Dilution – Shareholders Worst Nightmare, or Is It?

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Submitted by Saul Sterman / CrossProfit on stocks Evergreen Solar (ESLR) and Scottish Re (SCT)

In a previous article we cautioned investors that the dilution in SCT was going to hurt. A colleague wrote in his e-mail; “I have seen the shares of Sirius rise after massive dilution but their capital intensive (or should I say cash burning) business model is different from SCT.”

Q) Is it possible for share dilution to be a good thing?

Dilution is done only when a company needs to raise cash. The litmus test is to know why the company needs the cash and what the cash will actually be used for. In the case of SCT, the dilution is actually selling off 70% of the company so that shareholders will remain with 30% (or less). Otherwise SCT goes belly-up. In essence the cash injection is going to pay for past mistakes.

The future might be brighter, but whatever the future brings the current shareholders now have only a 30% stake or less. If prior to the dilution the shares were valued at $12 each, after the dilution the (old) shareholders full valuation would be $3.60. Others would argue that a $20 figure better reflects SCT value prior to the liquidity problems, in which case $6.00 would be top valuation after the dilution.

A) Dilution for the Future Can Be!

ESLR is a company accumulating losses at over $20M a year and will probably continue to do so well into 2008. Ever since the dot.com bust, investors are wary of companies that state “revenue growth is more important than profits”. Agree. The exception is with infrastructure intensive industries. Imagine, if you will, a new Exxon Mobil startup and how capital intensive that would be. The price to enter the exclusive oil E&P club is exorbitant. The same is now happening in the solar industry. Within a few years, only the


’s and Mitsubishi’s of the world would be able to commit the necessary resources for such an endeavor.

Every time a solar energy company expands or builds a new production facility the new entry level is raised. The secondary offering by Evergreen Solar is earmarked to cover production expansion costs.

Most investors are a bit unnerved with the ESLR business model. A quick check of competitors will show that most are growing while maintaining profitability. The crux of the issue is hidden in the production facility complex. Until recently, ESLR in essence was competing alongside the other solar energy manufacturers and realized early on that Chinese companies had a labor cost advantage. By writing off its old production facility and starting anew with state of the art technology, on the one hand ESLR compounded its entanglement with the investment community, yet on the other hand has embarked on a method that allows it to nimbly produce and adjust to future developments in a country (Germany) where labor costs would normally be an issue.

The Home Team Advantage

Being that the German government will most likely be ESLR’s largest customer in the foreseeable future, the German government now has a vested interest in keeping its home grown supply of solar power intact. Though existing contracts call for a reduction in compensation models over time, if in reality the figures turn out to be unrealistic, I doubt that the German government will begin ordering elsewhere.


is no different than the

United States

; both would like to regain some degree of energy independence.

Disclosure: At various trading intervals, short SCT and long ESLR. No long term investment position in either. This is the opinion of Saul Sterman (CEO CrossProfit) and is not the consensus of CrossProfit.com.