Greenlight Capital CEO David Einhorn gave two ideas on Monday at the Robin Hood Investors Conference.
One was a long position — in solar company SunEdison. And the other was a long/short — long Greek banks, short French government debt.
We’ve got the full presentation for you here.
It starts off with Einhorn’s long thesis on SunEdison (slides 1-37). It’s the best performing solar company of the year, and he thinks it can only get better. The stock currently trades at $US19.22 per share but he thinks that it’s worth $US32 per share.
Around slide 38 Einhorn sorts out some of the mess that is Europe, focusing on Greece first. He argues that the worst is behind the country. The hardest decisions about austerity and the country is now “living within its means.” He recommends going long Grek banks — Alpha, Piraeus, NBG and Eurobank.
France, on the other hand, is just starting to look ugly (that starts on slide 67). It’s over-budget, suffers from high unemployment, and needs reform. Once the bond market realises all of that, Einhorn says, it’s time to short French government debt.
The next day, The New York Times ran a page one story proclaiming, 'the beginning of a new era…' The sun would be the solution to all our energy needs. It was so exciting.
Unfortunately, the early solar modules were clunky, expensive, and inefficient. In the 70s, President Carter put solar panels on the White House roof and subsidized solar energy. In the 80s, the price of oil collapsed. President Reagan removed the panels, and we forgot about solar.Unfortunately, the early solar modules were clunky, expensive, and inefficient. In the 70s, President Carter put solar panels on the White House roof and subsidized solar energy. In the 80s, the price of oil collapsed. President Reagan removed the panels, and we forgot about solar.
In 1990, the Kyoto Protocol set targets for renewable energy, and the Europeans -- particularly the Germans -- ended up providing subsidies to jumpstart the solar market.
The main subsidy was the 'feed‐in tariff', whereby anyone producing renewable energy got paid for every kilowatt they fed into the grid. The turtle says, 'I'm getting an energy credit for installing the solar panels.'
The financial crisis pressured European government spending, which led to reduced solar subsidies, which became less politically popular when the solar manufacturing jobs ended up in China, rather than in Europe.
This happened just as China went manufacturing crazy. The resulting oversupply combined with improved manufacturing efficiency to dramatically reduce the price of solar panels…
…which led to a collapse in solar stock prices. By mid‐2012, solar stocks had declined an average of 80%…
…causing the naysayers to say that without generous subsidies, solar as an industry, as epitomized in the U.S. by Solyndra's failure, was dead again.
This happened just as solar was on the brink of becoming an economically viable means of producing electricity.
The cheaper solar panels have made solar competitive with traditional forms of electricity, even in markets without subsidies. Solar stocks have fallen over the last few weeks. We believe it's related to the recent drop in oil prices. However, oil is used mostly in transportation, rather than electricity generation. You can see that even a significant decline in oil prices would still leave it uncompetitive as a source of electricity. We think that the sell‐off in solar stocks in response to falling crude oil is unjustified and creates a good buying opportunity.
Solar cells become continually cheaper because they benefit from semiconductor innovation. The industry expects solar costs to decline another 20% by 2017.
Annual global solar installations have grown from just 2 gigawatts in 2006 to over 45 gigawatts this year. More than half of all new electricity capacity added in the U.S. this year will be solar.
Which brings us to SunEdison, our first investment idea today. SunEdison is a well‐run, financially savvy company, benefiting from an open ended growth opportunity trading at a bargain price.
In 2009 MEMC figured out that its core business of manufacturing solar products in the U.S. would not remain profitable in the face of Chinese competition. It acquired SunEdison and spun off its old business units. MEMC completed its transformation -- it is almost exclusively a developer of solar projects and has changed its name to SunEdison, or SUNE. Recently, it sponsored a new, public company called Terraform Power that enables SUNE to capture more value from its solar developments.
