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This is a speculative and fast moving play. Gun to my head, I’d guess the near term path of the stock is down, as we likely see continued lawsuits and a bankruptcy filing in the near term…. but, that said, I think there is the potential for massive upside here, and the probability weighted expected value here is pretty high. I’m fully paid up on ideas this year, and there is no post on HE to discuss ongoing process, so I’m posting this to get a discussion going (particularly for people with experience in the PG&E bankruptcy a few years ago), not as a full out recommendation (though I do have a small position as, again, I think it’s hairy but the weighted average EV is pretty good!)

Anyway, Hawaiian Electric Industries (HE) is a holding company with two major subs: Hawaiian Electric, the main utility in Hawaii, and American Savings Bank (ASB), the ~third largest bank in Hawaii. The company’s stock has been crushed recently as they likely caused the wild fire that burned down Lahaina and killed over 100 people, leaving them facing billions of liabilities. Last night, Maui County sued Hawaii Electric for billions in damages (including punitive damages!) for the fires and the WaPo broke a story that HE may have removed evidence from the fire scene. If that wasn’t enough, yesterday HE drew down their revolver, which probably signals an imminent bankruptcy filing so they can start figuring out what to do with the dozens of lawsuits streaming in.

At the start of the month (i.e. before the fire), HE had a market cap ~$4.3B. Almost every estimate of damages, even ignoring punitive damages, are well over that number, so there is a real chance HE’s stock is wiped out by the claims.

However, at today’s prices, I think the risk weighted reward is in investors’ favor.

At the end of July, HE was trading for ~$38/share. Let’s use that as the unaffected price. With ~110m shares outstanding, HE had a market cap of $4.2B. The stock price as I write this is ~$10/share, implying a market cap of ~$1.1B.

So you could look at those numbers and say the market is implying a ~75% of a bankruptcy and complete wipe out (the ~$28/share drop divided by ~$38/share). That feels too high to me, as there are a variety of outcomes here that could lead to equity recovery.

Let’s start with the first: we still don’t know for sure the cause of the fire. It seems almost certain that Hawaii Electric's equipment started the fire, but we don’t know for sure. In all of the infinite multi-verses, is there one where HE didn’t start the fire? Not many, but surely there’s one!

Next, there’s the question of if HE will be held liable for these damages. There are two ways HE could be found liable. The first is under “inverse condemnation”. Inverse condemnation lets property owners sue someone for taking their property without their permission. It’s generally used when the government takes private property for public infrastructure. It was used in 2018 to hold PG&E responsible for the wildfire damages; however, California was a unique case. As far as I am aware, inverse condemnation has not been used against utilities in any other states. While plaintiffs will try to get it applied in Hawaii (and the plaintiffs are very sympathetic; I certainly feel awful for them and am in no way trying to convey otherwise!), there is no precedent for inverse condemnation on a utility in Hawaii and it’s overwhelmingly likely that inverse condemnation will fail here.

Without inverse condemnation, in order to be held liable plaintiffs are going to need to prove that HE’s negligence caused the fire. There are some great strings for the plaintiffs to pull at; we’ve seen lots of reporting that HE may not have been acting full speed ahead to reduce wild fire risk (for example, WSJ has an article “Hawaiian Electric knew of Wildfire Threat, but Waited Years to Act”), and the county is alleging HE “negligently” failed to shut off power despite exceptionally high winds and dry conditions.

So there is real risk HE is found negligent. However, I would note that all of the reporting and lawsuits have been done targeting HE, and we have not heard their side of the story…. and I think HE will have some solid legal facts on their side.

On the “negligently” not turning power off front, HE has two defenses.

1. HE would argue that their electricity powers Maui’s water systems(and they’ve done just that in multiple stories!), so shutting down the power would actually remove the county’s ability to respond to fires. I’ve seen some reporting that argues the water pumps could operate without electricity; I do not know if that’s true or not (that article is the only one I’ve seen that has said that, and I’ve been unable to get a straight answer from my checks so far), but that actually blends nicely into the second defense. Shutting down power is not something utilities do lightly; when you do it, residents get mad. Critical services can be affected. Look at PG&E; in 2019, they started shutting down power during wildfire season, and residents were furious.

