What's Up With Enphase?

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What's happening at Enphase

On June 17th the stock of Enphase was getting sold off hard by investors who caught wind of a short sellers letter in which the author, Eiad Asbahi, Founder and Portfolio Manager of Prescience Point Capital, made numerous negative claims about Enphase. I don't mind short-sellers, they bring price discovery to stocks. In fact without short-sellers a stock will just run up to absurd levels unchecked; think back to Bitcoin before derivative markets were available. What I dislike are short-sellers who make outlandish claims and don't back them up with specific, detailed evidence of wrong doing.

My initial reaction was to dismiss the letter, but after a 26% sell-off in the stock I decided to add at those lower levels and put out a notice to all my readers. My response was quick and at a high-level that maybe wasn't completely helpful to my readers. The following day the stock was up 18% and gained another 2% today; though the stock is still more than 17% below its June 16th high.

Another Perspective

Today I'd like to introduce EnerTuition and their blog Beyond The Hype.

Beyond The Hype https://www.patreon.com/BeyondTheHype

EnerTuition can also be found on seeking alpha.com, you can follow them here:

https://seekingalpha.com/author/enertuition/instablogs. Beyond The Hype is an emerging company technology stock analysis service. Currently, they focus on identifying and investing in renewable energy, storage, EV, autonomous vehicle, CPU, and GPU markets. Please note that both the Stay Invested blog and EnerTuition are long Enphase stock.

Q: What are the key points to consider in the Prescience Point Capital letter?

A: EnerTuition

  • Enphase stock was battered by a note from short seller Prescience Point about alleged fraud. We show the weakness of the analysis.

  • The Prescience Point note is deeply misguided and we show demonstrably that the authors have poor understanding of the MLPE business.

  • We believe it is best for investors to ignore the Prescience Point note.

  • In response to Prescience Point note, Beyond The Hype called for ENPH a buy yesterday with the stock trading around $38.

Q: Can you describe what happened to Enphase stock from your perspective?

A: Sure

Enphase Energy (ENPH) had a rough day on Tuesday with the stock dropping 26% after news of significant insider sales and a coincident negative report from short seller Prescience Point ("Prescience") alleging fraudulent financials and other problems at the Company.

Prescience is not new to Enphase stock. This firm has alleged similar wrong doings at Enphase in 2018. Management did not respond to the short seller’s claim immediately then but, on July 31, 2018, during the Company’s Q2 earnings call,

management harshly put down the short seller’s claims. CEO Badri Kothandaraman’s response at that time was:

“Last week we were attacked by a short seller who accused us of fudging the books. We did not respond, but to be honest this news aggravated and enraged us as the remarks were baseless and wrong. I want to say a few worlds on our core values as a company. We hold ourselves to the highest standards of ethics and integrity. We tell the truth and don’t tolerate excuses and the only thing we value is data, logic and reason.

Last year McKenzie came in taught us how to work on costs. This literally involved working on hundreds of little things to improve the company. Just to show you every cent we take out of cost is important. A few extreme examples to show the extent of how we think and manage our, yes, for example we've spent a lot of time optimizing the labels and manuals on the microinverter to save pennies.

We've spent tons of time in minimizing and squeezing every square millimeter of PCB space for the microinverters. We spent a lot of time eliminating components such as resistors and capacitors even if it means a fraction of a cent at a time. I am proud to have an incredible group of people who have worked very hard and turned this company around. We are laser focused on our number one priority, improve profitability quarter-on-quarter and creating further shareholder value.”

Subsequently, the company’s continued to grow rapidly and the stock has since moved from the $20s to $60s. Given the background, and having not successfully proved its past claims, it is interesting to see Prescience Point come back with yet another set of claims against Enphase.

Q: What specifically was wrong with their short thesis?

A: Their premise is just wrong

The previous short thesis was wrong and now the current short effort seems to be deeply flawed as well, and based on innuendo and a lack of knowledge about the Enphase business. The report tees-off on a very weak premise:

“A breakthrough in our research of ENPH occurred in late 2019 when we were told by a former ENPH employee that the Company had, peculiarly, offshored many of its key finance and accounting (“F&A”) functions to its India-based office in late 2018. As past accounting scandals have shown, offshore entities can and have been used as a tool to help companies perpetrate fraud. Given this, and our previous reservations about ENPH’s accounting practices, we viewed this as a significant red flag that warranted further investigation.”

While fraud could be a possibility, a simple explanation for using India based teams was repeatedly communicated by management: cost cutting. If Prescience can misread such a simple business decision, it is no wonder that it struggles to understand how a company can cut costs as deeply as Enphase has:

“The logic-defying decrease in ENPH’s reported unit costs is fiction, in our view”

Based on a flimsy premise, Prescience proceeded to probe using a third-party investigation firm in India. Prescience’s narrative about the entire subject gets quite dubious with much innuendo about alleged Enphase fraud from ex-Enphase employees and ex-distributors. Then the report moves on, using half-baked assumptions to make a case that Enphase numbers are not trustworthy.

Q: Can you give some examples?

