Thursday, April 15, 2010

Kick-back on First Solar

One of the biggest benefits I get from writing this blog is that sometimes some very smart people disagree with me. In the investing business you will be wrong often. The earlier you realize that you are wrong the smaller (on average) your losses will be. I don’t think the blog can move markets through talking my book. (I disclosed a good argument for shorting First Solar and the stock went up!) But I do think that kick-back from smart people can help reduce my losses when I am wrong. Believe me that is often enough! If all that the blog delivers me is smart people who disagree with me then I will wind up being a well-paid blogger (and my clients will be grateful)!

I got a lot of kick-back on my First Solar piece – some of which makes me more nervous about the short – and some of the kick-back is from people who are very smart. I thought I ought to lay this kick-back out at least in part to get my own thoughts straight.

One of the solar industry trade publications asked my permission to republish the piece – which I have granted. They also warned that they might have a follow-up piece titled: “Why I am short Bronte Capital”. That ought to put us in our place! I have yet to see that piece – but honestly I look forward to it (even though reading it will be painful). It may convince me that I am wrong – in which case I will cover my short forthwith!

The basis for the kickback I have received

The core to my argument was that First Solar has disadvantages (notably lower conversion efficiency) offset by a couple of advantages – notably keeping higher generation in low light, less sensitivity to angle of light – and most importantly – lower cost.

My view was that lower cost would determine almost everything. Solar modules are fundamentally a commodity – and whilst the low-light advantages were real – they could easily be overwhelmed by cost.

I then made an assertion – which I did not back – that the cost structure of wafer-based cells will be competitive against CdTe (First Solar) cells when the polysilicon price gets low enough.

Most – but not all – of the kick-back I have received is based around this cost structure issue. This falls into two camps. Firstly they assert that I have the cost structures of the competitors wrong. Secondly they asset that First Solar will reduce costs enough to offset the advantage that wafer-module-manufacturers get from lower silicon prices.

The other kick-back I have received is on the sales-and-marketing department. First Solar has – according to customers – by far the best sales force. “They are a machine!” First Solar they think that this will allow First Solar to travel well for longer than I might anticipate. Moreover they thought First Solar’s average selling price would remain high because FSLR has presold a lot of modules to solvent utility scale operators – notably EDF in France.

In this post I examine these issues with the aim of getting my own thoughts straight (and hopefully invoking more kick-back from more people that are smarter than me).

A cost model for polysilicon producers

Polysilicon has several disadvantages vis CdTe technology. First the materials are more expensive (wafers are thicker than thin film) – but just as importantly the manufacturing process is much more complicated. At First Solar glass goes into the plant and comes out – about three hours later – as an almost complete module. Human involvement is minimal. Wafers however require more manufacturing – they are sawn – they have breakage rates – they are laced with wires to conduct the electricity away – and they are “assembled”. Manufacturing cost are higher.

That said we can construct a simple cost model for wafer manufacturing from comments made by competitors. YingLi – a Chinese module maker – made the following comment in their fourth quarter conference call:

In the fourth quarter, our non-polysilicon costs including depreciation further decreased to $0.76 per watt from $0.81 per watt in the third quarter and $0.86 per watt in the second quarter and $0.90 per watt in the first quarter of 2009. This decrease demonstrates our strong R&D capabilities, and execution capabilities to continuously improve the yield rate, field conversion efficiency rate and operational efficiency.

The blended cost of polysilicon continuously decreased by the mid-teens in the fourth quarter. I would like to emphasize again that Yingli has now provided long-term (inaudible) provisions to write-down inventory costs or polysilicon prepayments the challenging fourth quarter of 2008.

