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Archive for September, 2008

Surprise? Short Selling Measures Taken and Stocks Skyrocket?

September 18th, 2008 by Yehuda Fruchter   |   No Comments

The UK bans short selling, major US pension funds refuse to lend shares to short, naked shorting rules in the US are implemented… and stocks skyrocket? Coincidence?

Did short selling of financial stocks greatly exacerbate this panic? If so, Paulson and his cronies bankrupted Lehman (LEH), Fannie (FNM), Freddie (FRE), and took over AIG because of short-term pressure on stocks from illegal shorting? How else can the strange events of the last two weeks be understood. Some entities obviously profited big from the overnight demise of these financial companies. At the same time, long-term shareholders got completely wiped out. Was saving long-term shareholders, most of whom were employees of the companies, really a moral hazard, if wiping them out simply rewarded short sellers? The irony, of course, is that the same investment firms which facilitated illegal short sales are now being brought their knees by illegal short sales.

Unfortunately, it’s doubtful we will ever find out the truth of what transpired during this unusual month. However, it seems clear that the stock market casino, has apparently caused major political and economic upheavals. It should now be interesting to see which Wall Street firms win the business of managing the government’s new financial businesses (i.e. FNM, FRE, AIG). Goldman anyone?

US Government Bailout is More Like Government Robbery ala Latin America

September 17th, 2008 by Yehuda Fruchter   |   2 Comments

What the government is essentially doing in its current “bailout” schemes, in my opinion, is simply stealing companies from US shareholders. This sort of thing used to happen in third-world countries, like Brazil, where for example during the reign of their President Fernando Collor de Mello, citizens bank accounts were essentially confiscated overnight and replaced with less money the next morning.

In the same vein, Paulson and the rest of the US Government, are simply taking advantage of short-term liquidity issues to confiscate US companies, and wipe out shareholders in the process overnight. Yes, they haven’t actually gone into citizens bank accounts yet, but is there really a difference? And could we expect anything different when we hired a Treasury Secretary, whose former job was running Goldman Sachs?

Some may argue that the stocks are really worth $0 and hence the Government is doing the right thing. This of course is too complicated a subject to get into at the present time, but suffice to say, there are other more rational options to the current crisis and it is quite obvious that these companies are not worthless. And are regular shareholders really to blame for the current crisis? By what measure are creditors of these companies more worthy than the equity shareholders, especially since it’s the creditors who have created all these derivative schemes?

For instance, most people I’m sure realize that AIG’s fall had to do with the need to post collateral for credit default swaps. There is absolutely nothing wrong with AIG’s other insurance businesses. Why on earth AIG really feels the need to honor these collateral requests is beyond me, especially since most of the company’s counterparties are seemingly themselves facing a similar crash crunch. Couldn’t the level of collateral required been renegotiated or paid out over time when things settle down? And who exactly are the counterparties that are forcing AIG to post collateral immediately? Why should AIG bow to their demands?

The key question to ask, therefore, is who is getting wealthy off of these US “bailouts”? In the Lat Am countries, like Brazil, it was clear that President Collor and his friends and family made fortunes off of the bank raids. But, who is making money off of the US Government’s Robbery of US companies? Hedge funds that are shorting on inside information? Foreign governments?

Bottom line, the current bailout scheme is simply unprecedented in the US and is akin to government robbery of US business to benefit a few insiders. Time will tell how this plays out. In the meantime, if Brazil’s past provides any clue as to the ultimate endgame, it is this: At some point the robbery will end, business will get back to normal, and investor’s confidence will return.

It may take 1 year, 2 years or 5 years, but things will get back to normal, as there is not much left for the government to steal, unless of course they opt to pay for the next “bailout” by raiding US citizens regular day-to-day bank accounts. Perhaps, then US citizens can dip into Paulson’s and Bernanke’s bank accounts to pay our day to day bills?


Investment Opinion: Stick with commodities, related commodity/energy equities, such as alternative energy, and invest in companies with business overseas. After this crisis passes, the US dollar will plummet again, as no sane person could possibly believe the US currency is worth much, after all this. When the dollar once again begins its descent, oil and other commodities/energy will soar, along with the stocks in emerging markets, many of which are more stable the US, which has quite literally become now become a third world market.