A: Sure

Let's consider one of the key claims. Prescience, like it did in 2018, claims that it cannot believe the cost gains that Enphase made are possible. While we agree that the cost savings have been spectacular and we too were surprised by them, we do not see them indicating fraud. Note that Badri has directly addressed this issue in the Q2 2018 conference call as shown in the quote above. Badri was first and foremost an operational leader who was brought in to clean up the operations. And, as his comments show, with attention to detail, he has chased every cost reduction he could find.

Prescience Point points out that Enphase costs have decreased despite US tariffs and suggests this is not credible. However, this is not a strong claim since Enphase has had Mexico based, tariff-free operations and expanded them rapidly once tariffs came into picture. Companies across the US have also accelerated procurement as much as possible to beat the tariffs. The combination of these factors meant that the tariff impacts were significantly contained by Enphase management.

Some of what Prescience presents as evidence of fraud argues against their claims. For example:

“…the company had already instituted a major accounting change via the ASC 606. Prior to adopting this practice, and before Badri was promoted to CEO, Enphase deferred only the software portion of its sales…However, after the adoption of AS 606, the company has been deferring both the hardware and software portion of its Envoy revenue since Jan 18…This is Badri’s magic contribution to the company’s turnaround.”

We are baffled by this so-called evidence. This evidence suggests that Enphase adopted a more conservative, and not more aggressive, revenue recognition.

Some commentary suggest that Prescience has absolutely no knowledge about the intricacies of the solar business. Consider the evidence below that Prescience presents as an example of fraud:

“…(I think) that Enphase was buying turnover (revenue) using the services of shady CA (chartered accounting) firms…(The cost would be) clearly off set by the geometric gains that one makes in terms of valuation that this company has been achieving… The products are shipped at future dates as these resellers begin to get contracts from their installation partners. As long as you can show the advance orders you can continue to draw from the nectar of the deferred revenue.”

Q: Since the solar tax credits diminish each year, wouldn't every solar company be selling into their channel as much as possible to capture the biggest credits?

A: Exactly

Prescience has made a tragic mis-interpretation of safe harbor sales the Company has reported in the most recent quarters. These sales are explicitly made for consumption in future quarters as a work around to ITC credit step downs. It is understandable that an India based finance and accounting team may not realize the significance of these maneuvers, but it is a shame that a financial analyst writing about the company does not.

Q: What about the sales growth figure?

A: Prescience claims that Enphase reported sales growth far exceeds the growth seen at distributors.

Prescience takes management guidance of 80% of the sales going through distribution and seems to suggest essentially all of their business is going through distributors and therefore the distributor data is representative. This is in error. While we are not aware of any specific management guidance on the subject, we suspect that nearly all international sales are through distributors whereas only around 60%+ of the US business is through distributors. In other words, Prescience is missing a significant part of the picture and arriving at invalid conclusions.

It is customary for companies like Enphase to serve large customers direct and this business likely does not go through distribution. Similarly, some high dollar value sales, like the sales of safe harbor product, are also unlikely to go through distribution channel. With such dynamics, it is easy to see why there could be disconnect between distribution sales growth and company sales growth.

Furthermore, Prescience uses distributor Module Level Power Electronics, or MLPE, sales data to conclude that Enphase has not gained share and has lost share. This is a poor conclusion since it is not easy, may even be impossible, for distributors to distinguish between commercial MLPE sales and residential MLPE sales. Our analysis suggest that Enphase has been gaining share in the residential market while SolarEdge has been gaining share in commercial market where Enphase mostly does not participate.

Prescience also claims that the Company has lost market share as reported by Wood Mackenzie and could not possibly have grown revenue rapidly. While we do not have access to the data that Prescience refers to, this claim misses the fact that there are several dynamics at play:

  • The market for MLPEs, has grown rapidly. Even a smaller share of a bigger market can lead to greater revenues.

  • Wood Mackenzie data does not capture safe harbor sales as Wood Mackenzie will not see installations until many quarters later.

  • Woods Mackenzie data is installation data and lags Enphase sales.

  • Enphase has also been growing internationally.

  • It is unclear if the quoted data includes sales to SunPower, which is a business that Enphase bought in 2018.

We also find it extremely naïve on Prescience’s part to question Enphase revenue growth and point to it as something extra-ordinary. The reality is that residential MPLE inverter business has been a high growth business, and not just Enphase, but also its peer SolarEdge (SEDG).

(image below from author based on public filings)

The top line in the image above show SolarEdge revenues and the lower line show Enphase revenues. If Enphase’s revenue gains are fraudulent, are SolarEdge revenues fraudulent too?

To be sure, SolarEdge also benefits from a strong growth in the commercial sector. But, on the other hand, Enphase has been gaining share against SolarEdge on the residential front lately. All things considered, in terms of peer comparisons, there is little reason to doubt the revenue numbers from Enphase. All in all, the analysis from Prescience is weak and based on inadequate understanding of the solar MLPE business.

Q: Can we assume there's no fraud?

A: One cannot be absolutely certain, but the answer is “unlikely”

Certainly, not based on anything Prescience Point has presented. There is no graceful way of saying it: Prescience analysis is deeply sub-par.