Commentary for December 21, 2007 The Wolves Return to LDK
Because I thought LDK didn't get a fair shake from the analyst community in October, I wrote three articles on its hasty demise [ LDK Story (Oct.15, 2007); LDK & the Seven Samurai (Oct. 17, 2007); and Sell-Side Analysis (Oct. 23, 2007)] After yesterday's conference call I still think LDK is a buy.
Psychology governs trading in our highly connected market, and it's an established fact that negativity is more attractive to the human mind than positive approbation. Chalk it up to the Fall or original sin or the Karma of all mankind, but slander-mags and papparazzi are infinitely at home in the human soul. We like the dirt on Brittany, Paris, OJ and Barry, and want the media to feed it to us too. If it was bad for business they wouldn't print it and we wouldn't read it.
Our modern financial equivalent of instant communication (mouse clicks) takes this fallen nature and exacerbates it to the max in stock trading. If traders hear something negative about a firm they'll flee for the exits. Shoot first, ask questions later. That's the name of the game.
Which leads me to LDK and yesterday's conference call. There are 6 analysts who follow the company: Chong Tan Kim (UBS); Adam Hinckley (CIBC World Markets); Pierre Maccagno (Needham); Jesse Pichel (Piper Jaffrey); Cheryl Tang (Goldmans)and Sanjay Shrestha (Lazard Capital Markets).
Two of them are top-ranked Star mine Analysts - those analysts with a high degree of historical accuracy concerning a stock. Both men have 5 stars (the highest rating). Yet there's quite a difference in opinion from the two Star analysts. Chong Tan Kim (UBS) is positive on the stock and raised his target to $71. Adam Hinckley (CIBC World Markets) is openly derisive of LDK and has downgraded the stock twice. His contemptuous attitude was evident on the CC yesterday. He doesn't trust the company.
Pierre Maccagno (Needham) has remained steadfastly positive on LDK's prospects and takes the company at its word and its numbers as authentic. He " reaffirmed his strong buy rating on the stock, however, viewing it as undervalued at 19 times estimated earnings for 2009. He expects revenue to grow at a compounded annual rate of over 80% between 2007 and 2010, and said LDK is well-positioned in the photovoltaic value chain with high-end margins and potential to expand them by 2009 once it starts producing its own raw polysilicon. Maccagno's note also cited "an impressive customer base" that's growing and becoming more diverse geographically and whose output for this 2007 and 2008 is completely sold out on robust demand. " ( A Cloudy view on LDK Solar, Business week online).
Next up on the conference call was Jesse Pichel. Let's just say Mr. Pichel's not a management or shareholder favorite. He was the analyst who first received the Charley Situ correspondence - memos, emails, audiotapes and Excel sheets - and distributed comments on that information to his institutional clients (and which they in turn distributed to the WSJ, Barrons, and any short side hedge funds who might be interested). This began the debacle in October and November that destroyed the stock price, deleting $4BL in LDK capitalization. You might say too that because of this happenstance, Mr. Pichel has a vested interest in being right on being a bear on LDK (Judas Iscariot would agree); but unfortunately the INDEPENDENT audit by an outside accounting firm proved he bet on the wrong horse.
Although the audit has come and gone, Jesse Pichel and Adam Hinckley have not forgotten what precipitated it. I think they believe Mr. Situ was right and LDK merely dodged a bullet. If you see it from this viewpoint, you can understand their underlying tone of contemptuousness towards the company on the call. Mr. Situ was placed with the company (by the underwriters PJ, CIBC) because he was a specialist at GAAP accounting. This was deemed a weakness of LDK's before their IPO. It was also not in Mr. Situ's self-interest to expose accounting irregularities at LDK because in the aftermath he sacrificed $2.5 ML in LDK stock options plus his professional reputation too.
His actions were carefully planned and pre-meditated - secretly recording discussions among the executive staff on the inventory issue; then sending copies to Piper Jaffrey, and the SEC etc, including 8 mb of MS Excel spreadsheet records (that's a lot of data). He felt he had solid evidence to support his suppositions. He also said he did not want to be part of a "stock fraud". This kind of self-destruction is either corporate heroism or just plain stupid vengeance. Mr. Pichel and Hinckley listened to those tapes and went through the Excel data - they believed their man and the Street believed them.
But the audit repudiated this "slam dunk". I heard early on in the process (October 18th) that Mr. Situ might have missed two warehouses in his calculations because his source only had records from 3 out of 5 warehouses; plus the silicon in transit and the silicon being diced into wafers were added later. Institutional buyers know this. Even if he was right in principle he was wrong on his facts - they were incomplete - which gives credence to the company's claim that "hell hath no fury like a Situ scorned". But if Mr. Situ was indeed a tried and true do-gooder, then an alternative corollary might apply, "The way to hell is paved with good intentions".
Messrs. Hinckley and Pichel remain unwilling to let go of what they think they know, but as anyone who's gotten between two divorcees fighting it out in court, facts can be stranger than fiction at times. Another journalist instrumental in casting a pall over LDK in October - Bill Alpert of Barrons - is characterizing KPMG's audit as a "self-acquittal". In his usual scurrilous juxtaposition of two contradictory statements - an outside independent audit and inside manipulation - LDK's guilty until proven innocent and remains guilty after proof of innocence. It's his opinion that matters - not the facts.
