Not that long ago, I stated I’d share my Enphase (ENPH) adventure with this board. But…well…whatev…I’m a lazy git…it’s a long story, and there’s a whole lot happening everywhere. I was quite distracted. But…rather than abjectly disappoint, I thought some might find it interesting to learn why a fund manager recently chose to invest in ENPH:
https://www.valuewalk.com/2018/03/hidden-value-stocks-interv…
Quarterly revenue for the company had gone from $1 million in 2009 to over $100 million by 2014. Gross margins increased steadily from single digits to over 33%. The company was profitable, and it had a market cap of over $800 million. Then, in 2014, the solar industry went into a downturn, and falling energy prices made renewables less attractive. Increased competition among the panel makers, especially in China, caused massive supply increases that eroded prices throughout the value chain. Changes in regulatory policies added uncertainty into the market, which had initially been supported by subsidies and other incentives.
Enphase first came onto our radar in May 2016. The stock had fallen to $1.00 per share, the market cap was under $100 million, gross margins had fallen well into the teens, and there were big concerns about the company’s survival. With sales levels significantly reduced, Enphase couldn’t cover overhead and had to raise debt and equity just to stay afloat. As with any new idea, we always turn to the proxy to better understand insider ownership. Directors and officers as a group owned over 25% of the company, which we found intriguing. We also saw that a number of notable funds had significant stakes, which we thought unusual for a company that was apparently circling the drain. As we started to study the company more closely, we were impressed that the company had shipped more than 15 million of their microinverters (3 gigawatts of installed power) in over 600,000 residential and commercial systems in 100 countries. Given the popularity of their products and what we saw as long-term tailwinds for renewable energy, we thought that if they could manage to get their costs under control, then the upside potential was pretty large. At that point, we decided to monitor the company and keep an eye out for any large insider transactions which might suggest that the people closest to the operation were gaining confidence in a recovery.
In January 2017, we saw just that. There was a large strategic investment from T.J. Rodgers, who was the Founder and former CEO of Cypress Semiconductor, and as part of his investment, he was appointed to the board of directors. Rodgers has a long history and iconic reputation in the technology industry. He founded Cypress in 1982 and grew it into a multibillion-dollar company before he retired in 2016. He also had experience in the solar industry as Chairman of SunPower during its IPO. Upon joining the Board, Rodgers brought in consultants from McKinsey who he had worked with in the past, and they started to grapple with some of these cost issues and essentially initiated a companywide restructuring.
Then, in April, they brought in another Cypress veteran to the newly created role of Chief Operating Officer. He had a 20-year career with Cypress, including five years as head of Cypress India. His first impression was that the company had great products but lacked a focus on costs. They did not have strong sourcing agreements (which were crucial given their average product contained over 300 components), costs were high for reasons related to warranties, servicing, and freight, and they lacked pricing discipline. To combat all these issues, the company adopted several lean manufacturing practices and accelerated their product development roadmap. They also began partnering with panel manufacturers to incorporate their microinverters directly into the panels themselves. These so-called AC modules reduce costs, simplify installation and give the company a steady high-volume demand.
These initiatives have already started bearing fruit. Gross margins bottomed below 13% and have risen to above 18%, which is the highest level in the last five quarters. Cash burn has been reduced, and the company has posted positive operating and free cash flow. Last August, the CEO stepped down, and the company announced that the successor would be named within weeks. We figured it would be the COO, particularly because they gave a short window for the search, and that guess turned out to be correct. After the announcement of his promotion to CEO, we had a conference call with him, the CFO and Director Rodgers, which gave us a lot of confidence. The newest version of their product, the IQ7, gives the company the ability to offer the same version of the product to all geographies, which further reduces the manufacturing cost, weight and number of components. By the end of 2018, the IQ8 will launch, which is the real blue-sky upside for this company because it’s the first product that can work in both weak-grid and off-grid environments. Surprisingly, most solar power systems only work in tandem with a functioning electricity grid. These so-called grid-tied systems don’t work in places where electricity coverage is spotty or nonexistent, so having a product that can work in those environments really increases the potential market size. During the call, the CEO cited India as an example. The government there has announced plans for 100 gigawatts of grid-tied solar capacity by 2022, of which 40 gigawatts is expected to come from rooftop solar. That’s a massive opportunity for Enphase given their annual run rate is slightly less than 1 gigawatt. The estimated off-grid demand is several additional hundreds of gigawatts.
We think the plan they have outlined to reach a 10% operating margin by the end of 2018 is achievable given the product roadmap and cost reduction initiatives they have put in place. At that rate, we found ourselves buying a company trading at less than five times forward earnings before giving any credit to the revenue growth just mentioned. Enphase has had quite a run in the last few months as other investors are starting to realize this too, but we think there’s still a good deal of upside ahead.
This summary accurately states the current state of affairs. I became intrigued with Enphase years ago. I traded the stock through its peaks and valleys. When it fell to below $1.00, I bought multi-thousand shares until my position grew to more than 60% of my total portfolio. It’s been a wild ride but, in short, the profits have paid for all my living expenses for two years running, and my ENPH position still constitutes 60% of my portfolio.
It’s been a terrifying, satisfying, challenging, illuminating and…ultimately…profitable odyssey. I learned a lot. I hope to share some of that with y’all at some point in the future.
Meanwhile, I’m still LONG ENPH