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Lessons From The Fall Of SunEdison

"The boom is drawn out and accelerates gradually; the bust is sudden and often catastrophic."

- George Soros, Alchemy of Finance

There was a very interesting article in The Wall Street Journal a few days ago on the story of "the swift rise and calamitous fall" of SunEdison (NYSE:SUNE). Like a number of other promotional, Wall Street-fueled rise and falls, SunEdison became a victim of its own financial engineering, among other things. SUNE saw rapid growth, thanks in large part to easy money provided by banks and shareholders. Low interest rates and deal-hungry Wall Street investment banks helped encourage rapid expansion plans at companies like SunEdison and provided the debt financing. Yield-hungry retail investors suffering from those same low interest rates on traditional (i.e., prudent) fixed-income securities helped provide the equity financing.

Just like MLPs and a number of similar structures popping up in related industries, SunEdison provided itself with an unlimited source of growth funding by creating a separate business (actually, a couple of separate businesses) that are commonly referred to as yield companies, or "yieldcos". These yield companies are, in effect, nothing but revolving credit facilities for their "parent" business, and the credit line is always expanding (and the yield company is the one on the hook).

The scheme works as follows: a company (the "parent") decides to grow rapidly. To finance its growth, it creates a separate company (the "yieldco") that exists for the sole purpose of buying assets from the parent (usually at a hefty premium to the parent's cost). To source the cash needed to buy the parent's assets, the yieldco raises capital by selling stock to the public, by promising a stable dividend yield. The yieldco uses the cash raised from the public to buy more assets from the parent, and the parent, in turn, uses these cash proceeds to buy more assets to sell ("drop down") to the yieldco, and the cycle continues.

Thanks to a yield-deprived public, these yieldco entities often have an unlimited source of funds that they can tap whenever they want (SUNE's yieldco, TERP, had an IPO in 2014 that was more than 20 times oversubscribed). As long as the yieldco is paying a stable dividend, it can raise fresh capital. As long as it raises capital, it can buy assets from the parent, who gets improved asset turnover and faster revenue growth.

In SunEdison's case, the yieldco is Terraform Power (NASDAQ:TERP). (There is TerraForm Global (NASDAQ:GLBL) as well).

I made a very oversimplified chart to try and demonstrate the crux of this relationship:

SUNE TERP Flow Chart

It Tends to Work, Until it Doesn't

Buffett said this recently regarding the conglomerate boom of the 1960s, whose business models also relied on a high stock price and heavy doses of stock issuances and debt:

BRK Buffett quote on share issuances

If the assets that the yieldco is buying are good quality assets that do, in fact, produce distributable cash flow (i.e., cash that actually can be paid out to shareholders without skimping on capital expenditures that are required to maintain the assets), then the chain letter can continue indefinitely. The problem I've noticed with many...


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