Sky Solar (SKYS) – Merger Arbitrage – 110% Upside

Current Price: $2.88

Offer Price: $6.00

Upside: 110%

Expected Closing: TBD

This idea was shared by Writser.

 

Background

This idea is probably much too hairy for most of you but I think it is an interesting setup.

Over the past years a number of Chinese solar firms have successfully gone private (e.g. Trina Solar (TSL), JA Solar (JASO). Sky Solar (SKYS) is a slightly different animal. The first two companies were mostly in the business of selling solar panels, whereas Sky Solar is in the business of developing and operating solar parks all over the world.

Sky Solar IPO’d in 2014. Fortunately for the reader it is not a reverse merger, but a venture-capital backed startup. Nevertheless, since the IPO things have gone downhill quickly. In 2017 the company’s former CEO was found to have made unauthorized transfers to entities under his control. He has left the company, sold his holdings and settled with the company for $15m. Sky Solar has hired a new CFO twice the past few years. They settled litigation about a large solar project in Japan by buying out their partner for ~$139m. They are being sued by another partner, Hudson Capital (a clean energy private equity firm ran by a former Goldman Banker (Neil Auerbach), who is arguing that the company has defaulted on their notes worth $53m. Hudson has already appropriated several assets of the company and is arguing that Sky Solar is insolvent as of today (see the letter below dated May 28, 2020). I guess most of you can stop reading now and discard me as a crazy fool falling for yet another Chinese scam.

So, for those of you still reading, why would any sane person buy this pile of shit? Well, the interesting part here is that basically every party involved is trying to take the company private.

 

Timeline

Let me give you a brief timeline of events. Note that the company adjusted the ratio of the ADR’s in 2019 from 1:8 to 1:20. I have adjusted all historical prices to keep things consistent.

  • 26 Dec 2018: Sky Solar announces they have settled the conflict with their Japanese partner. They buy back all solar assets for $139m.
  • 28 Dec 2018: Hudson proposes to acquire Sky Solar for $5.375 - $5.625 per share (see court docket below, document 61). Immediately after that they start bombarding Sky Solar with lawsuits.
  • 24 Jan 2019: Hudson appropriated several solar assets (mostly in Uruguay) from the company as collateral for their notes, which they argue are in default.
  • 30 Oct 2019: Japan NK Investment KK (JNIK), a vehicle managed by a director of the company, buys a 36% stake in Sky Solar for $5 per ADR from the former CEO.
  • 7 Nov 2019: Sky Solar announces a settlement with Hudson. As part of the settlement Hudson agrees to buy ~102m shares, representing ~5.1m ADR’s, for ~$25.5m or $5 per ADR from another shareholder (not completed after Hudson backed out later).
  • 14 Nov 2019: Hudson and JNIK enter in a shareholder agreement with Fusion-Lynx Holdings. Literal quote: “HGF DE II and Japan NK Investment K.K. intend to, among other things, contribute and/or sell their respective Ordinary Shares (including ADSs), whether now owned or acquired in the future, of the Company to Fusion-Lynx Holdings, and thereafter cause Fusion-Lynx Holdings to take steps to acquire the remaining Ordinary Shares of the Company (the “Contemplated Transactions”). 
  • 16 Dec 2019: Deadline of the settlement agreement. Hudson backs out of the deal, but according to their 13D: “Hudson Solar is prepared to engage in discussions with the Company regarding a potential extension of the Settlement Agreement, conditioned upon the Company’s agreement to grant to the Reporting Persons and their representatives due diligence access in connection with a potential take-private, change of control or other strategic transaction involving the Company.”
  • 26 May 2020: JNIK, who first tried to take the company private together with Hudson, now files a going private proposal for $6 per ADR together with other shareholders. The consortium owns 72% of shares outstanding.
  • 27 May 2020: Hudson files new lawsuits against Sky Solar.
  • 28 May 2020: Hudson writes another threatening letter stating that Sky Solar is basically insolvent. However, they also mention that Sky Solar “chose not to disclose a previous, higher offer made by an affiliate of Hudson some months ago”.