Now YingLi is a good (meaning low cost) Chinese producer. It has terrible blended costs – but that is because it purchased silicon at high prices and its blended silicon costs are too high. But these costs do not seem wrong relative to competitors. [Inventory problems are surprisingly common in the industry as people hoarded polysilicon to avoid excessively high spot prices and wound up with huge inventories as the price collapsed.] The thing that is most notable about this is how fast the non-silicon costs have been falling – the sequence by quarter is 90c, 86c, 81c, 76c. This is roughly 4c per watt per quarter. It is of course impossible to know how far this will continue to fall – diminishing returns to technology and manufacturing reports will eventually occur. But for the moment we can take 76c and falling fairly fast (roughly 4c per quarter) as the non-silicon costs for various manufacturers. [Contra: slide 8 in Suntech’s latest quarterly presentation gives a much lower non-silicon price. That slide is so “out-there” different I tend to dismiss it – though if anyone has a clear explanation I would like it.]

Solar wafers used to require 7 grams of silicon per watt. Some manufacturers run at about 6.2 grams of silicon per watt – with 180 micron silicon. Applied Materials talk about 80 micron thick silicon wafers – though silicon use for those wafers is not reduced by 80/140 because wire saw (kern) losses are similar regardless of wafer thickness. Also as wafers get thinner they have higher breakage rates (and the incentive to cut wafers thinner is lower as silicon prices fall).

Its probably fair enough to use 6.5 grams of silicon per watt as the right number for modeling a silicon wafer module producer. The 6.5 grams is falling and in five years it may be 5 grams (if AMAT manages to sell more of their kit). Ok – but at 6.5g (or 0.0065 kg) per watt then the cost structure is easy to model…

YingLi cost per watt (in cents) = 76 (less any efficiency they get from manufacturing improvements) plus silicon price (in cents per kg) * 0.0065.

Now I am going to take a wild stab at what the number will be by June 30. My guess is that spot silicon will be $40 per kg and the 76c will be reduced to say 71 cents (which is still falling but by less than the 4c per quarter which the cost has fallen). This gives a cost per watt by the middle of this year of 97 cents. Polysilicon costs go below the magic dollar per watt!

Obviously this is highly dependent on the silicon price – a $20 silicon price would make the cost 13c per watt cheaper – say 84 cents per watt. A $100 silicon price takes cost per watt to $1.41.

Cost is also dependent on YingLi (and presumably the other commodity panel makers) getting efficiencies in the production of modules although at a reasonable clip – though as noted, I model a rate below the historic rate of cost improvement.

[I should observe here that Trina Solar – another Chinese manufacturer – gives their non-silicon costs at 78c per watt – 2c more expensive than YingLi in the fourth quarter. Trina’s cost reductions are also about 4c per quarter… See page 8 of their quarterly presentation.]

This cost model is fraught. The accounting of many of the Chinese players is difficult to decipher. One person I have talked to suggests that most other players are way above 78c per watt in non-silicon costs (although competition will get them there or force them out of business replaced by people who are at that level). They thought YingLi would be at 70c by the end of 2010. Against this the same person thought my grams per watt was too high (suggesting 6 grams per watt based on 180 micron thick wafers) and they thought that YingLi would be at 5.5 grams per watt by the end of the year. This is more or less a wash – with wafer costs a little lower than my estimate but base costs winding up a bit higher. Again all of this stuff is fraught – and although these broad numbers are not controversial the end competitiveness of First Solar is surprisingly sensitive to fine differences in base cost and silicon costs of their competitors.

What is the cost structure of First Solar?

First Solar has laid out ambitious plans to increase the efficiency of their cells and to further reduce costs. I do not want to go through those in detail – but I think we can extract two key charts from the last presentation. First slide 13 – which has the cost per watt falling still – but at decreasing rates. The cost-per-watt has fallen by 1-2 cents per quarter for the last couple of quarters (versus 3-5 cents for the non-silicon costs at YingLi).

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Then there is the less-specific presentation from their “roadmap” (see slide 14) which shows their 2014 target cost per watt.

image

I wish I understood how all of these gains were likely to be achieved – but they think they can get to 52-63 cents per watt by the end of 2014. However – for the moment I assume that they can meet their cost target and get to 58c per watt (a reasonable midpoint) by the end of 2014.

