Expect Continued Canadian Solar Financing This Year

After the close Monday, Canadian Solar (CSIQ) announced plans to sell 3.5 million common shares, raising the company’s expected fully diluted share count to nearly 36 million shares (32.4 million shares as of last report + 3.5 million shares from the announced secondary)  and its enterprise value  to nearly $1.4 billion.

Given our past discussion concerning the financing needs of several polysilicon-based module manufacturers, we were not taken aback by CSIQ’s latest secondary announcement, however we were somewhat surprised by the company’s financing method. We were expecting a larger convertible offering, instead of a direct placement of common shares. Arguably a convertible is a better means of long-term financing, since there is no immediate dilution to common shareholders.

Financing Still a Concern

Notwithstanding issues surrounding the current financing method, though, we think it’s important for investors to realize that this latest financing nowhere meets the actual financing needs of CSIQ, and as such we expect continued financings for CSIQ over the next year.

$1.7 Billion in Purchase Obligations

CSIQ’s financing needs are a direct result of the company’s astounding $1.7 billion in purchase obligations (page 64 in CSIQ’s 20-F). Interestingly, this number may in fact be conservative considering the company’s recent initiatives. Since the company will have to pay the vast majority of these obligations up-front to suppliers in cash, and will not receive adequate cash receipts from customers prior to the necessary payments to suppliers, CSIQ will be in need of serious cash in order to meet its production goals. Ironically, the more CSIQ pursues contracts at any price, the more cash it will need to fund its supplier obligations, and the more dilution shareholders should expect.

Future Cash Needs Uncertain As Cash Receipts from Customers Remain Unclear

At this point, it’s extremely difficult to project CSIQ’s real cash needs, since, as opposed to purchase obligations to suppliers, the company provides little disclosure as to its current payment terms with customers. Therefore, notwithstanding rosy revenue projections, it is completely unclear what the company’s actual cash receipts from customers are, and what the cash payment cycles looks like for new contracts.

Based upon our research, and a small dose of common sense when looking at businesses whose customers rely on government subsidies, our belief is that CSIQ currently receives little to no money up-front for customer orders and cash payments for these orders are being spread over ever longer periods of time. As such, we think that CSIQ’s reported accounting revenues and projections, greatly overstate the company’s actual cash receipts from customers, and hence significantly understate the company’s financing needs.

Our low-ball estimate is that CSIQ will need at least an additional $200 million in financing to support operations in the coming year. This cash may come from the Chinese banks (short-term loans) and/or Wall Street. In either case, the company’s enterprise valuation will increase even without a corresponding increase in the share price, leaving investors with little in the way of capital gains. Of course, if the stock price for some reason soars to irrational levels, the company’s financing issues may quickly evaporate. But, since we cannot forecast stock prices, we wouldn’t want to bet on this scenario.

Ignore Accounting Earnings and Wall Street Forecasts

Looking forward, since access to continued financing is CSIQ’s only means of survival, we would expect Wall Street analysts to continue recommending purchase of the shares based upon accounting revenue projections and paper profit (i.e. accounting earnings) valuations (e.g. P/E). At the same time, we anticipate that concerns regarding CSIQ’s serious working capital and future financing needs will receive little attention by analysts, though these are the main factors which will ultimately determine the value of the shares for longer-term investors. Therefore, we advise investors to look past these simplistic valuation models, and pay closer attention to CSIQ’s raw material and other purchase obligations, the outlook for raw material supply, and finally to the company’s actual/expected cash receipts from customers. These factors will surely play a greater role in the company’s longer-term share performance, than the other issues which may affect the nearly unpredictable day-to-day price movements.

Conclusion: Cash Flow Concerns Could Dominate for Quite Awhile and There are Possibly Better Alternatives

Ultimately, the bullish case for CSIQ rests on the assumption that because of escalating demand for polysilicon-based solar modules, the company will at some point become self-funding and will be generating more than enough cash to pay down obligations (both purchase and credit) and justify its enterprise valuation, even after dilutive actions.

However, since we remain reasonably certain that the suppliers of polysilicon-based solar modules (an extremely low barrier to entry business), will vastly exceed the suppliers of the raw material (e.g. polysilicion) for these modules (a very high-barrier-to-entry business) for the foreseeable future, we believe that the suppliers of polysilicon-based solar modules will constantly be squeezed from both their customers and their suppliers of materials. As such, we do not believe that these companies will be self-funding any time soon and the future free cash-flow (if any) will not justify the current enterprise valuation.

Investors looking to profit from the solar boom are probably best advised to research the investment potential of raw material and other suppliers to these polysilicon-based solar modules and/or stick to companies that have already proven their ability to generate operating cash-flow (i.e cash-flows prior to cap-ex).

 

Disclosure: None.

Comments

[rana]

wrong
outstanding shares will be around 35-35.5 M shares
fully diluted will be around 36.5 M shares.
go back to the report and check basic and diluted. diluted counts all probable shares that will be issued, including the convertible bonds since the conversion price was well inside the money.
for more info check the accounting standarts, which you don't like for one side of the equation but like them double what they warrant on the bad side.
please, try and give relaible info and don't get influenced by your basic thesis regarding certain companies.

[Envoy Global Research]

Thank you for pointing out our share count error. We stand corrected.

However, the mistake is hardly double as share number itself is only 10% (a mere $150 million vs. a $1.4 billion enterprise value). In any case, the analysis still stands. The company has $1.7 billion in purchase obligations coming due and cash receipts from customers are nowhere near that level. Ipso facto, they will need keep raising money and shareholders will get watered down.

