Solar Losers: LDK Solar

(LDK Solar story, updated for first quarter results date, analyst comments on LDK balance sheet)

NEW YORK ( TheStreet) -- Chinese solar company LDK Solar ( LDK) announced after the close on Thursday that it was pulling a planned U.S. dollar-denominated note offering, sending shares lower, but, in reality, serving as only one more trigger for investors to consider the Chinese solar company's long-standing balance sheet issues.

"Despite the postponement of this bond offering, we still expect to generate sufficient operating cash flow to support our business plan," stated Xiaofeng Peng, Chairman and CEO of LDK Solar in the release.

LDK Solar shares fell by 8% on Friday morning.

After the market close on Thursday, LDK Solar shares had declined by 4% (on top of a 4% decline during regular trading on Thursday.) Yet for solar investors to be concerned about a 4% decline in LDK shares, or the impact of the scrapped note offering, would be mistaking mole hills for mountains. For LDK, the mountains to climb exist, but those formidable peaks hadn't changed on Thursday, or materialized because of one scrapped bond deal. Compare the after-market decline on Thursday to LDK's decline since January, from a share price of $14.50 to $8.21 at the close on Thursday. Compare the scrapped senior note offering, which would have been used to pay off short-term debt, to the existing state of LDK's balance sheet.

Paul Leming, an analyst at Soleil Securities/Princeton Tech, who has been critical of LDK's financial management for years, said after the note offering was postponed on Thursday, "Reality -- not a big deal. They've been living on bank debt for years; they'll keep living on bank debt."

However, Leming does think the LDK balance sheet should be a major focus of investors amid what has been a string of very weak solar earnings reports and second quarter outlooks. LDK itself pre-reported that it would miss its first quarter revenue by as much as $105 million - the mid-point of its guidance revision was a revenue miss of $75 million. While solar management teams are by and large reaffirming full year shipment guidance, investors don't seem to be buying it. On average, solar stocks have declined by 40% since the sector reached a collective high point in October 2010.

The most alarming solar sector earnings outlook came this week when Chinese solar module low-cost leader Trina Solar said it expected gross margins to decline in the second quarter to the range of low-20%. Trina has specific third-party wafer buying needs that are behind the gross margin decline, but analysts and investors still say that the solar industry outlook remains uncertain, and that simply going along with the solar management team's reaffirming of shipment guidance isn't good enough to remove the ref flags.

Solar companies have been reporting accounts receivable and inventory figures in the first quarter that have not been seen on solar financial statements since the first quarter of 2009, when the financial crash and Spain's decision to put a hard stop on solar installations compounded issues for the sector.

In the first quarter of 2009, LDK Solar shares had a value of $4.55. On Friday morning, Kaufman Brothers analyst Jeff Bencik, who had been at a buy with a $24 price target on LDK, lowered the stock to a hold with an $8 price target.

While the LDK headline about scrapping the note offering is a non-event, according to the Soleil analyst, Leming added, "Perception is another matter all together. The world is awakening to the train wreck in the industry -- and the weakest balance sheet(s) get hammered the worst. This will underscore to everyone that the company is financially VERY, VERY weak."

Take the SunPower ( SPWRA) and Trina Solar ( TSL) first quarter reports as examples. SunPower inventory ballooned to 124 days in the first quarter, second only to the first quarter 2009 level of 175 days. Days sales outstanding increased to 69 days, surpassing the first quarter 2009's 64 days and to the highest level ever. SunPower went from a mild net cash position to a significant net debt position quarter over quarter. At the end of the first quarter, First Solar ( FSLR) was at a net debt position for the first time in years, though it arguably has the best balance sheet in the solar industry regardless.

Trina Solar days sales outstanding increased from 54 days in the fourth quarter to 90 days. Accounts receivable increased from roughly $377 million to $543 million sequentially. At the end of the fourth quarter 2010, Trina Solar's cash balance of $791 million compared to accounts receivable of $377 million. At the end of the first quarter, Trina's cash of $555 million was compared to the $543 million in accounts receivable.

