Trading Alert: EarthFirst Canada (ERFTF.PK or EF.TO)

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A few weeks ago, I wrote an article on the upcoming Clean Power Call in the Canadian province of British Columbia (BC). In a nutshell, the Clean Power Call consists of an auction conducted by the government-owned integrated power company to award long-term power purchase agreements (PPAs) to private wind developers. This is the model that has dominated in Canadian wind power so far. The notable thing about this model is that the PPA facilitates access to financing significantly for successful bidders, since the counterparty is a proxy of a credit-worthy government. EarthFirst Canada (EF) (ERFTF.PK or EF.TO) is one of the most active small-scale Independent Power Producers (IPP) in this region of the country. The company already holds a PPA for 144 MW of wind in BC (the Dokie I project), as well PPAs for a combined 75 MW of wind in other parts of the country. In total, the company’s development pipeline in Canada is roughly 2400 MW, which is quite large for a pure-play wind power IPP. A few months ago, EF was hit by the triple whammy: (1) it announced cost overruns for its flagship Dokie I project – capital costs were going to shoot up to $360 million (~$2.5 million/MW) from a previously planned $325 million (~$2.26 million/MW); (2) the firm’s wind consultant reduced its estimate of the annual electricity output for Dokie I by 2.3%, thus reducing potential cash-flows and the amount of leverage the project can employ; and (3) the credit crisis swung into full gear, making it all but impossible to find reasonably-priced capital to complete construction of the project and even impacting EF’s investment bank and financial partner negatively. With the Dokie I project less than 10% complete, running out of cash at this juncture could prove highly problematic. The result from all this was that in late August the firm announced it would engage ‘strategic’ advisors to help formulate next steps. In other words, EF is no longer able to secure the project finance facility it was counting on to build Dokie I and it will almost certainly run out of cash before too long. EF has about $65 million in the bank right now and ploughed through, according to its Q2 2008 cash flow statement, $51.7 million in project development costs in the first six months of the year. But is all lost for shareholders? I, for one, am not so sure. Like in many other industries, the result of this credit crisis for the wind developer sector will be a shakedown and consolidation. EF has about 220 MW of wind PPAs with solid counterparties (government-owned utilities), and an attractive growth pipeline. Canadian provinces have shown a willingness to push the wind industry forward, and, if anything, this could strengthen as the economy softens in Canada and governments look for counter-cyclical infrastructure spending. Lastly, I know from my own work in the field that a number of large international wind IPPs with good balance sheets are looking to enter the Canadian market, which is viewed by many as a potentially-strong market for wind. EF has gotten battered so badly in recent weeks that I decided to take a look. Generally, when I invest, I analyze companies as going concerns, or businesses that will be around for at least the duration of my investment in them. In my view, EF should not be looked at as such; the company will either go out of business entirely or its assets will be picked up by another IPP. This makes analysis of this company quite easy, as all one has to do is go over the balance sheet and figure out whether there is more value per share in the business than what the stock is trading at. Valuation The graph below shows the company’s balance sheet as at Q2 2008, the latest period for which financial statements are available. I went through each item on the balance sheet and adjusted them by a discount factor meant to represent the fact that, should the business be bought out, it would likely be a fire-sale price. The adjustments I made are discussed below.

Cash – Cash should be cash, and probably doesn’t need to be discounted. However, since EF probably used some of its cash in Q3, I reduced the amount by an arbitrary 50% and didn’t make it up elsewhere on the balance sheet. This is part of working my margin of safety into this analysis as I go along. Other current assets – I assigned no value to any of the other current assets. Why not? To be safe. Fixed assets – Those are computers and chairs. I also assigned no value to them. Windpower prospect development costs – This is the 500-lb gorilla in the room. This item effectively represents the nominal value of all of the expenses that have gone toward developing the wind projects to date. This includes items like foundation work on the projects, turbines, electrical connections, etc. Generally, companies would expense those items, and record them as costs on the income statement and reduce their income accordingly. However, EF has so far capitalized the majority of it, or made these expenditures into an asset. While some might term this approach “aggressive” as it understates losses on the income statement, it makes it a lot easier to perform this kind of an analysis, as it gives us a good idea of what a starting point would be for an asset sale: the total amount spent on project development to date. Here, I reduced the item by 70%. I think this is quite aggressive and the firm might fetch more than $0.30 on the dollar for those assets, but these are very uncertain times so better safe than sorry! Liabilities – I kept all liabilities all as they were, again to be safe. The result I came to was net (i.e. minus liabilities) adjusted assets of about $36.3 million, or roughly $0.35 per share. I had had a buy order at $0.10 for about a month (on the TSX) and it finally kicked in last Wednesday (Oct. 22). The position I took is tiny as this is emphatically a bet on a take-over or at least a significant asset sale. At the price I got and considering the analysis above, I think I have a solid margin of safety in case I missed something in my analysis. Nevertheless, I have no objective basis on which I can base the probability of EF being taken over rather than failing, thus my taking only a very small position. UPDATE (Dec. 1, 2008): Despite having placed itself under creditor protection, EF still managed to submit bids for the upcoming BC Hydro Clean Power Call. They are clearly still looking for a major asset sale but the question is: what is the likelihood that BC hydro will award them power purchase agreements if they are uncertain the projects can be developed? I am holding on to my shares but have written this investment off. To be continued… DISCLOSURE: Charles Morand has a position in EarthFirst. DISCLAIMER: I am not a registered investment advisor. The information and trades that I provide here are for informational purposes only and are not a solicitation to
buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.


