After Capital Infusion, LDK Solar’s Valuation Still Looks Stretched

LDK Solar (NYSE:LDK), the beleaguered Chinese photovoltaic product manufacturer, will sell a 12% equity stake  to Fulai Investments to raise around $31 million in additional capital. The firm will issue 17 million new shares at $1.83 each and offer Fulai two seats on the company’s board. ^[1] The move is the latest in a series of efforts by the firm to shore up its financial position.

LDK’s stock has more than doubled over the past three months to around $2, tracking the broader rally in Chinese solar stocks that was brought about by new deals and a government subsidy boost. Although the infusion of fresh equity is a positive development for the firm, we are sticking to our price estimate of around $0.90 for the time being, considering the firm’s weak sales and margins, high risk of insolvency and the mounting threat that the government could pull back its support to the firm.

Additional Equity Will Be A Drop In The Bucket Compared To Debt

LDK has the most leveraged balance sheet among the solar companies that we cover. The firm’s business of manufacturing wafers, cells and panels is very capital intensive and most of this capital expenditure was funded by short term debt. Given the magnitude of the firm’s leverage, the additional cash infusion would have a very minimal impact on the firm’s debt to equity ratio. At the end of Q3 2012, shareholder equity stood at a paltry $30 million while debt was over $3 billion. Around $2 billion of this debt is due in less than a year. In December, the firm hired Citigroup to help it renegotiate some of its borrowings but the progress is still uncertain.

Lower Prices And Declining Shipments Are Impacting Cash Flows

The firm’s solar modules have been selling at an average of $0.68 per watt in Q3 2012 while wafer prices were $0.30 per watt, declining by almost 50% since 2011.  Shipments have also been sluggish with the firm expecting to sell around 960 MW of solar wafers (down from around 1500 MW last year) and 530 MW of modules in 2012, which is abysmal considering that the firm has around 4300 MW of wafer manufacturing capacity and about 1700 MW (As of Q1 2012) of module manufacturing capacity. This overcapacity has caused weak utilization levels, affecting the firm’s processing cost per watt and consequently its gross margins and cash flows. To mitigate the effects of under utilization, the firm has been restructuring operations and cut over 9000 positions last year.

Given its precarious operating cash flows, the firm has been selling assets and land use rights to meet the working capital shortfall. Last year the firm sold a 20% equity stake to a state backed firm to raise cash and also entered into sales and leaseback arrangements for some of its manufacturing facilities and the management has indicated that more such transactions could be in the offing. We believe that given the depths of the firm’s financial troubles, it will not have much bargaining power in its negotiations with prospective buyers of its assets as well as with equity investors.

Threat That Government Support Could Fade

Despite having billions of dollars in debt and consistently reporting losses over the last five quarters, LDK has been able to stay afloat thanks to support from the Chinese state and central governments. However, in December the government took a tough position on supporting failing solar firms, saying that it would reduce the financial support extended to them and would ban state governments from supporting them as well. (See Also: Who Are The Potential Winners And Losers As China Pushes For Solar Reforms)

Although there is every possibility that the firm could slip through once again due to its size and the large-scale employment that it provides, we think that it still faces a threat of the government pulling back its funding given the depth of  its troubles. The government may be better off supporting a few healthy firms and pushing for consolidation within the industry.

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1. Bloomberg [↩]