MSF220 GROUP P3C2 MSPECTRUM, INC.

RENZ CAÑETE | JEROLD FLORES | MARC MORALES | JUSTIN NERY | JOAN OGNITA | ARCYL
ORFIANO

MSpectrum, Inc.
A Working Capital Management Case

CASE ABSTRACT

The deregulation of the energy market brought about by the Electric

Power Industry Reform Act (EPIRA) passed into law in 2001 forced MERALCO to
find other ways of servicing a portion of its customers that now has an option to
select its own supplier of electricity. In order to retain these customers,
MERALCO established MSpectrum, Inc. (or “Spectrum”) in 2016 in order to supply
electricity by offering rooftop solar products and services. The Company’s
management aggressively forecasted its revenues for the next 10 years, in line
with its intention of capitalizing the growing trend in renewable energy.
However, by theas of end of 2019, the Company has yet to hit its sales targets,
and the Company now faces the problem of growing levels of receivables and
inventory of rooftop solar panels that were already purchased in bulk in 2016. On
top of that, MERALCO has prohibited Spectrum from obtaining any external
funding or receiving additional equity infusion from MERALCO until its the
working capital issue is resolved. Will Spectrum be able to realize its vision of
becoming the trusted renewable energy provider in Asia and the Philippines,
when the Company already having problems managingwith problems its on
working capital arising on its third year?

Company History
Since the 1930s, the government owned and operated the country’s power generation,
distribution, and transmission. Everything changed in June 2001 when Republic Act No. 9136, or
the “Electric Power Industry Reform Act” (EPIRA) came into effect. EPIRA is “one of the most
important pro-market reforms in the Philippines 1” as it significantly restructured the entire
industry by introducing competition.

A key development brought by EPIRA was the creation of “contestable customers,” which are
large electricity end-users with an aggregate demand of at least 1MW. Contestable customers
can freely choose their supplier/s of electricity based on competitive pricing and other supply

1
“The EPIRA is working” by Bienvenido S. Oplas, Jr., Business World, June 24, 2018
benefits. The demand liberalization poses significant risk on Manila Electric Company
(MERALCO) whose main revenue originates from “captive customers” within its their franchise
area.

To mitigate this risk, MERALCO embarked on a decentralization program boosting its retail
electricity capabilities in the process. Part of the program was the establishment of MSpectrum,
Inc. (“Spectrum” or “the Company”) in 2016, which focuses on the development of renewable
energy solutions (See Exhibit A for Spectrum 2016-18 fAudited Financial Sstatements from 2016
– 2018).

Product Offerings
Spectrum operates mainly, but not exclusively, in the realm of rooftop-mounted solar
photovoltaic (PV) systems divided into three segments:

[1.] Commercial and Industrial (C&I) – installation of solar PV for customers whose main
purpose of procuring solar PV is the pursuance of business interests like hotels, malls,
and schools. Spectrum may enter into (a) an outright purchase agreement for the entire
system; (b) an Engineering, Procurement, and Construction (EPC) contract for certain
components of the system; or (c) a Power Purchase Agreement where the customers
are charged on a per-kWh basis. Spectrum promises to these customers that self-
generation lowers operating expenses in the long run. (See Exhibit _ for the breakdown
of installed capacity per segment);.
[2.] Residential – installation of solar PV for households wishing to reduce their monthly
electric bills charged by their respective Distribution Utilities (DUs) or Electric
Cooperatives (ECs). Spectrum may enter into (a) an outright purchase agreement for the
entire system; or (b) an Engineering, Procurement, and Construction (EPC) contract for
certain components of the system; and.
1.[3.] Operations and Maintenance (O&M) Solutions – technical services to operate and
conduct routine maintenance inspections and repairs for rooftop-mounted solar PV
systems.

Spectrum also develops micro-grid systems for remote and isolated areas not served by ECs. It
only constructs micro-grid systems as long as it incorporates renewable energy technologies. In
2018, it launched a 60kWp hybrid system in Quezon serving nearby resorts and households in
the area.
Ownership Structure
The Company is a wholly owned subsidiary of MERALCO, a public company whose common
shares are listed in the Philippine Stock Exchange. (See Exhibit B C for the complete ownership
structure of the MERALCO Group).
Institutional First Philippine
Investors, Holdings
Directors, Corporation and
Beacon Electric JG Summit Officers, Metro Pacific First Philippine
Asset Holdings, Holdings, Employees, and Investments Utilities
Inc. Inc. Public Float Corporation Corporation
34.96% 29.56% 21.02% 10.50% 3.95%

MSpectrum Inc.
100%

Figure 1: MERALCO Ownership Structure

Figure 2. Meralco Ownership Structure

Management Team
In January 2019, Ray C. Espinosa (RCE) was named as MERALCO’s new president and Chief
Executive Officer (CEO). In a disclosure to the Philippine Stock Exchange, MERALCO said its
board of directors, during a regular meeting on January 28, 2019, approved the appointment of
RCE as deputy CEO for four months until then-incumbent CEO Oscar S. Reyes officially retires 2.
RCE assumed the position of President and CEO on May 28, 2019.