Quick Follow-Up:
I listened to an interesting interview with Donald Trump yesterday who said that Paulson probably made a great deal with AIG. However, the flaw in this argument is that the government should not be in the business of “making great deals.” They are not a business, they are a government and a lender of last resort. As such, trying to negotiate a takeover of AIG, taking equity etc. is completely senseless and the wrong approach for government (as the Markets have already decided). Paulson, given his background, probably can’t help himself from acting like a businessman/shark in this environment, while what the financial system really needs is simply a government that supplies cash (“lender of last resort”) and restores confidence.

A second interesting debate, centers around the fact the government is getting equity in these failed institutions, and that ultimately these investments may become quite profitable, benefiting tax payers. But does anyone seriously believe this nonsense? In what way will taxpayers ever see the profits (if there are any) from these equity positions? Will the government lower taxes in years ahead or send out dividend checks to everyone, if these equity positions become profitable? I’m sure nobody believes either option is possible, and ultimately it’s not clear who benefits, if in fact the government’s equity in these failed institutions increases in value. The truth is probably that there are no financial benefits that will accrue to any taxpayers, and this is why the government forcing companies into bankruptcy, and taking equity stakes, instead of just supplying cash, is utter foolishness, in my opinion.

One of the issues in this crisis, probably centers around the fact that many in the government actually believe in the “reality” of the financial system. However, any rational person recognizes that the financial system is merely a ponzi scheme and can only sustain itself with constant cash infusions from the government. There is nothing wrong with that. That’s the game and it’s usually a fun game for everyone. But the government needs to recognize the game and keep it going by supplying huge amounts of cash, and not busy itself by negotiating to buy troubled businesses.

Quanex Building Products (NX): Thin Film Solar Connection Could Boost Shares

September 16th, 2008 by Yehuda Fruchter   |   Comments Off

Despite significant exposure to the US residential real estate market, I believe that Quanex (NYSE: NX), a recent spin-off, has above-average appreciation potential over the next few years. My optimism is based on the following two factors: the company’s growing presence in the thin film solar market, and a pristine balance sheet ($50 million in net cash, $2 million in debt, and $20 million in cash pending receipt), which should allow NX to pursue highly accretive acquisitions in the current weak operating environment. In addition, the stock’s low valuation, already appears to reflect the well-known problems in US residential real estate. As such, a slight sentiment change in the macro environment, combined with a growing recognition of NX’s solar and other green growth opportunities, could lift the shares.

Background
Quanex Building Products is a recent spin-off from it’s parent Quanex, which sold part of its business to Gerdau, the Brazilian steel giant, earlier this year. The remaining businesses were then spun off to shareholders. The two existing businesses for NX are: Engineered Products (a variety of door and window products) and Aluminum Sheet Products. You can find out more about these businesses at: http://www.quanex.com/index.html. The business that most interests me is the company’s Truseal Division (www.truseal.com) which manufacturers a wide array of green building sealant products, including adhesives for thin film solar panels. It’s difficult to get a ton of information on Truseal, but in the last few conference calls management has indicated that the company is the main supplier of adhesives to the largest US thin film manufacturer, which I assume means First Solar.

The Numbers
Current Price: $16.75
Shares: 38 million
Cash: $54 million (expect another $20 million from Gerdau soon)
Debt: $2 million
EV: $575 million
Estimated Sales: $880 million (these are trough estimates in a weak real estate market)
EV/Sales: 0.65
Gross Margin: 17% (this should improve as capacity is ramped up, and end markets stabilize)
Estimated EBITDA: $90 million (again trough estimates)
Cap-Ex: $20 million per year


What Went Wrong?
US Real Estate Crash.

What Will Change?

  • Stabilization of the US Real Estate Market At Some Point
  • Acquisitions of competitor(s) significantly increases the size of NX
  • Growing business in the thin film solar market, and other green initiatives

    • Financial Evidence
    Despite an extremely tough real estate end market, Quanex continues to generate significant cash, as evidenced in the past two quarterly earnings statements. Notably, in the last quarter the company generated over $22 million in EBITDA and $0.32 per share in EPS. If real estate markets stabilize and assuming continued growth in the company’s solar business, we would expect significant operating leverage to show up at the company in future financial results. In addition, given the company’s financial position, it seems likely to us that NX will soon consummate an acquisition which will significantly increase the size of the company.