   • Could HE argue that they weighed the risks of shutting down power versus keeping it on and the risks of blacking out a city outweighed the risks of a fire?

2. The second defense is a little more tin hat, but hear me out. Hawaii is a state very dependent on tourism. You know what tourists hate? Random hours long blackouts during their vacation. HE obviously knew there were risks of wildfires; is it possible over the last few years (particularly in light of the California wildfire and subsequent black out debacle) there are communications between HE and the utility regulator where the regulator leaned on them to do everything possible to avoid blackouts and keep the power running?

I think there is a good possibility that both defenses will have some merit or turn up some evidence; certainly enough to prove that HE did not act completely negligently.

The second negligent question is if HE didn’t adequately prepare for wildfires.

Maui’s suit certainly hits on this, noting that a lot of HE’s power system were over ground wires that were on wood poles (in fact, the suit calls out “decaying” wood poles quite a bit), which are much more at risk in high winds than underground wires. And a lot of the journalism around this points to HE’s 2022 request to increase their rate base in order to invest ~$190m into hardening their system. Utilities have a duty to public safety over shareholders, so even if that request was turned down or delayed (it appears to have gotten stuck in limbo), plaintiffs can say HE knew their system was at risk and failed to act in order to enrich shareholders. That’d be a huge no-no and quite negligent.

Again, there’s risk here, and it’s tough to tell, but HE is a utility. They’re always trying to increase their rate base. HE invests tens of millions into maintenance spend every year; I suspect they will be able to point to plenty of investments they’ve made into maintaining and hardening their system that would keep them far, far afield of “negligently” maintaining their system.

So, in order for HE to be found liable here, they likely need to be found negligent. Could they be? Absolutely. But it is by no means a slam dunk case; before these fires, I don’t think anyone would have pointed to HE as particularly poor operator. In fact, they’ve won several awards, including 2019’s “utility of the year.” So, if and when the trial comes, I think HE will have a strong case that they were a solid operator that got hit with extremely unfortunate conditions that caused a tragedy but they were by no means negligent.

But let’s say they are found negligent. Even then, investors would have some potential upsides.

The first is limiting the damages to the Maui Electric sub. Maui Electric (which provides electricity to Maui and would ultimately have caused the fire) is actually a 100% owned subsidiary of Hawaiian Electric (the utility sub which is ultimately owned by the HE holdco). There is a chance the the liability could be ring fenced and limited to just the Maui sub. If that’s the case, it would be a bonanza for shareholders; Hawaiian Electric did ~$190m in net income in 2022, of which ~$26m came from Maui electric. If you could just ring fence the Maui Electric sub, the rest of Hawaii Electric is probably worth ~$25/share to HE and the stock is a grandslam.

Do I think this is likely? No. Hawaiian Electric clearly controls Maui and they operate as basically one (for example, going to mauielectric.com will redirect you to the Hawaiian electric website, and my understanding is that all of their vehicles in Maui operate under the Hawaiian Electric brand), but (similar to the world where HE’s equipment didn’t cause the fire) there is at least some universe where plaintiffs cannot pierce the veil from Maui to Hawaiian Electric. HE is clearly exploring this option; their August 17th update notes ring fencing is a “complex legal question” that will take time to work through.

The second defense is if plaintiffs can pierce the veil from Hawaiian Electric to the the holdco. Remember, the holdco owns ASB in addition to the utility (the holdco also owns Pacific Current, which invests in renewables, but I don’t think there’s much value there). If the holdco can avoid having the veil pierced, there could be some stub value for equity holders here. The bank has ~$500m in book value (at the end of Q2) and did ~$77m in net income over the LTM. It’s probably worth between $5-10/share to HE…. however, HE has ~$7-8/share in holdco debt. So there’s probably nothing (or not much) here, and investors will need some recovery from the ultility in order to get a more than token recovery…. however, it is worth noting management has indicated ASB is completely ringfenced from the fire liabilities and swapped some directors from the HE board to the independent ASB board, so they are clearly working to preserve value. Perhaps there is some path to spinning the bank to shareholders through the bonds, or maybe the bank is worth a little bit more than I projected and it provides shareholders with a few dollars of downside in a complete wipe out of the electric utility.

