At first blush, you wouldn’t be foolish to read the earnings press release from Yingli Green Energy and wonder why this tiny Chinese company is playing with derivatives and playing badly with them by losing $29.9 million.
Even an analyst on the company’s conference call today was seeking help in understanding the derivatives-related loss. The answer he got back was “accounting treatment.” Which was true, but it’s a little more complicated than that and seems to do more with the vagaries of accounting rules rather than any silly playing around with derivatives.
The confusion begins with this language in the company’s press release today: “Loss on derivative liabilities in the second quarter of 2009 was primarily due to the changes in the fair value of derivative liabilities…”
Here’s what happened. In January, Yingli drew down a $50 million loan from an outfit called Asia Debt Management Hong Kong. It carries a 12% interest rate and it is a three-year lending facility. It also issues ADM 4.125 million warrants to buy stock, exercisable at $5.64.
Those are pretty onerous terms, so you can understand why Yingli would want to get out from that lending facility as soon as possible. And it did, earlier this summer. It raised $194 million in June through a stock offering and paid down the $50 million loan. Now here’s where the tricky accounting comes into play.
The company has said in filings with the Securities and Exchange Commission that accounting rules essentially make them figure the value of the transaction with ADM is the loan amount and the value of the warrants. So, what the company had to do was discount or subtract the warrant amount from the loan, which according to a transcript of the conference call, was a $35.6 million discount. So in essence the company paid $50 million for something worth about $15 million and had to write off that $35.6 million. (ADM still held the warrants when the loan was repaid). The warrant value rose significantly with the stock price, which traded over $16 a share in June.
Those warrants could still come back to bite the company because according to the terms of those warrants, any unexercised warrants have to be bought back by the company at $7 each.
Yingli also issued convertible notes to an outfit called Trustbridge and said today that the embedded conversion feature of those notes resulted in a charge as well, as did the warrants. That came out to an about $30 million charge.
The confusion over the derivative liabilities could very well be why the stock of this maker of solar cell-related products closed 5.28% lower at $11.12. When you strip away the charges, the company beat consensus estimates for earnings and came in with slightly higher revenues that had been expected.