That cost per watt reduction is 26c over 16 quarters – or 1.625 cents per quarter – roughly the rate at which costs have been falling historically.

Figuring that the were at 84c per watt during the fourth quarter of 2009 – and they are reducing costs by 2c per watt per quarter (that is a little faster than historic and slightly faster than their roadmap) costs will be about 80c per watt per quarter by the June quarter of this year.

A raw cost comparison – with the price of silicon being the main variable

With the trusty spreadsheet I can produce a reasonable cost-per-watt comparison…

image

On this cost structure the YingLi panels have higher production costs unless the silicon price is very low. That sort of makes sense. YingLi panels have higher production costs (the process for making them is more complicated) offset by lower non-silicon materials costs (they are more efficient and hence use less glass, backing wire etc). The swing factor is silicon.

This table however leaves off the single most important swing factor – which is that the YingLi panels are smaller per watt of output. (Remember my whole argument is dependent on the higher conversion efficiency of the polysilicon wafer modules.) There are wildly different versions of how much the installation cost advantage is. The advantage comes about because you need less cells, less land, less brackets and less converters to generate the same amount of energy.

This paper from the National Renewable Energy Laboratory has been my guide. This paper suggests that First Solar modules need to be priced 25-30 cents below c-Si modules to generate equivalent project returns (see page 26). Some people think this far too high. For instance Stephen Simko (an analyst from Morningstar who disagrees with me) thinks a 10 percent penalty (roughly 7c per watt) will do the trick. I for the life of me do not understand why this is a percentage (there is limited evidence that installation costs are falling at the same rate as manufacturing costs). 7 cents per watt is very different from 25-30 cents.

I would really like people to detail what the cost difference is. (If informed people send me emails I will be grateful…) I suspect it depends on all sorts of things like labor costs, brackets, land availability and things you would not expect like wind levels (wind requiring better anchoring for the panels).

For the moment I use 15c per watt (a number my research indicates is too low – but which Stephen Simko thinks is too high). At this point my cost table needs to be adjusted…

image

Now at this point the First Solar cells are about cost-competitive at a $40 silicon price. If silicon prices go as low as $20 per kg then the Chinese polysilicon makers (represented by YingLi) have the goods by a long margin.

I should note that this cost structure does not match the cost structure as presented by several people bullish First Solar… Here is a cost structure as presented by Stephen Simko comparing First Solar to Trina Solar (yet another Chinese wafer-module maker). In it however he keeps the silicon price constant at $45.

image

You can see the difference between Simko’s estimates and mine. I have Q2’10 costs for the wafer manufacturer a few pennies (say 3c) lower than Simko. Simko has the cost structure of First Solar falling about 3c per quarter (versus my 1.5 cents per quarter and adding up to a further 3c cost advantage) and he has an efficiency penalty of about 8c versus my 15c (or another 7c of cost advantage). He thus has First Solar maintaining a cost advantage of about 15-18c per watt over the next twelve months whereas the extra costs I suggest wipe most of that advantage.

At a $20 silicon price even with Simko’s cost estimates First Solar’s cost advantage disappears. This of course led Stephen Simko and me to a discussion of what drives polysilicon ingot prices. In that he changed my mind somewhat…

What drives the polysilicon price?

Polysilicon is a commodity. Sure there is better quality stuff (which makes more efficient wafers) but it is still a commodity. Usually with a commodity – when there is spare capacity in the system – the commodity is priced at the cash running costs of the highest price operational plant. When the world runs out of capacity the commodity disconnects from its “cost curve” and is priced at whatever the market can bear. At that point being a commodity maker is frightfully profitable. That profit attracts new entrants and new capacity. Eventually there is enough supply and the commodity price reconnects to the cost curve. (This pattern is familiar to anyone who has – for instance – studied metal prices generally. The pattern drives much of the Australian economy.)