  1. Was wondering what your thought’s are as of today’s news?
    Hadn’t saw your alert before today but, had them pegged in the $0.35 to $0.40 range. Picked some shares up on the 22nd as well.

  2. Adam:
    I hadn’t even seen the news yet!
    Not too surprising. They had a contract out for the full 48 turbines they needed for the project and a letter of credit to guarantee those, but no cash and no way to raise any.
    I’m not too sure what’s going to happen to common shareholders at this point, but I wouldn’t hold my breath. I’m writing 100% of this investment off.

  3. Hi,
    I am new to this site and like it. I have two points:
    1. I think I see the problem in the analysis for Earth First. The debt that just got called (see notice on Earth First site, at bottom, below receivership info) is for 130 million and the above analysis shows this as 13 million. Hard to see how there is much value now, but am not an expert (though am still tempted to risk a few thousand at 2 cents per share).
    2. With commodity prices declining, and credit tight for companies with existing debt tied to old sales prices of turbines, it seems there is an opportunity for companies to get suitable land and buy turbines at what likely will be lower prices (due to lower steel, etc. prices). Or to take over some assets (like PPAs) of struggling companies. Anyone have an candidates for such companies? (Of course with oil lower the economics of wind power also has shifted).

  4. Hi Joe,
    Yes, the company’s balance sheet shows only $13 million in debt and they do have a Letter of Credit out for about $130 million. The Letter of Credit is a guarantee to the turbine supplier issued by EF’s bank to the effect that the turbines would be paid for. The $13 million is what had been drawn on that Letter of Credit to date.
    The reason I did not include the Letter of Credit in my analysis is that I didn’t know the terms of it, and where it would rank on the pecking order if EF was going to go out of business. Now I know. This turbine supply contract was always what was going to push them over the edge, if anything. This is why I left plenty of margin in my analysis.
    What I was betting on here was that EF would succeed in selling off assets or the company before they went out of business, which they didn’t.

  5. I think so Deanna. If you read the press release carefully, they say that they are committed to honoring their commitments to their creditors in full before shareholders get anything.
    EarthFirst had been trying to sell itself for the past couple of months and there were no takers – at least at the price they sought. In this market environment, if you do the math, there isn’t enough value in the company to pay off what is owed to the bank and have much left for shareholders. The way they accounted for their “Wind prospect development costs” is pretty aggressive and doesn’t represent the true value of that asset, especially in current market conditions.
    I haven’t sold my position, but I’m considering this a write-off for all intents and purposes.

  6. Thanks for replying Charles. I know that EF was a bit of a risk considering that they had no revenue to date but their book value looked great. How’s an investor supposed to figure out that their assets were going to depreciate so much is so little time. Now that they are selling Dokie, they are saying that it won’t even have a benefit for shareholders. This boggles my mind since that should be worth quite a bit. Why didn’t they just stop completely instead of continuing to operate and getting in more debt? I thought it was just very precautious when they went into CCAA and that they would have found other financing and or sold assets in order to continue. Now they have sold assets and they are still going to fold and the shares are only worth $.03? Please give us your input.

  7. Alain:
    The problem lies partly in the way EF accounted for the $130 million letter of credit (see previous comment and response on this). That letter of credit was a guarantee by EF’s European bank to the turbine manufacturer in Europe that the turbines would be paid for no matter what – this is a common practice in overseas business deals for obvious reasons (i.e., the manufacturer no longer has to worry about trying to have its contract enforced in Canadian courts since the bank guarantees it in Europe).
    When EF found itself in a position where it could not pay for the turbines, the bank turned around and effectively pushed EF into bankruptcy so that it could pay the manufacturer through the sale of assets.
    This letter of credit is what is called an “off balance sheet liability”. So in the analysis I did the company looked cheap from a book value perspective because I did not account for that $130 million liability – if I had the investment would have been a no-go.
    That is my fault and I take full responsibility for it because there was disclosure on this in the financial statements – just not on the balance sheet. In my view, the way EF accounted for this liability can be considered “aggressive”. By disclosing only the drawn amount, or $13 million, they somewhat implied that that was what they were liable for, whereas in reality that letter of credit amounted to a loan for the full value of the turbine order and should have been disclosed as such.
    This is a cautionary tale for myself and other investors who invest in companies listed on the Pink Sheets, the Toronto Venture Exchange or the AIM in London. Disclosure is often sketchy and management will sometimes leverage lax reporting requirements to embellish the picture as much as they can. In most cases there is nothing terribly wrong with this, but you will occasionally come across cases such as this one.
    In terms of EF, they are in no position to continue operating. They have lost their key assets, their credibility and have no money. They have shown through various Dokie mis-steps that they were poor on the execution front (discussed in the article). The only way they could go on is if they managed to raise new money and replenish their portfolio of properties, but in order for that to happen there would have to be people out there willing to give that management team money. After what happened, would you? Me neither, along with most sane people.
    EF is done!


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