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Michael McDonald

Michael McDonald

Michael is an assistant professor of finance and a frequent consultant to companies regarding capital structure decisions and investments. He holds a PhD in finance…

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Sun Edison’s Stock Has Been Slammed. Is the Sell Off Justified?

As the specter of volatility returns to the stock market, investors in all segments of the market are starting to feel some of the pain that has hit energy investors so hard over the last year. This is small comfort to energy investors though, as stocks in that beleaguered sector have been hit even harder. The walloping in some companies is truly breathtaking and has to be putting some investors on edge. A classic case of this is Sun Edison, trading under ticker symbol SUNE.

Sun Edison is a good company that has built an enormous solar business, but much of its growth is predicated on debt. As investors have started to worry about oil prices, global growth, and the future path of interest rates, Sun Edison has been slammed. The stock is down from over $30 a share in July to roughly $11 a share at present. The eye watering drop of the last month is made even more significant by its implications for Sun’s acquisition of Vivint (VSLR). At this point the merger arbitration premium on that deal, assuming it closes, is a whopping 24 percent annually. Related: Sweden’s Nuclear Shutdown A Sign Of What’s To Come

The issue for Sun Edison is two-fold: First, the company has become extremely complicated in the last couple of months. In addition to buying Vivint for $2.2 billion, Sun has also created a yieldco called TerraForm Global (GLBL) and is dropping assets into that vehicle.

Further, in an effort to shore up capital and create breathing room on its balance sheet, SUNE recently did a $650M million convertible offering. The convertible price (as is typical in such deals) is set above current prices at $17.62, but that’s still well below the recent stock price. This is a case where timing made a big difference – two months ago such an offering could probably have been done for almost twice the valuation.

The TerraForm deal is an interesting idea, but yieldcos have already started to pass out of vogue for this economic cycle and with the Fed seemingly prepared to raise rates, fixed income-esque investments like high dividend yieldcos could suffer. Related: Did The Fed Intentionally Spark A Commodity Sell-off?

Similarly, the Vivint deal gives SUNE a line into the red hot residential solar panel market as VSLR is the number two installer in the country behind SolarCity. Nonetheless investors are concerned due to possible cuts for U.S. solar incentives in 2016, which, in turn, could cool the residential market.

As if all of this was not enough, the second issue facing SUNE investors is the firm’s significant debt burden. Sun Edison has a lot of debt and there is a good chance that higher interest rates in the future will push the firm’s debt costs higher as bonds mature down the road. This has some investors running for the hills. Given this, it is little wonder that investors have turned sour on SUNE stock.

Yet a 60 percent decline in price might be overdoing things a bit – if Sun Edison’s price in July was fair or reasonable, it’s hard to imagine that the situation has changed so drastically in 30 days as to warrant two-thirds of the firm’s value evaporating. Related: Mexico Sweetens The Deal In Offshore Lease Auction

Clearly though, this is the time for Sun’s management team to focus on improving operational efficiency at the firm. The company would likely be facing a more positive reaction from shareholders if it had better margins on its core operations. The firm has an enormous project pipeline, and that pipeline has continued to grow in recent quarters. But the key for Sun Edison now is not growth, it’s profits. If the firm can learn from efficient companies in the oil sector and start to demonstrate improving margins built around supply chain discipline and cost cuts, the stock has a lot of potential to rebound strongly. If the firm cannot demonstrate that kind of financial discipline, more pain could be ahead for shareholders.

By Michael McDonald of Oilprice.com

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