Opportunities in Volatility Beyond Startups

By Katherine I.

While our class has largely focused on investing in the earlier stage of renewable technologies development, opportunities also exist to find (and potentially create) significant value when those industries may experience disruption due to either technological development, changes in government incentives, or volatility in upstream supply that may lead to dramatic changes in input costs.

Between 2006 and 2011, the European solar industry basked in the glow of generous feed-in tariffs, designed to incentivize renewables adoption to meet the EU “20-20-20” targets, mandating 20% of energy consumption from renewables by 2020. However, these ambitious goals came up against harsh economic reality with the financial crisis and subsequent fiscal pressures felt across the continent, spurring countries rapidly to eliminate the feed-in tariff systems. While European installations accounted for 70% of global demand in 2011, most forecasts estimate they will comprise only 20% in 2014.

On the supply side, unprecedented declines in pricing across the solar photovoltaic value chain from 2011-2014 fundamentally changed the structure and landscape of the solar markets, as the prices of solar polysilicon and crystalline solar modules dropped more than 69% and 46% from Sept-2011 to January 2013, despite demand increasing at approximately 18% annually. In response to allegations of Chinese dumping, the European Commission launched an investigation aimed at manufacturers of PV modules, cells, and wafers, and planned to impose duties averaging 47.7% on imported solar panels.

This volatility in input prices, combined with a precipitous drop in demand in certain markets, created a perfect storm for companies within the European solar industry. Companies such as Q-Cells and SolarWorld, once the blockbuster growth story of Europe, saw their debt trading at cents on the dollar.

Given the unpredictability of future income streams, combined with the difficulty of securing traditional long-term bank financing during periods of industry and corporate distress, the European renewables industry, particularly solar, found itself in dire straits. Despite favorable geographic conditions, and relatively high electricity prices, the industry was far from reaching grid parity and sunnier markets across the Middle East and Africa increasingly looked like the engines of growth going forward.

Moreover, in the case of most European jurisdictions, a challenging (and uncertain) insolvency environment compounded the issue, despite attempts to streamline the bankruptcy process. Renewables insolvencies should bear particular caveats, particularly given the limited value of contractual reps and warranties in distressed situations, and the potential for warranty claims to create additional value leakage.

Despite the challenges, a number of interested parties provided interim financing to bridge the gap or help companies to restructure through debt/equity exchanges. In the case of Q-Cells, a marquee German photovoltaic producer, Korean industrial conglomerate Hanwha stepped in to acquire the company for a purchase price well in the low hundreds of millions – but only after creditors had negotiated the treatment of significant operating liabilities.

Another example is SolarWorld, an integrated photovoltaic producer based in Germany, the last relevant producer in Europe with ~1 GW of integrated capacity and ~2% market share. Small enough to concentrate on higher priced markets and niche segments, SolarWorld was a brand name recognized by the German consumer, but also positioned to sell into growth markets globally with a foothold in Japan, North America, and the Middle East.

However, with €1.1bn in outstanding debt, and EBITDA rapidly turning negative, SolarWorld found itself in an increasingly tenuous position. Falling ASPs drove a precipitous fall in revenues, with an increasingly uncertain outlook amidst cancelled feed-in tariff programs and the EC investigation on Chinese module manufacturers. The company was eventually able to negotiate a 55% debt haircut in exchange for a debt/equity swap, with Qatar Solar investing €50m through the restructuring in exchange for 29%.

At the end of the day, the question remains if distressed capital provides utility and creates value, or resembles the “vultures” that these investors are so frequently labelled. In the case of both SolarWorld and Q-Cells, as in many renewables investments, it is clear that the value of the entity as a going-concern far exceeded the liquidation value (given typically limited asset value other than in the underlying real estate of production facilities). The difficulty, of course, is that many potential white knights are hampered by either institutional factors (given the optics of acquiring a distressed asset for a conservative corporate board) or lack of legal know-how.

In the case of SolarWorld, while ASPs continue to fall, the company has been able to restructure operations through an overhaul of module procurement, reduction of group headcount by 7%, and a reduction in other overheads. As a result, the company is now far better positioned to sell into the growth markets like the Middle East, especially given a 30% strategic investment by Qatar Solar, a white knight that might otherwise have been dissuaded by the complexity of German insolvency procedures.

Distressed investors, as a result, provide an important form of bridge financing. This is particularly true in jurisdictions or situations where either the “rules of the game” are not conducive to less knowledgeable market participants taking control of distressed assets (as in Europe, given the complexity and shifting nature of bankruptcy regulation); or the negative connotations of distressed M&A (given complexities around both bankruptcy process and corporate image) make it easier for the white knights like Hanhwa or Qatar Solar to acquire a distressed asset or company secondhand, after the “dirty work” of restructuring has been accomplished. While there is not necessary any “right time” within renewable technology life cycles to invest, opportunities clearly exist both in good times and bad.

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About macomberjohnd

HBS Finance faculty interested in sustainability in the built environment including devices, structures, townships, and cities.

4 Responses to “Opportunities in Volatility Beyond Startups”

  1. By John Macomber
    Interesting observations about scale, opportunity, and financial engineering. Do you think there is something about these businesses that makes them harder – or easier – targets for distressed asset purchases than other industries might be? If you had capital and wanted to deploy it in manner in this space, what kinds of opportunities would you look for? Conversely, if you were a distressed-asset investor how would this sector appeal compared to others?

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  1. Some model posts – first round | Innovation in Business, Energy, and Environment - November 3, 2014

    […] https://innovbusenergyenviro.wordpress.com/2014/10/06/opportunities-in-volatility-beyond-startups/ […]

  2. More on Volatility, Distress, and Renewables – Beyond Startups | Innovation in Business, Energy, and Environment - November 3, 2014

    […] post is a further response to the original thread here and my comment asking about sectors, roles, and comparative opportunity here – […]

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