SUNE consists of 4 main parts: First is the core solar plant developer, which also has a growing Operations and Maintenance service business. Second is its 64% stake in publicly traded Terraform Power, and the related Incentive Distribution Rights or 'IDRs,' where SUNE gets paid a portion of Terraform's future cash flow. Third is its 50% stake in a poly‐silicon manufacturing joint venture with Samsung. And, fourth is its 58% stake in publicly traded SunEdison Semiconductor.
We believe the market misunderstands SunEdison. The financial statements are complicated because they consolidate the company's interests in several public companies, and the non‐recourse debt of various solar projects that SUNE controls. This makes it challenging to decipher the economic value of the company from a cursory review of the balance sheet or income statement. We believe this leads to sell‐side analysts mis‐analysing the company, and the market undervaluing the stock. We think the best way to evaluate SUNE is the sum of its parts.
Let's start with SUNE's core development business. As a quick overview, SUNE's project cycle looks like this: First it finds the best development opportunities, then it acquires the land or rooftops and secures all necessary permits to build the plant.
Then it finds a business or a utility to buy the electricity, usually for a 20 year term. This contract is called a Power Purchase Agreement, or PPA. With a PPA in hand, it secures financing and constructs the power plant. Until SUNE sponsored Terraform, it would usually sell the project to a third party financial buyer.
Most other solar companies focus on large utility‐scale projects where they compete directly with other wholesale sources of electricity. SUNE focuses on smaller commercial or industrial customers like a Home Depot or an airport that otherwise buy electricity from utilities at retail prices. By competing against retail rather than wholesale power prices, SUNE's projects generate attractive margins and returns.
SUNE earns a healthy margin of about $0.55 per watt for developing the project, and the third party buyer earns a reasonable return on its capital.
As an experienced project developer, SUNE's financial, legal, and due diligence expertise gives it a competitive moat. It has opened offices in the most attractive international markets several years before anyone else, giving it a first mover edge and unique geographic diversity in an industry that faces capricious governments, currency fluctuations, sovereign risk and competition.
SUNE has a 2.3% share of the solar market. It has guided to doubling production in the next two years, which would give it a rapidly growing share in a rapidly growing market.
To value the development business, let's look at 2016 when SUNE has guided to building 2 gigawatts of projects. As a developer, it earns $0.50 per watt or $1 billion. After overhead, interest and taxes this implies $1 in EPS. Since we think the development business will continue to grow at a healthy rate, we think it's conservative to value it at 15 times or $15 per share, which is almost where all of SunEdison trades today.
SUNE also owns 64% of Terraform Power, which is worth $4.54 per SUNE share at Friday's price. Terraform is a buyer and owner of renewable energy projects. Terraform pays out 85% of its cash flow as dividends. Investors value Terraform as a yieldco, rewarding it with a high valuation and corresponding low cost of capital.
Creating Terraform has allowed SUNE to take a good business and turn it into a better business. In the old days, SUNE used to take all the risk -- development risk, financing risk, legal risk, and balance sheet risk -- for a modest return. Now it has a lot less risk, and at the same time gets to keep a lot more of the economic value of its projects. Terraform also gives SUNE a low cost of capital buyer which will allow it to retain more of the value embedded in the projects it creates.
Terraform purchased its initial portfolio of projects from SUNE and we expect it to be a buyer of future SUNE projects. The cartoon says, 'Oh!... your people are my people? Well, that should make things a lot simpler.
Terraform is a particularly attractive buyer because it brings a low cost of capital compared to traditional financial buyers. We estimate the difference to be 2.2%, which translates into $0.50 per watt of additional value to be divvied up between SUNE, Terraform, and the energy customer.
SUNE also owns incentive distribution rights, or IDRs, in Terraform. An IDR is a share of the profits of Terraform where SUNE's share increases as Terraform grows its dividend. Initially the IDR doesn't pay SUNE anything. But once the dividend grows 50%, SUNE begins to collect, and once it doubles, SUNE collects half of the incremental cash flow.