 

Thesis

The way I read the situation all parties involved are trying to take the company private. Hudson is in a good negotiating position because of the notes they are holding. The current CEO of Sky Solar argues that Hudson is using these notes to pressure the company into a transaction (see the CEO’s affidavit, document 39 in the docket):

During most of 2018, Hudson and Sky were discussing a potential partial rollover plan where Hudson would convert part of its Notes into equity in Sky. In connection with those discussions, Sky allowed Hudson to conduct acquisition due diligence and, on December 24, 2018, Hudson proposed to acquire Sky via a statutory merger under Cayman law. Ex. 22. Just two days later, Hudson sent the first notice of an alleged event of default under Section 3.5(j) of the ARNPA-an alleged default that had been waived for years and for which no action had been taken for eighteen months.

[..]

I believe that Hudson has created or scoured the record for purported events of default in bad faith in order to accelerate a debt that is not due to seek to obtain control over Sky.

I won’t pretend to understand all legal intricacies here. I’m not sure if the notes are actually in default, whether the asset appropriations were correct and whether the company can claw back the appropriated assets (though I don’t think so). However, Hudson and Sky Solar were very close to a settlement in late 2019 and it wouldn’t surprise me if another settlement is agreed upon. Both Hudson and the company mention in their filings that they are willing to settle.

What I especially like here, and what makes this situation in my opinion somewhat different from other Chinese going-private deals, is that both an American player and a Japanese player have been trying to take the company private at a significant premium to the current market price. First together, and after Hudson backed out of the settlement deal the Japanese player is now trying to buy the company without Hudson. And the latest Hudson letter states that an affiliate of Hudson tabled an even higher bid.

The majority of the remaining company is doing business in Japan. Sky Solar has been active in Japan for over a decade and has a lot of assets there and a large pipeline (from the 10K):

We entered the Japanese market in 2009. As of December 31, 2019, we owned and operated 57 IPP solar parks totaling 85.4 MW, which are located in Tokyo, Chugoku, Kyushu, Hokkaido, and Tohoku. In 2019, these IPP solar parks received approximately 1,200 to 1,300 radiation hours. We also had 15.8 MW of solar parks under construction and 60.3 MW of shovel-ready projects ready to be developed upon receipt of funding. Additionally, we had 80.7 MW of solar parks in our pipeline in Japan.

Also note that, to resolve the conflict with their silent partner in Japan in 2018, Sky Solar paid $139m to buy out their partner owning 48.93% of the Japan assets (see 2019 annual, page 44). It is hard to come up with a valuation of the company but the actions of all stakeholders strongly suggest there is quite a bit of value in the Japan business that is (either fortunately or unfortunately, depending on your perspective) not immediately clear when looking at the financials.

So this does not appear to be a typical case of ‘Chinese management screwing US shareholders’. In fact, in the shareholder agreement dated November, 22, 2019, Hudson and JNIK specifically mentions that:

Each Party agrees to use its reasonable best efforts to support and consummate as soon as reasonably practicable after the Second Anniversary (i) an IPO or (ii) a Trade Sale [..] on the Tokyo Stock Exchange or another internationally recognized securities exchange as the Investors may mutually agree.

I recommend that you take a look at the shareholder agreement. The plan seemed to be: take the company private, let JNIK fix the Japan business, let Hudson fix the RoW (rest-of-world) business, and relist in Japan or on another (Asian) stock exchange.

JNIK is managed by Rui Chen, a director of Sky Solar responsible for their Japan operations (currently their largest business) who has been with the company since 2009. It is the largest insider shareholder of Sky Solar with a 36.4% stake, bought from the former chairman. I don’t know if Rui Chen is a strawman for the former CEO or an independent director but in either case it seems extremely likely to me that the board is supportive of this plan. Also, a Japanese majority holder trying to take private a distressed US company with a majority of operations in Japan with the plan of relisting in Asia seems like a sensible idea.