As the solar industry ramped up polysilicon prices disconnected from their cost curves. Spot prices of $450 were not unknown. The NREL paper cited above mentions spot prices higher than that. The spot price however was rarely paid – because most wafer makers purchased large inventories and entered into forward contracts. Some solar-cell makers have got themselves knotted up financially because they have purchased thousands of tons of polysilicon inventory at prices that are well above current prices and which prohibit them from making profits.

The excessive profits made by the ingot makers introduced many new suppliers to the industry. One source suggested that we have gone from six suppliers (and a cozy oligopoly) to 26 suppliers (who will cut each other’s throats). This market is becoming very glutted very fast. That means that the poly price will go to marginal cash cost. So what is that cost?

Well I started with the big players – and they have cash costs in the low 20s. I thought the polysilicon price would thus go to the low 20s. That would settle the issue because – even on the Stephen Simko’s numbers – the Chinese-wafer-based modules will have lower costs than First Solar at a $20 polysilicon price.

So – without stating it so clearly – I thought that the poly price would wind up closer to $20 per kg than the $45-55 modeled by most First Solar bulls.

Stephen Simko disabused me of this notion – and this time I am fairly convinced by his explanation. During the boom the most insane polysilicon manufactures built plants and with very different cash costs to the established (and presumably knowledgeable) players. He thinks the cash cost outside the established players is considerably higher than the cash costs of the established players. He points to a presentation by REC Silicon. Slide 45 of the presentation gives what REC purports is an industry cash-cost curve and whilst the Y-axis is not labeled the bottom of the curve represents about $20 a kg – and the top of the curve represents – well – who knows what? Here is the slide:

image

If this curve is correct the polysilicon price is unlikely to get to $20 because the marginal players will have costs substantially higher than $20.

The issue comes down to how flat is the cost curve? It strikes me – intuitively – as being likely to be very flat as the equipment to make silicon is pretty well understood – but if anyone is genuinely expert in this then I would love them to contact me. [The cost curve REC/Simko showed me however is emphatically not flat…]

This REC graph however has given me pause – because the really brutal outcomes for First Solar were dependent on a very low silicon price. If the silicon price were really to go to $20 and my cost numbers (somewhat more brutal than Simko and other bulls) are right then First Solar will wind up with no reason to exist – and the stock will go below $10 (currently about $130). If the poly price does not go below $45 and Simko’s numbers are right then First Solar will keep a cost advantage – and that cost advantage is sustainable – at least until a better technology comes along or First Solar’s patents run out. First Solar earnings might be difficult – but the business has a reason to exist.

Funny – I have not mentioned profitability

So far – in neither of my notes – I have not made a profit estimate for First Solar or any of the competitors. I have modeled cost – but thus far have not modeled selling price. Once we have a reasonable estimate of selling price and a reasonable estimate of cost we should be able to model profits give or take some things. [The main things we would need to give-or-take are inventory losses for the silicon manufacturers – some of whom have thousands of tons of overpriced silicon inventory, and the project gains and losses for First Solar which is an investor in utility scale solar projects.]

Looking at the current price for modules is not going to help you much. Many companies have both purchased silicon at fixed rates and pre-sold panels at fixed rates. First Solar locked in lots of fixed rate contracts – some with good solvent parties (for example EDF) – some with parties that are more questionable. The current prices realized by the solar manufacturers depend more on the contracts that they entered into (both price and solvency of the counterparty) and less on spot price for panels than a first glance might look.

There are disclosures in First Solar’s 10K which illustrate the problem. These disclosures can be read as “red flags” though I prefer to keep more neutral about their content.