This solar season has already seen one company cancel its first quarter conference call and teeter on the verge of bankruptcy, in the case of Evergreen Solar ( ESLR). It's not fair to compare a company as stressed as Evergreen to any other company in solar -- and Evergreen has been on bankruptcy watch for over a year. However, it's recent woes highlight how a bad situation can be made worse in a hurry if an entire sector goes through a downturn.

Wells Fargo Securities analyst Sam Dubinsky wrote on Friday morning that LDK's "very weak balance sheet" is likely to worsen in the first half of 2011 due to higher inventory days and days sales outstanding from poor sell through.

After pre-reporting that it would miss first quarter guidance, LDK Solar finally announced on Friday morning that it will report first quarter results on June 7.

SunPower didn't provide guidance and wrapped up its earnings conference call in 30 minutes, leaving some analysts in shock. SunPower may not need to convince anyone on Wall Street that all is OK since French oil giant Total ( TOT) announced that it was making a tender offer for 60% of SunPower shares at a 40% premium. SunPower certainly doesn't want to talk about how tough things are in the solar industry right now with Total getting ready to pay a premium for its stock, either. The Total deal also provides SunPower with a huge balance-sheet cushion, including up to $1 billion in debt capital.

LDK also has a lifeline of sorts. LDK Solar plans to take its polysilicon plant business through a spinoff this year, and anonymous quotes in the Asian press have put the value of the LDK polysilicon business at above $1 billion. Yet if the polysilicon business was creating a floor underneath LDK shares, the floor seems to be missing some boards in recent trading.

Polysilicon prices have started to decline rapidly in the spot market -- this week it was down to between $75/kg and $65 -- and high polysilicon prices have been a ballast to LDK. In addition, LDK's main solar business is its wafer business, and wafer prices have suddenly gone into freefall also, after being one of the most resilient pricing points in the solar supply chain. Additionally, LDK Solar is trying to transition to a major solar module sales business model, and module prices have gone down in a straight line since February from $1.80/watt to as low as $1.40 this week. The conventional wisdom is that if the low-cost module leaders like Trina are feeling the pinch, LDK's module business will feel it to a greater extent. ReneSola ( SOL) recently made the most controversial call of the solar earnings season, saying that module pricing could fall to $1 by the fourth quarter.

The Soleil analyst Leming says that the polysilicon business spinoff is far from a done deal, and furthermore that recent financing that LDK received is contingent on the deal closing. The China Development Bank and a group of investors paid $240 million for an 18% stake in LDK's polysilicon business in January, and the deal has lots of strings attached, including being contingent on a successful IPO in the next two years. There are also several financial targets that the polysilicon must hit in generating returns. The simple math can be done that if the China Development Bank and its investor group paid $240 million for an 18% stake, the polysilicon business is worth at least $1 billion. However, their $240 million investment came with the covenants that make them much better protected than a common equity investor ever would be.

"This IPO needs to happen, and LDK has to prove they can get it done in the environment we are in now," Leming said.

Wells Fargo's Dubinsky, writing along a similar line, wrote on Friday, "Poly plant spinout crucial but looking more difficult. A poly spinout could partially alleviate our concerns, helping raise the necessary funds to recap the balance sheet. However, this catalyst is looking more challenging with poly pricing likely to decline double digit in coming weeks/months given weakness at downstream customers."

Shares of Chinese polysilicon giant GCL-Poly recently declined for six consecutive sessions, according to a Bloomberg report. At the same time, GCL-Poly and South Korean polysilicon giant OCI are adding more and more capacity. OCI announced a major polysilicon equipment order with GT Solar this week, GT Solar's largest order ever from a solar customer. "I would never say the equity market would turn away from an IPO because there are already enough names out there. You can always get another one to market, but if you ask me what LDK brings to table that an investor can't get in OCI or GCL, what's the positive upside story, I'm hard pressed to answer," Soleil's Leming said.