He would like us to believe that an 8 week investigation by non-allied inquirers counting every bean in the store was an error, but a part-time employee and a hatchet journalist known for his venal conjunction of innuendo and implausibility got it right. A partial reading of some of his quotes in China's Solar Boom Has Lost its Luster shows Mr. Alpert's primary intent was to discredit the company and terrorize its shareholders. Read my exegesis of Mr. Alpert's methods in LDK Story (October 15, 2007) and make up your own mind.
Chong Tan Kim (UBS) and Pierre Maccagno (Needham) have taken the pragmatic approach of letting the facts speak for themselves and allowing a third party audit to determine the truth of the inventory question. This frees them up to analyze the company's financials without the baggage of Hamlet's dilemma - "To be or not to be (an avenger)".
The dynamic on the CC changed completely when Messrs. Hinckley and Pichel posited their "questions" to management. Ironically they were the only two that had problems with static (symbolic?) on their line and boy were they irritated about that. I kinda imagined two little self-important toadies asking the king in Sleeping Beauty why they weren't invited to the feast. Mr.Pichel is the solar analyst who Bill Alpert of Barrons has aptly likened to Henry Blodget - the guy who said one thing and did another, costing his Internet investors billions ($). Do you trust the analyst (Mr. Pichel) who spreads incorrect material information about the company he brought public when he blames them for his personal phone not working too? Often in small things you can see larger elements of character. I had had no previous experience with Mr. Pichel. All's I knew was that he was a favorite among solar analysts and had name recognition. I was shocked at his pettiness and derisiveness. He's definitely got a perception problem when it comes to personal responsibility or sorting out accusation from assertions. There was also a touch of miffed self-importance in his petty phone irritations.
The other thing I noted is how the Chinese gentlemen on the other end of the call were clearly afraid of these two analysts. If somebody had cost me $4 BL I'd be afraid of him too. They couldn't get their answers quite right; there were also some natural problems in both understanding and speaking in a non-native tongue (English). I thought Mr. Peng's attempts to speak in English were admirable considering the circumstances. He's probably had just a few months' practice at it. Both of the analysts were leaders in the October putsch that blitzkrieged the stock; both of them took Situ's side and quickly betrayed any impartial loyalty they might have shown to LDK. So I don't think I'm exaggerating when I say a personal element of saving face was involved in this call. Inflated self-infatuation was definitely on the line too.
So how did the market react to this state of affairs? It massacred the stock. It ran with the negative take on LDK from Pichel, Hinckley, and Shrestha and completely ignored the reiteration of strong buy from Needham and the buy from UBS. Warren Buffet has a saying that " in the short term the market is a voting machine, in the long term it's a weighing machine". That's just it, I don't think the situation has been weighed yet.
In the October go-around the naysayers were eventually proved wrong and the plaintiff now appears to be a disgruntled ex-employee who botched his $3ML in LDK stock options. Now we're at it again - same voices, subtle (yet not so subtle) accusations of improbability, similar juxtaposition to options expiration week.
However I wouldn't bet against Mr. Peng and his dream of producing polysilicon by the end of 2008. Everything he ever said he would do he did, and 3,000 Chinese construction workers going at it 24/7 could surprise us yet. His management style is clearly summed up in the phrase, "Let your actions speak louder than words". He's incredibly focused on his business; and somewhat secretive in his communications. As an investment analyst, I can assure you blather is highly overrated.
How do you value a company that's $70 on Wednesday and $45 on Thursday after another blowout quarter? Separate fact from fiction. Before Mr. Situ, LDK was never submitted to this kind of egregious perfection expectation. LDK is all about growth. If you split the analyst commentary in two you'll see that one half says, "LDK did this, this and that. Based on this, I think the following for 2009."
The other half says, "I don't see how LDK can say they did this or they did that, and because of that I don't believe anything they say." The commentaries of the second opinion are all about belief systems, not facts. If Mr. Pichel really wants an excuse for analytical mistrust, he should buy himself a floor-length mirror. How can investors trust his impartiality or efficacy when he's become such a negative force against the shares? For example: as reason for downgrading the stock to "sell" he openly accused LDK of making (in the future no less) off-spec solar wafers for sale at premium prices. That's tantamount to calling their 2008 product line a lie.
I find it hard to believe that all those new contracts from established solar companies in Q3 and Q4 were just misguided billions ($). At a certain point the LDK soap opera needs to switch from morality play to financial reporting, and from "my dad can beat up your dad" to something akin to credible investment analysis. The facts are they are SOLD OUT of their 2007-08 inventory and the new Q-Cells contract will probably take a big dent out of 2009 too.
I don't think Mr. Pichel deserves much mercy because he surely hasn't given any. His errant comments cost investors $2.75 BL yesterday and today. How can he get his facts straight if he sees LDK through the eyes of contempt? He would do much better to drop the personal antagonism and seek some kind of reconciliation with the company. He's already proven wrong twice: first on financing for the plant and capex expansion; and now the audit results refute the Situ information he disseminated. I've heard Piper Jaffrey might have lost LDK's investment banking business to Needham too. When does Jesse Pichel become a liability? When do you call a spade a spade and a hatchet job a hatchet job? If the market weighs this as carefully as I think it will, we'll be heading north the week after Christmas.