Also noteworthy is that Hudson, as part of the proposed settlement, was going to buy all shares owned by IDG-Accel China Capital L.P., currently the second-largest shareholder of the company owning ~24% of shares outstanding. IDG-Accel is a partnership between Accel Partners, a US venture capital firm, and IDG media, a US media company that was bought in 2017 by China Oceanwide Holdings Group. This is a legitimate partnership that has raised several billion dollars for Chinese venture capital funds during the past decades (see link below), probably looking for an exit. After the Hudson deal broke down they joined the rollover group of the new proposal, led by JNIK.

At the current price of $2.88 I think the risk/reward is pretty interesting. This vehicle traded around $1.30 during the panic in March and there’s a potential $6 offer on the table. So, an extremely simple back-of-the-envelope calculation suggests 50% downside, 110% upside. The barrage of lawsuits from Hudson might have some merit, but in the meantime Hudson has been trying to buy equity in the company several times. I think it is likely they are applying pressure to get a slightly better deal for themselves and I think it is in the best interest of all parties involved to reach some sort of settlement and not to burn the company to the ground, potentially endangering the ‘shovel-ready’ pipeline in Japan.

Also, consider this: I think it is very likely this security is mispriced. Who would ever want SKYS on their book? It ticks all the wrong boxes. Chinese, Solar power, lawsuits, potential insolvency, three CFO’s in two years, former CEO was a crook. Good luck explaining that to your clients!

 

Conclusion

I think this is a risky proposition, I might very well be missing some things and there is a definite chance this vehicle is going down in flames. This is probably one of the most stomach-churning securities out there. But a closer look shows that this company is backed by a US venture capital firm, that several non-Chinese parties see value in the remaining assets and that there were plans to relist the company in Asia. The company has a few backers with financial firepower, making it unlikely that Hudson will be allowed to sue the company to bankruptcy if the backers see upside in their equity position. The free float is limited, making a buy-out relatively cheap and easy. And as far as I know this security isn’t exactly on anyone’s radar. All things considered the picture looks not as bleak as you would think at first sight. I think there is a decent chance the company is actually taken private. And if that actually happens this stock will likely double or better. In May shares spiked over 150% after the preliminary bid was filed but they traded down significantly since.

Of course, again, the MAIN and REAL RISK is that Hudson and the company do not reach a settlement and that Hudson wants to litigate and get their money back rather than work together with the other major holders to fix and relist the company. The latter was already the plan but Hudson reneged on that deal the last minute. So there is no definitive deal on the table and Hudson can throw a spanner in the works. Risky!

I have a small position. There is a real risk this goes to zero. But I do think this is a decent market-neutral bet when sized appropriately. Also, I think that there can be some actionable events in this name in the near future. That’s one of the reasons I’m publishing this: even if the idea is currently not your cup of tea I think you have an edge when the situation develops in the future if you have been following this story for a while as it is quite complicated. So I’ll try to keep this thread up-to-date. Not to mention that I think following the court (and company) filings is actually an interesting and educational endeavour, besides being potentially profitable. Yes, I’m a nerd.

 

Additional sources

Hindenburg short pitch from February 2019

NY supreme court docket of 2019 litigation with Hudson

NY supreme court docket of 2020 new litigation with Hudson

17 COMMENTS

  1. Zulu Investor

    Thanks for publishing, Writser.

    Like you said, this situation is a bit too hairy for me. Might consider a small position 1-2% since It does seem like an attractive head or tails bet scenario. I would look at it the way BMY-RT is and size it up accordingly, knowing it could go to zero.

    I’ll just be following and tuning in for now.

  2. jwestern

    I find the behavior of Hudson pretty confusing. Almost seems like they aren’t serious, or have some ulterior motive. They want to buy at ~$5.375, then get a chance to buy some shares at $5 but let the opportunity pass, then they want to sell to Fusion-Lynx, just kidding we gotta do due diligence because maybe we want to buy, etc.

    1. Writser

      Well, they wanted to buy the entire company. The $5 / share was part of the settlement and in that case they would own ‘just’ 25%. I think, if you read between the lines, that Hudson thinks they can extract a better deal for themselves and that that’s why they backed out of the settlement, even though they are still willing to buy the company. That’s just my educated guess though, and I could be mistaken.