Along with RCE, most Chief Operating Officers (COOs) assigned to subsidiaries, were changed.
Victor L. Risma IV (VLR) became the COO of Spectrum in July 2019 and immediately introduced
some noticeable changes.

On top of it, internal processes were streamlined resulting to additional departments and
functions that were not previously existing. For example, the MERALCO Group has shared
services for its subsidiaries like Commercial Services, Engineering and Design, and Operations
and Maintenance (O&M). However, with the growing need for dedicated staff, Spectrum

2
“Meralco names incoming president” by Victor V. Saulon, Business World, January 30, 2019
decided to form additional organic departments specifically handling these functions. Currently,
only the Human Resources and Information Technology are the remaining departments that are
shared with other subsidiaries. (See Exhibit CD for the Spectrum organizational chart).

Industry Aanalysis
Industry overview
When EPIRA was passed into law in 2001, it introduced structural reforms were introduced in
the power sector was instituted.

The generation sector was deregulated and market competition was introduced. ReformsThese
changes also in the generation also included the operation creation of the Wholesale Electricity
Spot Market (WESM), which allowed electricity prices to be market-driven. The transmission
sector was unbundled from the generation and led to the privatization of the national grid
through The National Grid Corporation of the Philippines (NGCP). TIn the Distribution sector
welcomed the, Retail Competition Open Access (RCOA) was introduced which allowinged large
consumers with an aggregate power demand greater than 1MW to choose its own energy
supplier rather than being forced to transact with its distribution utilitiesDUs or ECs. Eventually,
the RCOA is seen to will be made available to smaller end-users with a demand as low as
750kW.

The reforms developments brought by EPIRA and the Renewable Energy Act of 2008 eventually
led to the rise of renewable energy in the Philippines. In particular, the Department of Energy
(DOE) has cited solar as one of the promising renewable energy sources in the Philippines that
can help reduce the country’s dependence on harmful traditional energy sources such as coal
and oil. Harnessing the power of the sun has great advantages which include:

 Data from the sun does not vary greatly as compared to wind or hydro power plants
making the required time for feasibility studies shorter; and
 Solar panels are relatively easy to install as compared to other renewable energy
systems;
 Solar panels are a source of clean energy and does not produce noise pollution


Industry trends
The solar energy industry is expected to grow by a CAGR of 13.4% in the next five years. This is
driven by an increasing energy demand in the Philippines and declining solar PV systems
globally. Since 2009, solar PV systems have cut costs by more than 80% which resulted to lower
costs of electricity for consumers. As a result, both government and the private sector has been
bullish in investing in the industry in recent years.
The table below shows the cost of solar PV modules per watt. From 2014 to 2019, prices for
solar PV modules have declined by 13.9% on average. For the next two years, cost of solar PV
modules are expected to decrease further by a CAGR of 5.9%.

Solar PV module cost, USD per Watt

0.55 -13.9% CAGR

0.41
0.39 -5.9% CAGR
0.34
0.3
0.26
0.24 0.23

2014 2015 2016 2017 2018 2019 2020 2021

Solar PV module cost, USD per Watt

Source: Mordor Intelligence (2018)

Competition
The solar energy industry is highly concentrated with most of the market dominated by around
4-5 players. Philippine sTop market players for solar energyolar developers comparable with
Spectrum in the Philippines include Solar Philippines, PI Energy, Solenergy Systems Inc., and
Energy Renewable Asia Inc. Business models for solar energyof these players include
development of ground-mounted solar farms, solar roof topsrooftop solars, and hybridized
systems for micro-grid systemsgrids. (Exhibit D E shows a comparison of Spectrum’s financial
performance versusalong with its peers).
Problem
On December 18, 2019, Spectrum held its board meeting to evaluate its actual performance
based on (1) revenues, (2) net income, and (3) installed capacity from 2016 to 2019. Target KPIs
were derived from the rooftop solar adoption study conducted by the Business Development
and Research team of MERALCO.