We estimate Terraform will grow to 10 gigawatts in 2018, creating $109 million in IDR payments or $0.31 per share to SunEdison.
On a DCF basis, we calculate the IDRs to be worth $3.2 billion, or $9.04 per share to SUNE. We think this is roughly 9 dollars per share more than the value being assigned by most street analysts.
In the recent sell‐off, Terraform's shares declined with the oil and gas MLPs. Because most MLPs pay out cash flows from depleting oil and gas reserves that need to be replaced with new wells, these companies need continued access to cheap capital just to sustain their dividends. Terraform doesn't face that risk because solar assets don't deplete. So Terraform will only raise capital for growth.
As we sum up the parts: SunEdison's core development business is worth $15 per share, the Terraform stake is worth $4.50, the IDRs are worth around $9 and a couple other assets are worth another $3. This sums to about $32 per share, which is a good distance from where the stock is trading.
Greece is a small country with only 11 million people that has generated a lot of global news. And unless you go for vacation or to study Ancient History, most of the recent Greek experience has been tragic.
Greece was the largest sovereign default in history, and in 2013 earned this New York Times headline: 'Seen from Greece, Great Depression Looks Good'
…and systemic tax avoidance. The cartoon says: 'Printing Drachmas is a nice job, But the work is undeclared'
So what happened? The Greek economy all but collapsed, with per capita GDP falling by a cumulative 25% to around $22 thousand, which is about half of Germany's but double Brazil's. Unemployment more than tripled from 8% to 27%, with half the youth unemployed.
Government reforms have also had a significant impact on the economy and the average Greek. Without its own currency, Greece could not devalue but instead reduced labour costs directly: The minimum wage was cut 20 to 30%, public pensions were cut 15%, and most private pensions were cut 30 to 50%. The Government piled new taxes on top of reduced incomes, including a new real estate tax for 2014. The cartoon says, 'Yes, they're draconian measures -- but then, I am Draco'
After swallowing the bitter medicine, Greece now appears to be on the road to recovery. GDP is turning positive and should accelerate next year. Unemployment has started to decline.
The current account deficit has gone from €15 billion in 2008 to a small trade surplus. This has helped the Greek Government finances as well…
The budget deficit has practically disappeared. So from both a trade and fiscal perspective, Greece is living within its means.
Both consumer and business confidence have improved, and economic sentiment has almost returned to pre‐crisis levels.
Heading into the crisis, Greek banks had significant exposure to Greek sovereign debt and ballooning non‐performing loans. They all became insolvent and needed substantial EU funding support. The cartoon says, 'It's the new directive from Brussels. We're to steal from everybody and give directly to the banks.'
Several years passed. All the foreign banks left, and the domestic banks were consolidated into 4 survivors: Alpha, Piraeus, NBG and Eurobank.
In 2013 and 2014 the surviving banks were recapitalized. We are long Alpha Bank and Piraeus Bank. Between them, they control just over half of the loans and deposits in the market. They trade below tangible book value.
Since the recaps the banks have begun to turn. Net interest margins have improved as deposit costs have fallen.
Closing branches and reducing headcount has improved the cost‐to‐income ratios and driven growth in pre‐provision profits.
The rate of new non‐performing loans has decelerated and we expect it to approach zero in 2015. Loan loss provisions have peaked.
Provision coverage is now very high with cash and collateral adding up to over 100% of non‐performing loans. Starting in 2016 we expect provisions to be released and added to capital.
The cartoon says, 'How much longer 'til we're responsible for the consequences of our actions?' In 2008 the Government passed a law that prohibited foreclosures. As a result, many non‐ performing loans are from consumers and small businesses who can repay, but have chosen not to. Next year this law reverses and we think many non‐performing loans will begin to perform.