      Another point that I didn’t touch in the write-up is that Hudson is suing to get back the principal + accrued interest on their notes (~$54m) but also 69% of the ‘yield maintenance account’, being another $42m. If Hudson really thinks it can win this lawsuit then getting close to 200% of your principal back might be a better deal than the settlement that was on the table. But again, the fact that they have been, and explicitly say they are still, trying to buy the entire company makes me think it is likely that Hudson is applying pressure to get more or cheaper equity, rather than trying to bankrupt the company.

      FWIW, I am not sure at all why shares are up ~30% since this write-up was published a few days ago. I see no news whatsoever. I hope it isn’t a few readers bidding up the stock who will get angry with me when it turns out I completely misread the situation and SKYS goes bankrupt!

      1. jwestern

        Thanks for your thoughts. Hudson may also have considered owning a large position without control to be unfavorable. I guess that would make their rejection of 25% @ $5 make sense.

  3. Writser

    FWIW, shares are now up ~50% since I posted this piece, and there has been no news apart from what David mentioned. And while I am not sure how much weight to assign to Hudson starting another foreclosure proceeding on some American assets I have a hard time seeing it as something positive. I.e. best case it is some posturing, worst case Hudson has decided they are done with negotiating and want their money back, potentially leading the consortium to pull the plug on the acquisition.

    I’m still long but I’ve been taking some money off the table.

    FWIW, another thing to consider is that the ‘Robin Hood / reddit / bored lockdown trading’-crowd occassionally has been going nuts with some of these illiquid Chinese special situations. Just as an example, I owned some shares in CXDC, a crappy Chinese merger that the market usually would price at a juicy discount, but last week on Tuesday and Wednesday the stock was pumped / bought up by some clowns and traded >20% over the going private price at some point during after hours.

    With an average volume of ~50k shares traded and a limited free float (the consortium owns 72% already) this stock certainly has some potential for shenanigans. I’m not saying that’s a reason for buying / holding, but it’s something to keep in mind.

  4. Writser

    Shares are now trading around $5.50, up ~90% since the write-up. The consortium now owns ~77.5% and filed a tender offer expiring July, 31 today. If they manage to get to a 90% position they can take the company private. Obviously this is the best possible outcome. I don’t know exactly what is happening behind the scenes but in a parallel universe things could’ve gone south (and even in this universe things can still go wrong).

    Some thoughts on the SC TO-T:

    – The document confirms my suspicions that the Japan assets are the crown jewel here. Not only the current Japan assets but also the development pipeline and government concessions. The consortium states that book value is not a ‘material indicator of value’. On page 14 of the offer to purchase you can read that Hudson tried to buy the Japan sub for as much as $108m in February. I think the consortium is totally fine with Hudson foreclosing on their collateral and then some, as long as they keep the Japan assets for a possible relisting in Asia.
    – Minimum acceptance condition is to get to 90%, so ~55% of unaffiliated shares have to be tendered. I think this should be doable. Volume is very limited, hard for Hudson to buy a blocking stake. All other bagholders are probably delighted with the offer.
    – I think another key risk is on page 35/36: basically there should be no court orders blocking the merger and/or forcing the company to wind up. The deadline of the tender offer is July, 31. Conveniently 2 days after the SKYS filing deadline in the NY supreme court. By doing this quickly I think they are trying to sidestep any legal issues. But Hudson undoubtedly will try some stuff. On what grounds can they block the transaction though? If they want their money back it shouldn’t matter who owns the company. I think their case would be weak.

    At the start of the day I think it was still an attractive situation and I bought back some shares around $5.12. As of now shares are trading around $5.50. Not sure if that’s super attractive anymore but I will sit this out for a few weeks. Bottom line is: consortium owning 77.5% is aware of all lawsuits and still interested in buying the company. Good luck stopping them. And, as I said, Hudson backed out of their deal to get equity and the consortium will probably make sure they settle with and/or pay Hudson.

