|Shares Out. (in M):||227||P/E||NM||17.0x|
|Market Cap (in $M):||3,100||P/FCF||NM||45.0x|
|Net Debt (in $M):||-1,050||EBIT||-117||225|
MEMC Electronic Materials (WFR):
"MEMC Electronic Materials, Inc. produces silicon wafers. The Company's products are used in computers, telecommunications equipment, automobiles, consumer electronics products, industrial automation and control systems, and analytical and defense systems. MEMC operates manufacturing facilities in Italy, Japan, Malaysia, South Korea, Taiwan, and the United States."
Effectively WFR operates in three different businesse - semiconductor silicon wafer production, solar silicon wafer production, and solar installation development / ownership / operation via SunEdison.
Following a period of ~18 months of industry and company-specific disasters, the general equity community has turned its back on WFR and is ignoring a number of compelling developments which suggest under-appreciated growth and profitability over a 3-5 year period with solid downside protection:
(a) a strong cyclical rebound in its traditional semi wafer business;
(b) the beginning of a long-term secular trend in solar growth in younger (non-European) markets like the US and China;
(c) evidence of some price stability in solar wafers as price pressures moves to other parts of the solar value chain, and;
(d) underappreciated value from SunEdison's solar PPA model.
WFR Equity Has Under-Performed: WFR almost re-touched its November 2008 lows in December 2009 (~$12) and then again following its February 2010 Q4'09 earnings release. Since then, the stock has rebounded to $13-14. This represents 30% appreciation from the lows - a massive underperformance vs. other cyclical technology names and more in-line with pure-play solar stocks (e.g., FSLR) which continue to struggle. I believe that overtime, as solar grinds towards grid-parity, WFR should track the global energy markets - it is informative to look at a simple chart of WFR vs. crude oil. Over time, these charts should begin to correlate more highly vs. WFR's current drastic underperformance.
Today WFR is valued at 7.8x and 6.0x consensus 2010 and 2011 EBITDA. I view this as inexpensive on a relative and absolute basis given WFR's historical valuation and the potential for significant top-line and operating leverage outperformance vs. current analyst estimates.
2010 = Pent-Up Demand: Capital spent on solar projects plummeted in 2009 due to (a) global credit constraints, (b) falling energy prices vs. 2008, (c) solar incentive uncertainty, and (d) general macroeconomic weakness. We expect that 2010-2012 will see a strong snapback in solar projects as energy prices show significant YoY increases, purse strings loosen, solar costs fall and the US begins to more fully address solar incentives.
Lower Than Expected Supply: Over the last 24 months, solar silicon has gone from a supply shortage to a significant oversupply situation. Solar bears point to significant additional supply coming online in 2010-2012 and generally low barriers to entry in the market. While some of these concerns are fair, I note that the supply that was supposed to come from metallurgical silicon is unlikely to materialize (metallurgical silicon is not at all cost effective given current poly-silicon prices). Moreover, many of the smaller, capital constrained solar silicon producers in places like Korea and China are likely to abandon planned projects at current prices. Conversations with various persons on the ground in China suggest that sell-side supply models are meaningfully overstating the ultimate amount of supply the industry will see.
Lack Of SunEdison Appreciation: A major driver of WFR's sell-off following their Analyst Day in February was the degree to which management emphasized SunEdison as a core strategic asset and the weak job they did explaining SunEdison's business model. SunEdison is the leading solar development / ownership company in the US (and a meaningful player in Europe). In the US alone, they have installed over 300 projects which cumulatively total more than 100MW. The company is targeting the installation of another 100MW+ this year. SunEdison operates in two chief ways - either direct sales of solar developments to the owner / end-user (~20% of total) or via power-purchase agreements or PPAs (~80% of total). These PPAs, in which SunEdison enters into a sale-leaseback with a financier like Wells Fargo, do not display well on a GAAP basis as WFR is forced to carry debt on its balance sheet - BUT, this debt is non-recourse to WFR and represents the collateralized sale-leaseback agreement. These agreements are complicated given various tax and state incentive issues, but they effectively lock-in contracted and highly-reliable cash flows on a 20 year basis for SunEdison. Estimating the cumulative present value of these cash flows available to SunEdison from the projects they install over the next 6 years from this PPA model (and assuming no value post-6 years when the major Federal tax credit, which incentivizes Wells Fargo etc. to do these deals expires) suggests a total SunEdison value of ~$5 per share. Current sell-side reports are either (a) ignoring SunEdison, (b) giving it value equal to the purchase price (~80 cents per share), or (c) penalizing WFR for SunEdison given the high optical capex (which is reimbursed, at a profit, for PPAs) and growing non-recourse debt load. Effectively, the SunEdison PPA business is much more analagous to a REIT model and should be analyzed as such - traditional technology investors laser-focused on gross margin etc. are not appreciating this and stockholder churn is putting downward pressure on the stock.
WFR Equity Stakes = Underappreciated Value: Solar silicon prices reached absurdly high-levels (up to $350/kg in 2008) as demand outpaced supply and recently capitalized solar module manufacturers bid for market share. While in hindsight these prices were absurd, many solar cell producers entered long-term supply contracts (8-10 years) with WFR at these inflated prices. WFR has been renegotiating these contracts given that current prices are more like $50-60/kg. As part of these renegotiations, WFR has been taking equity stakes in its customer base - effectively WFR has been using artificially inflated currency (the existing contracts) to buy undervalued equity stakes. I do not believe that the equity market is currently adequately recognizing the potential value of these stakes.
Clean Balance Sheet: WFR has a clean, unlevered balance sheet with $31MM of recourse debt ($383MM of non-recouse debt) and $1000MM+ of cash. This large net-cash position gives WFR the ability to finance SunEdison development projects over the short-term (before contractually pre-negotiated reimbursment on PPAs). Unfortunately, GAAP will prevent WFR from popping up on cash rich / low debt company screens in the future.
Management Changes: In November 2008, the poorly regarded former CEO of MEMC resigned. An interim CEO, Marshall Turner, was succeeded by the current CEO Ahmad Chatila in February 2009. Marshall Turner remains on the BOD. Subsequently, Chatila has replaced his CFO and reorganized his management team. All new individuals are well regarded.
WFR is not an easy company to value in its current state given wildly fluctuating margins from its silicon businesses, limited historical data from SunEdison and fact that SunEdison's PPAs need to be separately modeled. That said, my conservative modeling of the traditional businesses with a 10% revenue CAGR from 2010-2016, movement towards 30% gross margins, and capex sustained at 15% of sales suggests a $15 fair value on just the silicon businesses. This means you are getting SunEdison for less than nothing whereas my modeling suggests that SunEdison is worth $5+ a share. This suggests a $20 price target on the combined business - as solar takes off in earnest in the US, I can see the price moving well above this level.
- Additional disclosure and explanation from WFR management on SunEdison business should lead to attribution of value to SunEdison from sell-side
- Stable solar silicon prices, robust semi silicon demand, and improving long-term margin profile over next few quarters (even as Germany undergoes FiT reductions) should alleviate some pressure from bear case
- Continual announcements of new SunEdison installations