During the first quarter of 2009, we amended our Long-Term Supply Contracts with certain customers to further reduce the sales price per watt under these contracts in 2009 and 2010 in exchange for increases in the volume of solar modules to be delivered under the contracts. We also extended the payment terms for certain customers under these contracts from net 10 days to net 45 days to increase liquidity in our sales channel and to reflect longer module shipment times from our manufacturing plants in Malaysia. During the third quarter of 2009, we amended our Long-Term Supply Contracts with certain of our customers to implement a program which extends a price rebate to certain of these customers for solar modules purchased from us and installed in Germany. The intent of this program is to enable our customers to successfully compete in our core segments in Germany. The rebate program applies a specified rebate rate to solar modules sold for solar power projects in Germany at the beginning of each quarter for the upcoming quarter. The rebate program is subject to periodic review and we adjust the rebate rate quarterly upward or downward as appropriate. The rebate period commenced during the third quarter of 2009 and terminates at the end of the fourth quarter of 2010. Customers need to meet certain requirements in order to be eligible for and benefit from this program.

Essentially the customers or sales channel was liquidity constrained – so terms needed to be made more generous (45 days versus 10 days). Moreover we needed to offer a price rebate (presumably a rebate on our fixed price contract) to enable customers to compete. Those rebates were subject to certain tests (presumably solvency tests but we do not know the content of those tests). Some of these contract changes exchanged smaller fixed price contracts for higher volumes at lower fixed prices.

Whatever – the industry is rife with fixed price contracts. Spot prices are below the fixed price contracts. One day these fixed price contracts will roll off – and new fixed price contracts will struck at considerably lower prices. As we do not know the duration of the fixed price contracts – and even if we did that duration keeps getting extended in exchange for lower prices – we can’t really tell the path of the selling price.

But I have a method which should be familiar to any economist – and I think works for working out where the long term selling price will wind up. It is simple really. The Chinese competitors are numerous and very hard to pick apart from each other. Some are ultimately going to be pennies per watt better than others – but because they are numerous and in fierce competition they will drive the price. This should be bleatingly obvious – anyone who has competed with numerous Chinese manufacturers by now would know that the price is driven down to the price where the Chinese manufacturers make a mid single-digit ROE.

That price however is much lower than the current selling price and probably much lower than the selling price First Solar will realize in 2010.

Moreover the price should be fairly easy to determine: I will just do it for one manufacturer. At year end Trina Solar had book value of $677 million. Some of that value was inflated because they were carrying some high-cost silicon inventory. They had output ability of about 550 megawatts per year (averaging 600 in panels and 500 in wafers). To earn 15 percent pre tax on that equity they need to make roughly 100 million per annum or they need a margin of 18c per watt sold. The first-cut estimate of the long term price of these things is thus – and I am being very simplistic here – whatever the Chinese manufacturers cost plus 18c per watt.

This first cut however is a sharp over-estimate. The equity I am including is too high because of overpriced inventory. The ROE I am demanding is too high too (Chinese competitive manufacturers make far less than that!) The industry is continuing to get efficiencies – and they will be competed away – so the margin per watt will come down for that reason too. You do not need to make any unreasonable assumptions for the right margin per watt over the cost for the Chinese manufacturers to be 10c.

From here an earnings model is easy… First Solar will produce (on their guidance) about 1.7 gigawatts this year and 2 gigawatts next year. The selling price will be whatever YingLi’s cost is plus 10c… You can work out the margins using either mine or a bull’s cost estimates (I use mine). Multiply margin by wattage and you get pre-tax profit – give or take a little bit. I do this below.

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Now – using numbers I think are inherently likely – I get earnings falling sharply. If we take the silicon price to $20 then First Solar has no earnings. If we think the installation penalty is 25c rather than 15c as per the NREL paper earnings go away up to a silicon price of about $40.

