Wall Street Daily - A Stark Lesson From the SunEdison Collapse - Issue #1,224

This email is part of your Wall Street Daily subscription.
WSD
Home Contact Print Unsubscribe

Legendary Investor Issues $68 Trillion "Biblical" Prophecy

Jim Rogers is one of the best pure investors on earth. His predictions have handed him some $300 million over the years. They've also generated average annual gains of 419% for his clients at Quantum Fund over a 10-year period. But today Jim is revealing the boldest prediction of his career...

America will soon witness a $68 trillion collapse of our economy, and our social order. And Jim says the data - and an obscure passage from the Bible - prove it. For details, and how to prepare, please click here.

Read More »
A Stark Lesson From the SunEdison Collapse
Solar energy company SunEdison Inc. (SUNE) filed for bankruptcy on April 21.

This event demonstrates the weaknesses of a business model dependent on renewable energy subsidies - especially when the subsidies have only just begun to lessen, never mind dry up altogether.

It also demonstrates the folly of over-leveraged business models.

Sadly, the biggest losers from SunEdison's bankruptcy will be bondholders, especially those who invested in SunEdison's many securitization vehicles.

Among securitization vehicles, income investors should avoid debt and equity in the "yield cos" actively peddled by Wall Street.

If you're unfamiliar with the term, yield cos are basically corporations that typically own renewable energy assets like solar farms and wind farms. But they own the more stable, cash-producing operating assets, rather than more capital-intensive areas like research and development and construction.

The goal is to deliver greater earnings, which are paid to investors through dividends. In short, they're designed to strip out some of the risk of investing in renewable energy.

However, SunEdison's yield cos differed from other securitization vehicles because they involved issuing equity rather than debt. Solar power and other renewable energy plants were hived off into separate companies, which then financed themselves with IPOs, issuing dividend-paying equity to investors and assuming a whole pile of debt.

Two such companies were formed from SunEdison - TerraForm Power Inc. (TERP) and TerraForm Global Inc. (GLBL).

The Problem With Yield Cos

There were several problems with the structure:

  • First, the yield cos' income depended on the amount paid by utilities and consumers for power, as well as on any subsidies they received. As power prices declined along with oil and gas prices, subsidies also declined and yield cos' revenues weren't able to sustain their dividend payments.
  • Second, the leverage was too great. At its formation, TerraForm Power had almost no tangible equity in its capitalization.
  • Third, since SunEdison controlled the yield cos, it could force them to enter into unattractive transactions - such as the failed takeover bid for Vivint Solar Inc. (VSLR), a rooftop solar panel installer. Indeed, as SunEdison ran short of cash, it was able to transfer cash from the yield cos.
This combination of problems has caused share prices of both TerraForm Power and TerraForm Global to decline by 75% in the past six months.

Now that SunEdison has filed for bankruptcy, the future of the yield cos is highly uncertain.

SunEdison's creditors will undoubtedly attempt to get at the better assets and revenue streams of TerraForm Power and TerraForm Global, arguing that SUNE controls both companies, so their assets should be made available to the creditors.

Meanwhile, the yield cos' own debt will require servicing, and there may not be enough cash flow to do so.

The obvious vulnerability is the yield cos' dividends - which currently provide investors with a double-digit yield. They'll almost certainly be cut back or, more likely, eliminated altogether.

Avoid These Investments

You won't be surprised to learn that SunEdison was a favorite investment of several hedge funds. This kind of aggressive financing-driven growth is a favorite tool of that sector.

Of course, the Fed has helped this strategy by keeping interest rates below the inflation rate for nearly eight years. This encouraged all kinds of dopey schemes - such as the one undertaken by Valeant Pharmaceuticals International Inc. (VRX).

However, my advice isn't to avoid investing in hedge fund-driven get-rich-quick schemes. As an income investor, this should be obvious.

Instead, beyond get-rich-quick schemes, there's a problem in investing in securitization structures in general - whether debt or equity.

After all, you've probably heard about the $5 billion fine imposed on Goldman Sachs (GS), partly for misstating the quality of subprime mortgages it securitized.

From the email traffic, we know that in some cases Goldman Sachs executives had inspected mortgage portfolios and discovered that they didn't fit the description in the prospectuses used to sell the securities.

I don't want to channel Senator Bernie Sanders, but in my view, a fine - where the cost falls on the Goldman Sachs' shareholders of 2016 - a decade after the problems occurred is the wrong punishment. If there was evidence of fraud, someone at Goldman Sachs should have gone to jail.

We'll never keep Wall Street steering towards the white side of the many gray areas involved in finance if we don't invoke the ultimate penalty.

Goldman's 2006 malfeasances were only possible because once you've bundled assets up into a securitization package, it's impossible to know what you have in there.

The rating agencies may give it a stellar credit rating, but the near-impossible task of assessing it is evidenced by the fact that the rating agencies themselves were fooled by the mortgage securitizations of 2006-07. And after all, home mortgages are a pretty simple asset.

Part of the problem is that Wall Street has no clue how to manage risk properly, as it uses Gaussian mathematical models based on assumptions that simply aren't true.

As a retail investor in a securitized debt or equity, you're buying the ultimate pig in a poke. The seller knows more about what's in there than you, but you can't trust either his ethics or his competence to have disclosed it completely.

And in any event, a proper disclosure may be 200 pages long, and who has time to read it all?

So as an income investor, avoid securitization structures - no matter how attractive the immediate dividend may seem.

Good investing,

Martin Hutchinson

Leave a Comment »

[INSIDE LOOK] It's like Bitcoin, only better...

We've uncovered an emerging cryptocurrency poised to soar in value. In fact, this one simple investment could put as much as $56,700 into your bank account over the next 9 to 12 months. If you're 55 or older, it could change your retirement plans for the better. Click here now.

Read More »
Buzzworthy
Profit From China's Hardball Strategy
Carl Delfeld examines China's plans to dominate Asia, and pinpoints a few ways you can profit.

Read More »
Recommended Content
4.25.16
Japan's Infamous Widowmaker Trade
By Alan Gula, Chief Income Analyst
 
4.21.16
China's New Silk Road: Railway to Europe
By Tim Maverick, Senior Correspondent
 
8.13.14
Dividend Investors' Guide to Yieldcos
By Tim Maverick, Senior Correspondent
 
You are receiving this e-mail at as a part of your subscription to the Wall Street Daily e-letter.

Manage your subscription.

Or to cancel by mail or for any other subscription issues, write us at: Wall Street Daily Attn: Member Services 105 West Monument Street Baltimore, MD 21201

Copyright 2016 Wall Street Daily, LLC All Rights Reserved Wall Street Daily, LLC.

If you would like to contact us with a question or comment, please click here.

Wall Street Daily, LLC is a financial publisher that does not offer any personal financial advice or advocate the purchase or sale of any security or investment for any specific individual. Members should be aware that investment markets have inherent risks and our past performance does not assure the same future results. The stated returns may also include option trades.

Protected by copyright laws of the United States and international treaties. This newsletter may only be used pursuant to the subscription agreement and any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), in whole or in part, is strictly prohibited without the express written permission of Wall Street Daily, LLC. 105 W. Monument Street, Baltimore MD 21201.
Twitter Gplus Facebook

105 West Monument Street
Baltimore, MD 21201
North America: 1.855.405.3939
International: +443.353.4052
Website | Contact Us

About Wall Street Daily

No-nonsense, free investment newsletter that picks apart Wall Street's latest headlines to expose the truth and real profit trends, written by seasoned investment ...