In February, LDK raised $162 million in a secondary offering, but by April, LDK had to pay $353 million in cash to holders of convertible debt who balked at LDK's plans to refinance the convertible notes.

These issues aren't even at the core of the LDK balance sheet concerns, though.

In its annual report, LDK Solar noted that as of the end of the fourth quarter, before conditions even became weak across solar, it had a working capital deficit of $1.6 billion -- total current liabilities of $3.6 billion exceeded total assets of $2 billion. As of December 31, 2010, LDK had short-term borrowings and portions of long-term debt totaling $1.5 billion. LDK had short-term debt obligations of less than one-year of $1.2 billion at the beginning of the year.

"LDK has access to Chinese bank debt to stay afloat, but interest rates could increase and the debt is short term in nature (does not solve the long-term problem of shoring up the balance sheet)," the Wells Fargo analyst noted.

In the opinion of the Soleil analyst Leming, though, one of the more alarming balance sheet items that is often overlooked is the bills that LDK is required to pay its equipment providers. It's not typically viewed as part of the debt issues on the balance sheet.

Soleil analyst Leming explained that the devil is in the details of these equipment charges. LDK had purchase of equipment charges of $469 million last year and of $404 million this year. Now LDK owes vendors (within 12 months) $404 million for equipment that has already been installed. If LDK had paid their contractors and equipment vendors on time, they would have had to borrow money to do that, the Soleil analyst surmises. By not paying their contractors and vendors in a timely fashion (and booking the money spent as a liability) they were ability to keep short-term debt $400 million lower than it would be if they had paid their bills on time. "I would argue that one can add this $400 million to their short-term debt to arrive at their true level of debt. Every company has current liabilities, but this is not day-to-day supplies of raw materials. That is real money owned to someone well inside of a 12-month time frame," Leming said.

At the beginning of the year, LDK had $857.3 million of non-cancelable purchase obligations: $231 million in purchase obligations to Applied Materials, for wafering wire saws, squarers and solar cell production equipment to be delivered during 2011; $169.3 million in purchase obligations to JYT Corporation for pullers and DSS furnaces to be delivered in 2011 and 2012; and $73.8 million in purchase obligations to Centrotherm Photovoltaic AG for solar cell production equipment to be delivered in 2011.

In the opinion of Piper Jaffray analyst Ahmar Zaman, the reaction to the LDK announcement that its bond deal was scrapped is an overreaction, as are claims that its finances are dire. In fact, Zaman said that LDK Solar management didn't even need the bond deal to occur to meet its financial obligation, and was basically looking for some icing on the cake financially. "I spoke to bond buyers in Asia and they told me that the reason this deal didn't get done is because LDK misjudged investor interest in a solar bond deal, and there were two other big Chinese industrial companies shopping debt at the same time." This does, however, raise the issue of whether the financing environment for all solar companies is becoming more difficult.

Soleil's Leming agreed that the bond offering was never the issue, yet says of LDK's massive short-term debt, "normal companies want a high debt load funded WAY out in time...their balance sheet remains a train wreck."

The Piper Jaffray analyst offered support for a more optimistic view of the LDK balance sheet:
  • It has a $1.1 billion revolver which remains untapped
  • It started the year with $700 million in cash (though $500 million of this cash was already pledged)
  • It already raised $400 million (more than covering the convertible investor payment)
  • It will generate $600 million in cash in 2011, according to Piper Jaffray's estimate (though LDK has guided to $800 million in cash from operations this year)
  • Furthermore, LDK only needs to spend $500 million this year and $100 million in interest payments, according to Piper Jaffray analysis. "It has sufficient liquidity and doesn't even need to tap the $1.1 billion revolver," Zaman said.

    Soleil's Leming stressed that he has always held to the belief that LDK will remain funded. "My gripe is not about an imminent 'liquidity crisis.' My gripe is about 65% of capital structure being debt," he said.

