 2013

PV Crystalox Solar: struggling, but returning cash

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:

  1. What’s the current financial condition of the company?
  2. What kind of future performance should we expect?
  3. 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

Bunch of quick updates (STP, WH, DSWL, SALM)

Suntech Power (STP)

With the debt maturity of Suntech’s $541 million in convertible bonds at the end of this week it’s not a surprise that this issue is getting a fair amount of attention recently. Today the company announced that it had entered a forbearance agreement with 60% of the convertible debt holders. They have agreed to not exercise their rights until May 15, 2013 if the company doesn’t pay at the end of this week. Suntech’s plan is to try to restructure the notes. My bet is that this is going to result in massive dilution for the equity. Bankruptcy as a step in between also seems like a plausible scenario since 40% of the bondholders haven’t signed the agreement. It could take some time to see how this is going to play out.

WSP Holdings (WH)

Basically nothing has changed fundamentally between 21 February, when I first wrote about the going private arbitrage opportunity, and today. We are still waiting on the SC 13E3 filing, so it’s probably going to take at least a few more months before before it will go private at $3.15/share. Despite this the price has gone up from $2.83 to $3.05: changing the potential return from 11.3% to 3.3%. Annualized that would still be decent if it’s a transaction with zero risks, but it isn’t. So I’ve decided to substantially reduce my position in the company, and I’ve sold all my shares that I bought two weeks ago.

Salem Communications (SALM)

SALM has been on fire since I bought the stock a bit more than a year ago, returning almost 170% including dividends. Intrinsic value has been moving upwards at a significantly slower pace, and while I don’t think the company is expensive at current prices it’s probably getting pretty close to fair value. At the same time SALM had grown into a big position in my portfolio. Because of this I’ve decided to sell 50% of my position last week at $6.99. I’ll keep the other half to see at what rate they will be able to refinance their debt: I expect that this will provide a nice boost to FCF.

Deswell Industries (DSWL)

I have been looking at various Chinese small caps, but in most cases I’m thinking that I simply like DSWL more because it’s profitable, the balance sheet is rock solid and the company has a long history of returning cash to shareholders. Since Deswell wasn’t a very big position to begin with I thought the logical thing to do was to add a bit to this position instead of buying into an inferior idea. Increased my position size last week by 33% at $2.51.

Disclosure

Short STP, Long WH, SALM, DSWL

STP debt maturity in 9 days, board without plan

The maturity date of Suntech’s $541 million in convertible bonds is getting very close and it seems that the company is heading straight for bankruptcy. Shi Zhengrong, who was ousted as chairman this week, said that the board has no solution to handle the debt maturity. With the maturity in 9 days there is definitely not enough time to organize a debt for equity swap, so bankruptcy is the only option if there is no miracle bailout. Despite this the market cap of the equity is still more than $200 million while the bonds are trading at 37% of par…

Disclosure

Short STP