    The Valuation
    As can be seen above NX currently trades at less than 10X depressed EBITDA and less than 1X EV/Sales. As such the stock has significant room to move up should sentiment improve and/or should the company complete announce a major accretive acquisition.

    Risks
    Real estate market does not stabilize and the US financial system continues to deteriorate (hard to believe that’s now considered a major risk).

    Major Financial Institutions Failing: So What?

    September 11th, 2008 by Yehuda Fruchter   |   No Comments

    First there was Bear. Then Fannie and Freddie. Now possibly Lehman will fail. But the key question, I keep asking myself, is: So What?

    Has the economy really been damaged by the failure of any of these firms. The answer is: No. Will the economy be damaged by more failures. The answer, again, despite the marketing by biased financial institutions and the Fed is, I believe: No. In fact, these firms should be allowed to fail as quickly as possible, so the economy can get back to creating, producing and selling products/services that are actually needed by society.

    The major US financial institutions have long ago ceased to provide any product/service that is actually in demand or needed in society. Even simple mortgages, and especially mortgage-backed securities, are not essential to a fully functioning real estate market (see below for a brief explanation).

    Of course, there is a need for basic banking services in an economy, but major US financial institutions, and especially the investment banks, hedge funds etc. have not really been focused on “true” banking business, for quite some time. Instead, they are in the business of selling, marketing, and trading what amounts to worthless paper. Society does not really need what they sell. As such, should these firms completely disappear the US and world economy would be no worse off. Quite a few paper billionaires, make become mere millionaires, but should that really concern society?

    I’d be more worried, if a company, like Microsoft or Google, was on the brink of failure, since they produce products that are needed and demanded by society. Then again, even if they failed, it would not be much of a worry, since there are plenty of smart entrepreneurs who could fill the void and recreate the products.

    Basically, as long as there are companies, and most importantly hard-working people, in an economy, which create and supply products/services that are needed and in demand, an economy can continue to grow and flourish. Naturally, without major banks peddling worthless securities, many companies would fail, since due to the paper ponzi scheme developed by Wall Street, many businesses are not run to produce profit, but rather to sell securities. However, there are millions of businesses that are run for profit, and that sell needed products/services and these companies would continue to flourish.

    Getting to investment strategy: as long as the companies you invest in provide needed products/services and do not need continued financing, you should not be worried by the current sell off (assuming of course you do not buy on margin and are diversified). The values of these companies, even considering major fluctuations, will be mostly retained over time, since they sell something that is needed and, presumably, can do so at a profit.

    On the Mortgage Market: Quick Take
    Interestingly, if the mortgage market completely disappeared, society would still function and people would still buy real estate. Need proof of that: Consider traveling to other countries, like Brazil, where the vast majority of real estate transactions are and have always been conducted in cash. Of course, without a mortgage market, real estate prices would plummet further, since few can afford current prices in cash. But, still the market would function perfectly normally and over time it would eventually recover and go higher due to steady demand from population growth.

    Stress Testing Lufkin’s (LUFK) Earnings for Significantly Lower Oil Prices

    September 9th, 2008 by Yehuda Fruchter   |   Comments Off

    Like many stocks in recent weeks, Lufkin (LUFK) has sure been a roller coaster. After recommending the stock back in July at about $78, the stock soared after an exceptional earnings report, only to completely collapse over the last week or so in the broader oil/commodity sell-off. Given sharp share price drop, I thought it might pay to take a step back and run an earnings stress test on LUFK assuming oil prices continue to decline dramatically. Interesting, this type of stress test can be done for many other oilfield service shares, in order to determine potential downside in the event that oil prices do not stabilize (an unlikely scenario in my opinion).

    In looking at past 10-K’s, I noticed that back in 2006 when oil prices were in the 50′s and natural gas prices were at about current levels ($7.50 MCF), LUFK was still able to earn nearly $5 per share. Going back to 2005, with oil prices below $50 and natural gas at under $6, LUFK earned $3 per share. Even going back to 2000, to before oil even entered most speculator’s minds, LUFK was profitable and was earning over a $1 per share.