The Greek banks have gone through several rounds of international exams and stress tests. Alpha Bank has a Core Tier 1 capital ratio of 16.3% and Piraeus is at 15.0%, making them two of the most highly capitalised banks in Europe. On October 26, the ECB will announce the results of the latest stress tests. We expect Alpha will pass and Piraeus will either pass or need to make minor adjustments.
Highly concentrated banking markets are very profitable. We think that once the non‐ performing loans settle, the Greek banks will do great. Banks in consolidated markets generate at least 15% returns on equity. We believe that in a few years Alpha and Piraeus will reach that, and when they do, should easily trade at 10x earnings and 1.5x book.
Starting with Alpha's current tangible book, adding 30% for over‐reserving, and some core earnings over the next three years, we expect book value to exceed €1.00 per share in 2017. At 1.5x book value, Alpha stock can nearly triple from here.
It's much the same story for Piraeus: Starting with tangible book, adding back loan loss recoveries, which for Piraeus will be smaller than Alpha, and three years of earnings, sums to book value of €2.00 per share and valued at 1.5 times, a €3 stock price.
But wait….there is an even better way to play this. Both banks have publicly traded non‐ dilutive warrants. The warrants have three‐and‐a‐half year remaining lives, and have escalating exercise prices. Each Alpha warrant allows you to purchase 7.4 shares of Alpha stock at between 47 cents at the end of this year and 55 cents at the end of 2017. Each Piraeus warrant allows you to purchase 4.5 Piraeus shares at between €1.81 at the end of this year and €2.14 at the end of 2017.
This structure gives an investor significant upside exposure for a relatively minimal outlay of capital. If the banks perform and are valued as we expect, the Alpha warrants will be 5‐baggers and the Piraeus warrants will be 10‐baggers.
One of most obvious tail risks for the Greek banks is the possible break‐up of the Euro or sovereign re‐default. There is a huge disparity in how the market views the same risks when assessing Greek banks compared to French government bonds. While Greece is priced as if a Euro break‐up or another default is rather likely, for France either is unthinkable. The French 7 year bond yields 71 basis points, which means that investors hope to receive just 5 points of interest through 2021. Let's look at France.
France is a challenging place to do business. The labour laws are stifling, the 35‐hour work week includes 5 weeks of vacation, and at over $12 an hour, the minimum wage is nearly the highest in the world. It is difficult and expensive to dismiss workers, and one‐quarter of college graduates wish to emigrate.
French government spending is well over half of GDP. In 2012 France elected the Socialists led by Francois Hollande who then lowered the retirement age, raised the corporate and VAT taxes, and sought to raise the tax rate on salaries over €1 million to 75%. This encouraged high‐earning tax‐payers to leave the country.
And while Greece's economy continues to improve, France has lagged the global recovery and may be headed back into recession.
Right now France is clashing with the European Commission, where its proposed 2015 budget exceeds the 3% limit, putting France in 'serious noncompliance' with the new EU rules. France is potentially undermining EU authority, setting a dangerous precedent for other EU countries, and setting the stage for a possible Euro crisis.
The winning party in the recent European Parliamentary elections in France, with a 25% share of the vote, wants France to exit the Euro.
Greece has taken its bitter medicine, restructured its obligations and economy, and is recuperating after its near‐death experience. France appears too proud to reform.
The debt service in France has remained stable. Ever lower interest rates have offset total debt ballooning from €1.2 trillion in 2006 to €2 trillion today. Greece's restructured debt has low interest rates and distant maturities. Almost half the debt pays no interest for a decade. Now, Greece has a lower interest burden than France.
Yet, while France's troubles are still ahead, 10‐year French Government bonds yield 1.3%, while Greek 10‐year paper yields 9%. If the market re‐prices the French sovereign risk just slightly, France's debt service will quickly get out of hand. Given this dynamic, we think shorting French government debt is a good currency and tail risk hedge for owning Greek bank stocks.
While everyone is worried about Greece, they should be more worried about France. French seven‐year paper yielding 71 basis points is a unicorn -- it should not exist.
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