A bullish analysis for CSIQ may attempt to show the potential cash flow a few years out vs. the expected enterprise value after more financings. In addition, it would explain how this company will pay for $1.7 billion in purchase obligations.

[Jack Yetiv]

Envoy, can you supply me the source for this statement (the first half, of course) which you make above:

"Since the company will have to pay the vast majority of these obligations [the $1.7 billion you refer to] up-front to suppliers in cash, and will not receive adequate cash receipts from customers prior to the necessary payments to suppliers, CSIQ will be in need of serious cash in order to meet its production goals."

Thanks, Jack

[rana]

jack go to the PDF version of CSIQ F-20 exhibit 19 page F-26

[bockwai]

Envoy, Im confused as Jack above. Where do you come up with $1.7B in payments coming due in 1-3 yrs? According to their 20-F on page 64 as of 12/31/07 the chart shows that they have around $1.05B in payments coming due in total over this 1-3 year time frame. Now this figure doesnt include the LDK deal back last month but Im still not seeing what needs to be added to the 12/31/07 payment due figure that would come to $1.7B in 1-3 yrs. Can you elaborate further on what youve added to their 12/31/07 payment schedule?

[Envoy Global Research]

Hi all,

Thanks again for digging deeper and checking out our numbers. This is the positive thing about these boards. Unfortunately, we can't really edit anything on SeekingAlpha, since they only syndicate these posts and it's not updated real-time. But, the "1 to 3 years" is definitely an error above, and we have edited this out on our own blog this morning, where subscribers have emailed us with the same exact question. We apologize for any confusion.

For the benefit of the readers here:

The $1.7 billion is the total figure in the 20-F ("the next 1 to 3 years" above should be edited out). Six hundred million is stretched out after the third year. So the post above number is off quite a bit for the next 1 to 3 years. CSIQ has mentioned, though, that they are upping the cap-ex this year (a number which is included in the purchase obligation figure in the 20-F), and we've added an estimate of that into our number. Nevertheless, you are correct that $1.7 billion is definately too high for the next 1 to 3 years. It's probably more like $1.1 billion. We'll have to wait till earnings to find out an exact number.

Using a revised $1.1 billion, which includes cap-ex, our expectation is that they will raise $130 million??? in the secondary (we assume it will be oversubscribed) and then probably raise another $130 million from a Chinese bank. If that happens they should be fine for the next year, and then another raise will be done in 2009, we suppose.

Of course, alot can happen between now and then. The key numbers to really get a handle on with CSIQ is cash receipts from customers and payment cycles. If management would provide more figures on that, it would be possible to figure out at what point they will be cash-flow positive and provide a better model for valuation. We should also get more information on that also in the upcoming conference call.

Best of luck.

[PELUSIN]

ficking short. you need to cover

[Ames Tiedeman]

Shorting the Solar space the past 2 months has made some money. Longer term solar may become more viable.

[Jack Yetiv]

Envoy, any comments about the convertible TSL announced today, and the 13% in the stock's price?

Jack

[Envoy Global Research]

Hi Jack,

Looked at TSL quickly. Converts are presumably better than direct equity offerings (i.e. CSIQ), but the issue with TSL is that their short-term debt level is already very high (up to $320 million or so as per their 20-F). So TSL is getting quite leveraged, relative to their size (i.e. $800 million market cap and $440 million in total debt now).

Obviously, this will provide better upside should they succeed and get to cash-flow positive, but at the same time, this increases risk.

Upcoming earnings should provide better insight into the balance sheets here, and the outlook for financings going forward.

What's interesting about CSIQ and TSL, is that they are both pre-announcing very strong quarters and essentially "giving away" their numbers for the quarter. It's hard to see what else they can now do to get the stocks up, as they've already used their ammunition, so to speak. Now with the numbers already out there the question is: What's Next? Good earnings are presumably priced in already.

Hard to understand why they needed to announce such positive news prior to earnings (CSIQ actually had a string of announcements), as it's usually better to surprise on earnings day. Our suspicion is that they are both very low on cash, and needed to close the financings quickly in order to meet obligations, so as to have the ability to meet future production goals. Of course, we have no proof of that per se, but the upcoming earnings should provide a glimpse into the financial condition of these firms.

[10Q Detective]

Excellent review of CSIQ's financial position. I wonder, too, how long before CSIQ & its peers become the memory-chip players in the solar game, too.

industry.bnet.com/ener.../

My Best,

David J Phillips - Editor, 10qdetective.blogspot....
Contributing Energy Analyst
CNET/BNET

[VP of Common Sense]

Unless I am reading things incorrectly, their 'purchase obligations' are merely raw material contracts. Since they are in a very raw material intensive business this seems like a normal practice.

[inettor]

Ha Ha...Envoy must have felt the unbearable stings from CSIQ stock spike(up almost 20% in a shitty market day) after it recently raised revenue from 188M to 210-214M for 2ndQ.
IMO, he must have shorted tons of shares...now feeling so bitter and hopeless...he's got to find way to lessen the pain. Aha, perfect oppotunity, CSIQ just issued new shares. This is the perfect time to blah blah again! Look pal, CSIQ grows fast and it needs the money to support the expansion. That is expected. CSIQ will make it more profitable and valuable ==> increase share holders value.
Envoy, look and learn when Amazon.com grew awhile back and stop your useless blah blah!