    As one can see, sharply lower oil prices will have no effect on LUFK’s profitability, though of course the level of profits would fall off. But, since the recent years numbers are prior to the huge jump in oil prices and record profits at oil producers, it seems clear that even if oil prices would fall by another 50%, LUFK would still earn about $4+ per share (Note: oil producers are so flush with cash, they can and will spend on infrastructure for years even at much lower oil prices). This earnings level, combined with $100 million in cash, no debt, and low cap-ex needs, leads me to believe that the downside in LUFK is quite low at current prices.

    Assuming 10X low-end estimates of $4 per share (in a $50 crude environment) + cash, LUFK would probably still be worth about $50, or about 30% below current prices.

    On the upside, if oil prices remain at higher levels (even assume $80 oil), it seems clear that LUFK will earn well above $5 per share and the stock would be valued at much higher levels. Currently, I actually estimate that LUFK will earn over $6 per share over the next year, giving me an upside value of $100+.

    Fair value, given the above numbers, if you assume a 50% chance of oil going back to $50, would then be about $75.

    In conclusion, though it’s disheartening to see such huge drops in formerly profitable holdings, I think it’s important to remember that stocks like LUFK are by no means comparable to the .com’s of old, which imploded and never recovered. Those .com’s had no earnings, cash-flow or any type of business model. It was truly a bubble. In the case of LUFK, there has been solid demand for LUFK’s products for over 100 years already, and there will probably be solid and increasing demand for the next 100 years. As such, I see no reason to panic, and believe the stock still represents an excellent investment in the energy space in the year ahead, for the reasons detailed in my first report.

    Buy the Bad News

    September 5th, 2008 by Yehuda Fruchter   |   No Comments

    With the stock market in another big swoon, I thought it would pay to review one classic method of making money in stocks. Hopefully, this post will help us fight the emotion of fear which grips all investors during major corrections, of which we’ve had tons in the last year or so.

    It’s no secret that stocks are falling once again. Personally, this month is starting off terrible for my portfolio. After having one of my best months in two years last month, when most hedge funds posted steep losses, nearly all of my gains for the year are once again slowly disappearing. So of course, I’m becoming gripped with fear about continued losses and, worst off all, going into negative territory for the year, which has not happened to me in over five years.

    However, since these types of extreme corrections have become quite common in the last year so, during the current bear market, I’ve gotten somewhat used to these big swings and the fear that accompanies them.

    During these sell-offs, it’s important to remember that to make money in any type of investment game, and especially the stock market, you need to Buy the Bad News.

    It’s extremely difficult, and counter-emotional, to buy stocks on major declines and bad news. At that point, you’re losing money, and afraid of future losses. But, buying on declines and bad news is the only way to make money and, in fact, it’s the only rational way to act.

    Simply put, from a rational perspective, as stocks decline the risk/reward ratio improves. As stocks rise, the risk/reward ratio deteriorates. That is basic common sense. So, obviously, you need to buy on the declines and the bad news. In addition, when people sell on bad news, the price of the stock begins to reflect the bad news, and as such further downside becomes limited.

    In other words, stocks discount future news, so during huge declines and bad news, one’s mind should try to focus on potential positive changes that could reverse the decline, as opposed to negative events that can accelerate the decline. Conversely, when stocks are moving up (i.e. you are up 20%+ on a particular position) and good news is reported, one needs to immediately shift one’s focus to potential negative changes that can stem the rise and cause a sell off.

    With that said, I’m off to buy some shares on the open today, with the expectation of selling at a profit later this month, when market sanity returns and the current huge fear of a financial meltdown has once again dissipated.

    The trick of course to buying on declines is to:
    1. Make sure you do your research and are buying companies that are cheap financially, and could recover on good news in the months ahead.
    2. Buy Slowly, as you never know how long the correction will last.
    3. Stay Diversified. Some stocks will never recover from the correction, but many will. By staying diversified, you’re guaranteed to make at least some money on the eventual rebound.
    4. Make Sure You Sell Into Rallies so you have cash to buy on the declines.

    Power-One’s Shares (Nasdaq: PWER) Could Recover Significantly in 2009

    September 5th, 2008 by Yehuda Fruchter   |   Comments Off

    Summary:
    Power-One Inc. (Nasdaq: PWER – Current Price: 2.10) could potentially rise 50% to 100% over the next twelve months, as financial results, driven by the company’s fast-growing solar and winder inverter business, begin to show significant improvement. In addition, a recent acquisition of a competitor to PWER by Schneider Electric , a huge European conglomerate, provides a solid metric for estimating the potential takeout value of PWER under various scenarios.