    The Piper Jaffray analyst did allow that if wafer pricing and polysilicon pricing continue to fall, LDK Solar could be cash-flow negative in the second half of the year and its cash from operations might be closer to $400 million, as opposed to $600 million. Yet he said LDK Solar will still generate cash of $200 million from the first quarter, when wafer and poly pricing was high, and should generate significant cash in the second quarter.

    The Soleil analyst said that the positive discussion about cash from operations can be turned on its head when the longer term picture is considered. "Let's take this company into cash-flow negative territory in the second half and ALL of 2012. One more time -- I don't worry about a liquidity crisis. I worry about this company's valuation on $300 million of annual EBITDA in late 2011/2012. Put a 10X multiple on that EBITDA and subtract $2.5 billion of debt and you have $3/share of equity value. THAT is the problem," Leming wrote in an email to The Street.

    "With its shares at 7.40, it's at book value and, for me, a good buy here," Zaman said. He added that if module prices do come down to $1.30/watt in the second half of the year, LDK will be one of lowest-cost module providers in industry because of its in-house wafers and polysilicon, Zaman said. He added that the replacement cost for the polysilicon operations alone are $900 million and currently LDK Solar is trading at a market cap of $1 billion.

    The Soleil analyst countered that it's a common Wall Street fallacy that low-cost producers can't lose money in a downturn. "Low-cost producer" does not equal "guaranteed to be profitable," and he added that margins in wafers and polysilicon can be slim.

    In the end, though, none of this suggests that LDK Solar has the potential to go bankrupt. In fact, both Soleil's Leming and a second solar analyst said it's impossible to conceive of an LDK bankruptcy.

    If the LDK polysilicon plant spinoff is a near-term floor on share price with a perceived value to be unlocked, the real foundation for LDK may be the $8.9 billion loan package that the China Development Bank has put in place for the company, though no funds have been allocated, and it is contingent on meeting financing requirements.

    "This company is too big to fail, and will still be able to roll over short-term debt," Piper Jaffray's Zaman said. "Its shares have been as low as $4 before, but at $7.40 it's already trading at the poly plant replacement value," the analyst added.

    On this point, Leming countered that replacement cost means nothing if an asset cannot turn a profit: "I've followed several companies with high replacement values of asset who have gone bankrupt because those assets (with the high replacement value) couldn't generate any cash flow. What was the replacement value of the assets at any newspaper that closed its doors over the last three years? If the business is broken, and there are no buyers for the assets, who cares what the assets cost to build -- they ain't generating any cash flow."

    Yet even the Soleil analyst sees no bankruptcy risk for LDK, though not necessarily for reasons that positively reflect on the LDK balance sheet. "This is a job intensive industry and no major company we know and love in China will go bankrupt. LDK will not go bankrupt. The Chinese banks will fund it to protect jobs," Leming said.

    The second solar analyst added with similar logic, "I've been to the LDK facilities in China. It's like a city. There is no way that the government lets it go bankrupt."

    However, the analysts said that in the least, investors need to consider the possibility that bankruptcy is not the issue. Just because LDK won't go bankrupt doesn't mean equity value doesn't go to zero, the analysts cautioned.

    In any event, Soleil's Leming says that the bankruptcy question should just send investors back to the more pressing question about whether current solar management confidence that a turnaround is right around the corner is correct. Most solar management teams are conceding that the first quarter was a nightmare between a horrible winter in Germany and Italy grinding to a halt, and taking the approach that everything that could go wrong did go wrong, but they will still make full year guidance with a strong second quarter for shipments and demand resurgence in the second half of the year.

    "Look at Trina. They say they will clean it all up and get back on track as we go through year," noted Soleil's Leming. "I happen to think these companies are going to struggle to get inventories and receivables under control two quarters from now, but I can't prove their confidence wrong," the analyst said.

    -- Written by Eric Rosenbaum from New York.

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