    Some other thoughts:

    – Price action was very suspicious the past few weeks. I’m pretty sure some people were buying with more information than others.
    – At first glance, this was an uninvestable situation. A lot of uncertainty, Chinese involvement, solar power, lawsuits, appropriations and a failed takeover in the past. I think 99% of all investors dismiss such a stock within a nanosecond. But a closer look revealed that insiders had been fighting to take the company private for years, wanted a relisting in Asia and that the China connection was actually legit: no reverse merger but a partnership with a US venture capital firm. Not to mention that the eventual buyer was actually a Japanese company. I think the combination of hair + Chinese + uncertainty caused this to trade as a Chinese penny stock despite it being a legitimate situation. Yes, it was risky and the outcome was/is uncertain but i don’t think shares should have been trading below $3 after the bid was disclosed.

    FWIW I have had very good experiences with Chinese deals listed in the US. I think there’s a lot of value in that space because almost all US investors dismiss these deals outright since the Chinese ‘cannot be trusted’.

    1. Zulu Investor

      I’ll have you know that I put in $300. With hindsight of 20/20, would have been nice to add a couple zeros to it :)

      Kidding aside, congrats on the successful investment, Writser. Looks like dinner is free for me this week!

  5. dt

    Thanks for sharing and congrats on a very well-timed trade. I did not expect the events to develop so quickly and so positively.

    With almost 100% gain in a month, I am marking this as closed.

    8.5% spread remains and if Hudson does not raise any waves this should get closed in a few weeks as well. As you suggest not really clear what can be done by Hudson to block this tender – hard to imagine they will get court sanction so quickly.

    Btw, we are putting together dataset on recent (the last few years) US-listed Chinese deals. Will publish it shortly. So if you are aware of any transactions that should be added to the list, let us know. So far we have:

    Still Open: DL, SKYS, WUBA, GSUM, BITA, CBPO, CO, CXDC
    Closed: JMEI, HPJ, SORL, EHIC, CYOU, ZPIN, KZ, QUNR, EFUT, KANG, SYUT, TSL, JASO
    Failed: ATV, CCRC, CBPO, GSUM, BORNY, CSIQ, CAAS, JMEI, SVA, CO

    1. Writser

      Seems about correct. I think ATV does not belong in the list: it was doing business in China but the buyer and owner is an American. Also, the JMEI deal closed already. SINA is a recent proposal. I think you missed QIHU, WX, DATE, and probably some more ( https://www.valuewalk.com/wp-content/uploads/2016/04/whitepapersqueezeouts-english.pdf )

      Will have a look to see if you miss a few. I think a key distinction is to see what deals failed after a binding offer is on the table. Non-binding offers I would be extremely careful with: they are made extremely opportunistically. I would never advice buying CAAS or GSUM at this point, for example. I think Duff and Phelps publishes a very good overview of what is going on in the Chinese corp. act. space once or twice a year (example: https://www.duffandphelps.com/-/media/assets/pdfs/publications/mergers-and-acquisitions/china-transaction-insights-late-spring-early-summer-2019.ashx ).

      Would also be interesting to do something similar for Russian / Eastern European deals. I think they are treated similarly by the market, but there are not as many (CTCM was an example I think).

    2. Zulu Investor

      Wait Dt, JMEI should be on the closed list. I had that position myself.

  6. Tom

    I completely missed round one of this trade, but I have put my toe in the water over the last 2 days. Unfortunately, I don’t feel that I have an understanding of what Hudson wants or the court process. I really purchased now based upon the original thesis that there seems to be a real interest in buying the company at $6 (perhaps by more than one party) and a not insignificant chance that Hudson will blow the whole thing up. At $3.5 it seems worth taking the risk.

    I’d really appreciate hearing the thoughts of Writser and some of the other contributors that have added very helpful remarks in the past.

  7. Brian

    I sold half my position when the spread went to under 2% but unfortunately held the rest and have nibbled a little the last couple of days. The setup remains interesting and I think the market is skittish even though the whole thing feels nuts. The float is about $16 mil at the current price.

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