    Background on Company:
    From SEC Filing:

    We are a worldwide organization and leading designer and manufacturer of hundreds of high-quality brand name AC/DC power supplies and DC/DC converters, inverters and power management products. We are engaged in the design and production of renewable energy inverters. Our renewable energy products, also called alternative energy products, are generally stand alone units that are sometimes called “inverters.” These products are DC-to-AC converters that convert DC voltage from solar arrays, wind generators, or fuel cells into useable AC power; and range in size from a briefcase to a large cabinet. The global demand for harvesting power from the sun (called solar or photovoltaic energy) and wind to be converted into useable power is one of the fastest growing markets due to increasing energy costs and concern for the overall environment. Additionally, the cost of renewable energy products is decreasing and with many countries offering incentives to individuals and companies, we expect this market to expand rapidly throughout the world.

    Current Price: $2.10
    Shares Outstanding: 88 million EV: $255 million
    Cash: $38 million Debt: $112 million (see debt notes at end of this post).
    Estimated 2008 Sales: $555 million ($50 million in renewable)
    Gross Margins: 20% (projected to improve dramatically in the year ahead due to renewable sales)

    What Went Wrong?:
    Power-One has been a terribly mismanaged company for quite some time, as past financials indicate. The past problems would seem to lie in poorly integrated acquisitions and a significant drop in gross margins due to product mixes (and likely competition in mature markets). As a result of these problems PWER’s stock has been quite depressed falling to about $2 from over $10 a few years ago.

    What Changed?
    There are three major changes related to PWER that I think increase the probability of improving financial results going forward:

  • Complete Revamp of Senior Management.

    • Notably, the new CEO of PWER, Richard Thompson (joined PWER in 2/2008), was CFO of two competitors of PWER which were ultimately sold for significant premiums. Interestingly, the last company PWER CEO was at was APC which was sold to Schneider (same company that recently purchased another competitor of PWER – see below) for $2 billion.

  • Growth in Inverters for Renewable Energy.

    • The inverter market for renewable energy (solar and wind) is booming and PWER’s sales in this market are growing quickly (i.e. the company expects renewable inverter sales to double in 2009 and double every year for a few years). Importantly, gross margins for renewable energy inverters are much higher than the traditional margins for PWER products, so as the sales of renewable energy inverters increase as a percentage of sales, the company’s bottom line will get a significant boost. In terms of information about Renewable Energy Inverters this information from the last conference call is extremely interesting:

    “Now, let’s discuss the increasing opportunity we are seeing in the renewable energy inverter market. While this market is still in its infancy, it is estimated that total available market for solar inverters will be $1.3 billion in 2008 and currently growing over 30% a year. Additionally inventers in the wind market are expected to be $1.1 billion. At the current time the market for our products is largely in Europe where governments are driving adoption of alternative energy by offering subsidies and putting into effect a variety of regulations that are stimulating the adoption of greener power. We continue to broaden our reach in many European countries including Germany, Italy and Spain. During the quarter, we strengthened our renewable energy sales and service team in Germany in order to address a growing market demand for our products in that country. Our ability to be flexible and scale our operations in this market allows us to quickly implement product innovations. Our products range from 1.5kW to 300kW are both grid and off-grid and address both solar and wind while most companies in the market address either solar or wind but generally not both. As I discussed earlier, this quarter we introduced five new products in renewable energy. We plan to introduce more products including 100kW to 300kW products for the commercial market in the US. Our inverters deliver over 96% efficiency over an extremely wide operating range and we have a very broad product portfolio.

    Power-One currently has a small market share in inverters for renewable energy. We estimate it as under 5% of the worldwide market for solar and wind which we regard as an enormous opportunity. By making investments in engineering and infrastructure and also through strategic partnerships, we believe we will double this business each year for the next several years. We expect that this market at the end of 2008 will have a revenue run rate of more than 10% of our sales and sales in 2009 will surpass the $100 million mark. “

  • Acquisition of Competitor.

