Suzlon Energy: The Wind Energy Boom and Its Warning Signs (2005 to 2008)

In 2005, Suzlon Energy was a fast growing Indian company that made wind turbines. It had been started in 1995 by Tulsi Tanti, who originally ran a textile business and got into wind power because he was frustrated with unreliable electricity supply for his own factories. Once he saw how well wind turbines worked for his own use, he decided to build wind turbines instead of just buying them, and Suzlon was born out of that decision.

By the time Suzlon came out with its initial public offering in September 2005, it was already one of the leading wind turbine makers in India. The IPO was priced at Rs 510 per share and was oversubscribed several times over, showing very strong investor demand. When the stock listed, it opened at around Rs 692, well above the issue price, and this instantly made Tulsi Tanti one of the richest people in India.

What Was Driving the Growth

Suzlon was riding a genuine global wave. Oil prices were rising through the mid 2000s, governments across the world were pushing renewable energy, and India itself had a long standing shortage of reliable power. Wind energy was seen as one of the fastest ways to add power capacity without waiting years for large power plants to be built. Suzlon had built a strong position in India by then, and it was expanding fast overseas too, setting up plants and taking orders in the United States, China and Europe.

The company's order book kept growing quickly. By May 2007, Suzlon's combined order book stood at around Rs 9,486 crore, covering nearly 1,958 megawatts of wind capacity, split between domestic and overseas orders. For the year 2006-07, the Suzlon group's sales rose by 108 percent to Rs 7,986 crore, and profit after tax grew by 14 percent to Rs 864 crore.

Notice something here already. Sales more than doubled, but profit grew by only 14 percent. That gap between how fast revenue was growing and how fast profit was growing is worth paying attention to, and it is a point we will come back to later in this case study.

To grow faster and gain access to better technology, Suzlon went on an acquisition spree funded almost entirely by debt. In 2006, it acquired Hansen Transmissions, a Belgian company that made gearboxes for wind turbines, for around 431 million euros. In 2007, it won a hard fought bidding battle against the French company Areva to buy a majority stake in REpower, a German wind turbine maker, in a deal valued at close to 1.6 to 2 billion dollars. Suzlon kept adding to its REpower stake over the next couple of years, and in June 2008 it bought out the remaining stake held by Areva for more than 350 million euros, even as the company's own debt levels were already climbing fast.

This borrowing added up quickly. Suzlon's total debt, which was only around Rs 400 crore in 2005, had grown into a much larger number by 2008 and 2009, and by the financial year 2008-09, the company's interest costs alone had reached Rs 1,053 crore. That is a large amount to pay out in interest every year, and it shows how much the acquisitions were being funded through borrowed money rather than through the company's own cash flow.

Suzlon's capital needs were also expanding fast alongside this borrowing. To keep up with its growing order book, the company was racing to expand its own manufacturing capacity, targeting a jump from around 2,700 megawatts to about 4,200 megawatts by the end of financial year 2008, which meant heavy spending on plants, equipment and working capital on top of the money going into acquisitions. All this extra capital meant that the return Suzlon was earning on the total capital employed in the business was coming under real pressure, even though it kept reporting strong headline profit numbers each year. A business that keeps raising more and more capital just to keep its growth rate up is not necessarily creating more value for its existing shareholders, a distinction worth watching closely, rather than only looking at how fast sales are rising.

Why Investors Got Excited

By 2007, Suzlon was being talked about as one of the world's biggest and most valuable wind turbine makers, and Tulsi Tanti and his family were said to be worth around 10 billion dollars at their peak. The stock kept climbing through 2007 and touched its all time high in January 2008. The story investors were buying into was simple and exciting. India's power shortage was real, wind energy was the future, and Suzlon was the Indian company best placed to become a true global leader in this space. Every large acquisition was seen as another step toward that goal, rather than as an added risk.

The Cracks Start to Show

Even while all this was happening, problems were quietly building up. Late in 2007, cracks were discovered in the blades of Suzlon's S88 wind turbines that had been supplied to customers in the United States, including Edison Mission Energy. In February 2008, Edison Mission disclosed the blade cracking issue in a filing with the US securities regulator. At first, Suzlon said only a small number of blades, around 45, were affected, and it estimated the cost of fixing the problem at around 25 to 30 million dollars.

As the company looked deeper into the issue, the scope kept growing. Eventually, Suzlon had to run a much larger retrofit programme covering more than 1,250 blades across multiple customers, and the total cost of fixing the problem rose to around 100 million dollars.

This matters for two reasons. First, the United States was one of Suzlon's most important growth markets, and a quality problem there could hurt its standing with big customers. Second, the fact that the cost estimate kept rising, from around 25 to 30 million dollars initially to around 100 million dollars later, tells you that the company did not fully understand the size of the problem when it first came out. That is often a sign worth watching for. When a company's own estimate of a problem keeps growing every few months, the true picture is usually still being worked out, and investors are often the last to know how big it really is.

At the same time, the company's margins were coming under pressure at the group level. For the financial year 2007-08, Suzlon's consolidated turnover rose to Rs 13,679 crore, a jump of about 71 percent over the year before, but net profit rose to only Rs 1,017 crore, up by about 18 percent. So once again, revenue was growing much faster than profit, and this gap widened further after REpower's lower margin business was added into the group's numbers. On a standalone basis, Suzlon's operating margins had actually held up reasonably well over the 2005 to 2007 period, generally staying in the 18 to 25 percent range, but the group's overall profitability was clearly being diluted as the company grew mainly by adding debt funded acquisitions rather than expanding its original, more profitable business.

What an Investor Could Have Noticed by Late 2008

Putting these pieces together, a careful investor tracking Suzlon through 2007 and into 2008 could have noticed a few things. Revenue was growing far faster than profit, which usually means margins are being diluted somewhere in the business. Debt was rising quickly to fund acquisitions, and interest costs were already becoming a meaningful drag on profits even before any wider slowdown had hit global markets. A real product quality issue had shown up in the company's most important overseas market, and the cost of fixing it kept growing larger than first stated. And through all of this, the company kept pursuing more acquisitions rather than pausing to strengthen its balance sheet first.

None of these signs on their own would have been enough to call the stock a clear sell. But taken together, they painted a picture of a company growing very fast on borrowed money, with early signs of strain already visible, well before the wider difficulties that came later.

Three Lessons for Investors

1. When a company's revenue is growing much faster than its profit, it is worth asking why. Sometimes it means the newer parts of the business are less profitable than the older, established ones, and this can quietly weigh down overall returns even while headline sales numbers look great.
2. Growth funded mainly through debt carries a different kind of risk than growth funded through the company's own profits. Rising interest costs can eat into earnings quietly for a while before they become impossible to ignore, so it helps to track how fast debt and interest costs are growing compared to profit.
3. When a company reports a problem, whether it is a product defect, a cost overrun or anything else, and its own estimate of the size of that problem keeps increasing over time, it is usually a sign that management does not yet have full visibility into how serious the issue is. This is worth watching closely rather than taking the first estimate at face value.

Sources

Suzlon Energy's investor press releases and annual results announcements, reports from Windpower Monthly and CompositesWorld on the S88 blade retrofit programme, coverage from Forbes, Business Standard and Business Today on Suzlon's acquisitions, debt levels and IPO, and Wikipedia entries on Suzlon Energy and Senvion for general company history.