Anyway, to get that bank value you’d need to avoid piercing the veil from the utility to the holdco. Unlike with Maui Electric, I think there’s a very good chance you can avoid that pierce. Hawaiian Electric operated as a completely independent sub with its own debt, its own management team, etc. from HE. It will get contested (the Maui county lawsuit names the holdco as a defendant), but I do think this line will get defended.

So, to sum up, there’s a lot in the air here. The key questions are

• Did HE start the fire?

• If yes, will HE be liable for the fire? How?

  • Inverse condemnation?

  • If no, negligence?

• If yes, can HE ring fence Maui Electric from Hawaiian Electric?

  • If no, can HE holdco ring fence Hawaiian Electric?

At ~$10/share, the market is saying there’s a ~75% chance that the answer to all of those questions turn up against HE. That just seems too high to me. HE not starting the fire or ring fencing Maui Electric are long shots, but in the immortal words of Lloyd Christmas, there’s a chance!!!… and, as the story plays out, it seems like there’s at least a 25% chance HE can prove they weren’t negligent.

There is one other part to this story that is worth mentioning: settlement and politics.

Again, the plaintiffs here are very sympathetic. This is an absolute tragedy.

But utilities are capital intensive beasts. It sounds nice to say “bankrupt HE and take everything they’re worth for victims…..” but if you do that it’s going to be very hard to get investors to pony up capital (particularly equity capital) to literally keep the lights on. Utilities are astute lobbying machines, and HE is a massive employer (Hawaiian Electric is the 12th largest employer in Hawaii, and ASB is #33) with decades of lobbying relationships built. They are going to call in every favor they have to let politicians know how dangerous it will be for the islands long term health / capacity to rebuild if they try to completely ax HE in a downside scenario.

I would point to something like what happened with PG&E’s bankruptcy as a path forward. You can see the full emergence deck here, but PG&E used the bankruptcy to agree to pay out victims through a combination of cash and equity. Importantly, regulators approved extra rate base to help the company emerge.

 

It wasn’t pretty for existing equity holders, but they received ~25% of the equity in the new company. All in, if you held PCG stock from 2018 through the emergence, the value of your shares dropped ~80%. Not great, but tey did have value. And, considering the company emerged and did a huge equity raise at literally the depths of COVID (May/June 2020), it’s a pretty impressive feat!

 

HE’s stock is already down ~75%, so it’s mirroring the full decline of PCG. Obviously, you could argue this is warranted: California is much bigger than Hawaii, and PCG is much bigger than HE. Both helped (a big part of the emergence was all California utilities contributing to ongoing wildfire funds). But HE doesn’t have inverse condemnation, and HE has all of the other defenses I’ve mentioned before.

How does this all play out? Who knows? But there are lots of avenues for value creation from here. Could HE file for bankruptcy and reach a settlement with victims that is, in part, backstopped by an approved rate increase? If HE paid victims $3B, with part of that funded by equity and regulators allowing for a big rate base increase, the stock would likely be a homerun.

I certainly don’t know how any of this plays out…. but the market is implying ~75% chance HE is a flat zero. That just feels too high to me. There are a variety of ways this can play out where HE realizes recovery in excess of today’s share price, and there are a lot of consensual paths that create value for all stakeholders that sees shareholders get equity value around or in excess of today’s share price.

So, apologies for the rambling post, but wanted to throw out a bunch of thoughts on an interesting and ongoing situation and see if anyone else was looking at it.

PS- one more thing worth noting. Right now, things are moving fast in the HE case. Maui sued, we’re getting breaking journalism every day, etc. I suspect HE will preemptively file for bankruptcy in the near future….. but, after that, things will slow down meaningfully. Look at the PCG chart above: the stock got hammered as it became clear they’d be on the hook for wildfires. It was down ~80% in six months, but then it kind of just drifted along as the bankruptcy process played out. After HE files, I suspect the story and news flow slow down a lot, and the stock has already been absolutely hammered. This obviously isn’t trading advice, but implied vol on HE’s options is around 150-200. Given I think this is a much slower and drawn out process than the market, there are probably interesting plays in using those options capture volatility in some way.

Catalyst

Settling the huge liabilities in some way shape or form