    • In late July 2008, Xantrex Technology (XTX.TO) a Canadian competitor of PWER, a major player in the renewable energy inverter market agreed to be acquired by Schneider Electric for C$500 million. Details of the transaction are available below. In the valuation section for this post, I’ll discuss how this acquisition relates to the potential value of PWER.

    Acquisition Information:

    On July 27, 2008, Xantrex announced that it has entered into a definitive agreement to be acquired by Schneider Electric for a purchase price of $15.00 per share. The all-cash transaction has an equity value of approximately C$500 million ($US 468 million). As a condition to the sale of Xantrex to Schneider Electric, Xantrex also entered into a definitive agreement for the sale of its Programmable Power business to AMETEK, Inc. for US $150 million.

    So total value of transaction for XTX.TO in US dollars using current exchange rates is:

    U$150 million Valuation for Programmable Power: Estimated C$80 million (US$75 million) in programmable sales in 2008, so about 2X Revenue.

    U$280 million Valuation for Remaining Business (subtracting about C$40 million in debt), which includes Renewable Power (C$155 million – US$145 million estimated revenue) and Mobile Power (C$60 million – US$56 estimated revenue) for total estimated sales of US$200 million. Valuation = 1.4X Revenue.

    Total Valuation of XTX.TO: US $430 million or about 1.5X Sales. Notably, gross margins for XTX. TO were about 33% and climbing.

    Financial Evidence for Improving Results:
    Interestingly, aside from management’s forecasts, there is some financial evidence that PWER’s results are improving.


  • Core Cash-Flow of Company Seems Solid Despite Past Dismal Results:

    • PWER has very High D&A charges of nearly $20 million a year and extremely low cap-ex relative to sales of about $9 million. As such, the company’s accounting earnings are misleading to an extent and greatly overestimate current losses. On a theoretically non-leveraged business in a breakeven scenario, the company’s free cash-flow, based on D&A and maintenance cap-ex would be about $10 million a year ( 15X that is $150 million or $1.75).


  • Last Quarter EBITDA Swung into Positive Territory

    • Though PWER still has some working capital issues to deal with, the company’s EBITDA swung into positive territory in the June 2008 quarter. This is vs. losses in the year ago period and previous quarter. Specifically, EBITDA was about $5 million+ in the June quarter vs. a $600K loss last year and about an adjusted $5 million EBITDA loss in the 1st quarter.

  • Solid Backlog Number Indicate Growing Demand and Strong Future Revenue Growth

    • As of March 2008 180-day backlog w as $132.8 million and 90-Day was at $109 million, up significantly year-over-year. In the June 2008 quarter, 180-day backlog w as $134 million and 90-Day was at $107 million, up 60% and 40% year-over-year.

    Risks:
    There are two major company-specific risks for PWER:

  • High Leverage

    • High Leverage (at 50% of current market cap and $9 million a year in interest expenses, which eat up the high D&A) leave Little Liquidity Room If Results Do Not Improve and Cash Losses continue.

  • Operating Missteps

    • The company does not have a history of executing well on its business plans and it’s still not clear whether new management has revamped the company’s operations well enough to take full advantage of the renewable opportunity

    The Numbers and Valuation: (Upside/Downside)
    At the current price of about $2.10 per share, PWER’s Enterprise Value is about $260 million.
    The following are several valuation scenarios:

  • Core Unleveraged Cash-Flow

    • Based on core cash-flow assuming no leverage and a breakeven, as discussed above, I think PWER can throw off $10 million a year in free cash-flow. At 15X that number the valuation would be about $150 million or about $1.70 per share. This implies about 25% downside.

  • XTX.TO Comps

    • Based on the takeout of XTX.TO, I’d go with the following valuations for PWER:
    Total estimated revenue in 2008 of about $555 million with Inverter sales at 10% of that.
    $50 million in Inverter sales would be valued at 1.5X Revenue or $75 million.

    Rest of business will be at $500 million in revenue and worst case (because of much lower gross margins) would be valued at $250 million (0.5 X Sales, way beneath the XTX.TO valuation).

    So total valuation on a takeout should be at least $325 million or about $3 per share (0.6X EV/Total Estimated 2008 Sales). This is vs. a current enterprise value of $260 million. A near 50% upside.