KPI Metrics 2016 2017 2018 2019LE

Revenues, PHP
Target 466,839,000 535,500,464 940,964,436 1,624,401,749
Actual 10,201,495 16,769,765 45,792,583 496,389,017
% Attainment 2.2% 3.1% 4.9% 30.6%
Net Income, PHP
Target 13,719,014 51,213,077 113,039,052 248,501,702
Actual (470,538) 1,283,072 23,690,000 38,147,699
% Attainment 0.0% 2.5% 21.0% 15.4%
Installed Capacity, kWp
Target 8,476 7,937 22,031 30,781
Actual 211 2,020 6,483 7,446
% Attainment 2.5% 25.5% 29.4% 24.2%
Table 1: Key Performance Indicators | LE = Last estimate

Figure 2. Key Performance Indicators

LE = Last estimate

It was clearly determined that the Company is not hitting its targetsKPIs. The Management
Team identified the main barriers in achieving these targets:KPIs:

[1.] The Commercial Services Head reported that his team finds it challenging to compete
with the prevailing pricing trends of solar rooftops in the market. Management’s
direction is to maintainhave a gGross mMargin of at least 20%..
[2.] Company uses Ppercentage of Ccompletion (POC) method, and delays in construction
causes some gap in the n timing of recognition of projectcontract revenue recognitions.
There were also cost overruns from these delays caused by weather, contract disputes
between suppliers or customers, and some are due to newly enforced power
requirements..
[3.] Red tape in rRooftop sSolar permitting i.e. Certificate of Electrical Inspection (CEI) andor
Certificate of Final Electrical Inspection (CFEI) which are issued byis prevalent
municipalities in many government agencies and municipalities. In fact, mMost
municipalities do not have a standardized approach, so requirements vary widely and
may change per project.
The bBoard of dDirectors instructed the Management Team of Spectrum to review the
Company’s targets and forecasts for the next ten (10) years and present it onto the next board
meeting.

The board then turned their attention to the financial position of the Company. The Finance
Head reported to the board the status of, particularly their receivables and inventory. The
Finance Head reported that Mmajority of the accounts receivablesthese AR are still within the
credit term of 30 days and are still not due. However, the board is not pleased that a significant
portion are already past dueremains uncollected. As of November 30, 2019, Spectrumthe
Company has an Accounts Receivable Balance of PHP119.7 million M broken down as follows:

Days Ssales Ooutstanding

AR Balance
(DSO)
Less than 31 days 73,657,817
31-60 days 14,609,584
61-90 days 5,294,874
More than 90 days 26,104,650
Total 119,666,925
Table 2: Aging of Accounts Receivables

Figure 3. Aging of AR

The board is also particularly concerned with the large volume of solar panels and spare parts
that were purchased in bulk in 2016. The significant portion of these panels remain idle in the
Company’s warehouse. Currently, the Company is still accumulating inventory, as well as
accounts payable because of its pipeline of projects.

The Company funds its solar projects and expansions exclusively from equity infusion. However,
the board reiterated the direction from MERALCO that no additional funding will be approved
until the Company manages to show signs of improvement in its working capital.its working
capital efficiently.
EXHIBIT A: MSpectrum, Inc. Audited Financial Statements
of MSpectrum, Inc.
 EXHIBIT B: Installed Capacity per Segment

Installed Capacity, kWp 2016 2017 2018 2019

C&I - Outright Purchase & EPC 172 1,172 5,334 3,767
C&I - PPAs 810 1,040 2,232
Residential - Outright Purchase & EPC 39 39 49 48
Microgrid 60 1,400
O&M Solutions
Total 211 2,020 6,483 7,446
 EXHIBIT CB: Complete Ownership Structure of MERALCO Group

Institutional Investors, First Philippine Holdings

Directors, Officers, Metro Pacific Corporation and First
Beacon Electric Asset JG Summit Holdings, Inc. Employees, and Public Investments Corporation Philippine Utilities
Holdings, Inc. 29.56% Float 10.50% Corporation
34.96% 21.02% 3.95%

MSpectrum Inc.
100%

Corporate Info eMeralco MRAIL, Inc. MERALCO Energy, MERALCO Meridian Atlantic MERALCO Lighthouse Vantage Energy eSakay, Inc.
Solutions, Inc. Ventures, Inc. 100% Inc. Financial Services Light Company PowerGen Corp. Overseas Solutions and 100%
100% 100% 100% Corp. Limited 100% Insurance Limited Mng’t, Inc.
100% 100% 100% 100%

Meridian Power MERALCO Clark Electric Cornstech Pure Meridian M Pioneer Bauang Private Aclara Meters Rockwell Business Indra Philippines,
Ventures Limited Industrial Distribution Corp. Integration Hydropower Corp. Insurance Inc. Power Corp. Philippines, Inc. Center inc.
100% Engineering 65% Alliance, Inc. 50% 49% 38% 35% 30% 25%
Services Corp. 100%
99%
 EXHIBIT DC: Spectrum Organizational Structure

President and CEO

Chief Operating Officer

Corporate Planning

Special Projects Commercial Engineering and Operations and Contract and Supply Chain Finance and Human IT Legal
Services Design Maintenance Project Admin Services Resources
(O&M) Management

Organic departments

Shared services with MERALCO and other subsidiaries

 EXHIBIT ED: Selected Financial Ratios of MSpectrum and Peer Averages 3

3
Peers include Solar Philippines, PI Energy, Solenergy Systems Inc., and Energy Renewable Asia Inc.