    However, considering the fact that inverter sales may grow to $100 million next year, the valuation of that business could jump to $150 million. The remaining business, if profitability could be achieved could be worth about 1X revenue or $500 million. Total Value would then be $650 million or about $6.50 per share (enterprise value). An over 200% upside.

  • Worst Case

    • It’s always difficult to define a worst case in a PWER situation, but assuming continued cash losses and a major economic slowdown, the stock could easily drop 50% and head to $1. However, I do think that the probability of this low, especially considering the core unlevered cash-flow figure.

  • Probability Scenarios

    • In any case, taking the four scenarios outlined above and assigning equal probabilities would yield a fair value target for PWER of about $3 per share or 50% above the current price. Importantly, if financial results improve the probability weights would change dramatically and the fair value of the stock would jump significantly.

    Timing of Purchase
    PWER stock is trading at multi-year lows and is off over 50% this year alone.

    Conclusion:
    If PWER continues to execute on its renewable energy inverter growth and the company’s core business operating results improve, the company’s stock could increase significantly, given the low valuation relative to recently completed acquisitions. A Probability-Weighted Scenario analysis of PWER, suggests a current fair value of about $3 or 50% above the current price.

    Debt Notes from PWER SEC Filings:

    $80 Million in Convertibles

    On June 12, 2008, the Company entered into a purchase agreement (the “Purchase Agreement”) under which the Company agreed to sell $75 million aggregate principal amount of its 8% Senior Secured Convertible Notes due 2013 (the “Notes”) to Lehman Brothers Inc., as initial purchaser (the “Initial Purchaser”) for resale to certain qualified institutional buyers in compliance with Rule 144A under the Securities Act of 1933, as amended (the “Securities Act”). On June 17, 2008, the Company issued $75 million of the Notes. The Company also granted the Initial Purchaser a 30-day option to purchase up to an additional $5 million aggregate principal amount of the Notes. On July 16, 2008, the Company issued the additional $5 million of the Notes.

    The Notes are governed by an indenture, dated as of June 17, 2008 (the “Indenture”) between the Company and The Bank of New York Trust Company, N.A., as trustee. The Notes bear interest at a rate of 8% per annum, payable in cash in arrears on March 31, June 30, September 30 and December 31 of each year, beginning September 30, 2008. The Notes will mature on June 17, 2013. The Notes will rank equal in right of payment with all of the Company’s existing and any future senior unsecured indebtedness that is not subordinated by its terms.

    The Notes are convertible, at any time prior to the close of business on the business day immediately preceding the maturity date, into shares of common stock of the Company, $0.001 par value per share (the “Common Stock”), at an initial conversion rate of 304.8780 shares of Common Stock per $1,000 in principal amount of the Notes (which is equivalent to an initial conversion price of approximately $3.28 per share), subject to certain adjustments set forth therein, including a potential reset to the conversion rate on June 18, 2009 if the average Common Stock price is lower than the initial conversion price during the five trading days preceding the reset date, subject to a conversion price floor and limitations on conversion under the rules of The Nasdaq Global Market.

    Credit Facilities $32 million

    At June 29, 2008, $30.7 million of the total $31.9 million credit facilities outstanding were held at a subsidiary that the Company acquired in connection with the acquisition of the Power Electronics Group of Magnetek, Inc. in October 2006 of which $23.7 million relates to revolving credit arrangements with various banks. These revolving credit arrangements bear interest at various rates based on the European Interbank Offering Rate (EURIBOR) and bore a weighted average interest rate of 6.6% at June 29, 2008.

    In addition, this acquired subsidiary has an agreement with a European bank to provide borrowings secured by the subsidiary’s land and building over a ten-year period. The initial commitment to lend under this agreement was $9.2 million, with the commitment amount reduced ratably on a quarterly basis beginning March 31, 2004 and ending December 30, 2013. Borrowings outstanding under this agreement were $7.1 million at June 29, 2008 and bore interest at the EURIBOR plus one and one-half percent (6.4% at June 29, 2008). The agreement contains financial covenants that require a minimum EBITDA as a percentage of net revenue and a maximum percentage of debt to equity. At June 29, 2008, this subsidiary was not in compliance with these financial covenants. The $7.1 million outstanding balance under this credit agreement at a 6.4% interest has been classified as a current liability as the Company has not sought to obtain a waiver and considers this debt potentially callable by the bank.

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