Now Mr Simko reckons that the cost advantage of First Solar is about 13 cents per watt better than my number. [He has an 8c installation cost rather than my 15 etc…] 13c per watt equates to $20 per kg on the silicon price (remember we are assuming 6.5 grams of silicon per watt). In other words if you use Simko’s numbers then take my silicon price estimate and add $20 (say $60 instead of $40) to read the earnings numbers. Even on Mr Simko’s numbers First Solar’s earnings fall fairly sharply when the competition amongst Chinese manufacturers drives their ROE down to normal Chinese levels. That makes me more comfortable with my short. First Solar may not be a devastating failure but earnings will fall sharply and the stock starts with a teens PE ratio…

Innovation and the long-term future of First Solar

So far my argument has been predicated on the silicon price falling. At low silicon prices First Solar becomes uncompetitive. The only real question being how low is low?

But First Solar can become more or less competitive depending on how much they can reduce costs or increase efficiency versus their Chinese wafer-based competitors. First Solar has an ambitious target of reducing costs over the next four years. I want to repeat the slide on that cost reduction strategy.

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Now I know you have seen this slide before… what you probably did not notice is that it is not drawn to scale. The company plans to get 18-25 percent cost-per-watt reduction via efficiency – and and only 15 or so percent cost-per-watt reduction through everything else (plant utilization, scale etc). That makes sense because First Solar plants are already highly automated. Glass goes in one end and almost-complete modules come out the other end with little human intervention. It is almost impossible to improve that manufacturing because it is already almost perfect!

So the only place they can get their cost-per-watt down is by getting more watts-per-glass-sheet – that is improving efficiency. Efficiency is the core to First Solar’s roadmap to lower costs.

I will be blunt. I do not think they can do it. Efficiency is already 11.1 percent. If they get 21 percent out of efficiency – something like a midpoint of their 18-25 – then they need to get efficiency to 13.4 percent – and they need to do it over 16 quarters. Efficiency must improve almost 15 bps per quarter. Efficiency for the last six quarters was 10.7, 10.8, 10.9, 10.9, 11.0, 11.1 percent – something less than 10bps improvement per quarter. This is something which should asymptotically approach a theoretical limit – and yet First Solar is modeling that the rate at which they improve efficiency will increase for the next four years. Maybe they can do it – but trees do not grow to the sky.

Against this – what is driving the Chinese manufacturers is manufacturing efficiency as well as conversion efficiency. The Chinese processes are difficult – involving sawing, lacing wires on wafers and assembly. There are many more and difficult steps than First Solar’s thin film process. That is bad for them now but provides opportunity. Chinese manufacturers are – if we know anything about them – relentless in taking out costs.

So my guess is cost-per-watt will fall faster in the Chinese silicon manufacturers than in First Solar precisely because there are more opportunities for manufacturing improvement.

Stephen Simko had the opposite view. He figured that thin film is a new technology whereas wafers have been around for a long time. That means that there are more opportunities for conversion efficiency improvement in thin film than wafers – and he thought that would drive costs over time. I have an answer to that – 10.7, 10.8, 10.9, 10.9, 11.0, 11.1. But really to get comfortable with that I want to talk with a particle physicist who knows a lot about semiconductors. My knowledge of (low energy) particle physics (and hence the mechanism by which a thin film semiconductor might work) is not much more than you can garner from Brian Cox’s excellent mass market book on Einstein and the Standard Model and a few other populist things (many from Mr Cox). On the interaction between atomic sized gates and the efficiency at which electrons can be forced across a thin-film semiconductor layer I am – as you might expect – totally out of my depth…

So there you have it – the whole First Solar thing modeled out. I think I am right – but sensible people take the opposite view – and one industry publication wants to write a piece about why they are short Bronte Capital. If anyone tells you this investing game is easy ignore them. This is tough – and the bets we take occasionally fill us with angst.

John

34 comments:

Abhishek Shah said...

Some problems with your assumptions

1) FSLR is not going to produce 1.7 GW this year , more like 1.4 GW . The rev guidance also includes revenue from the EPC side of the business.

2) While considering costs you are not factoring in the higher bankability of FSLR modules plus in some situations cdTe modules are more efficient to employ such as low light conditions/overcast conditions.

3) Poly price can't go much below $30/kg on sustainable basis. I would rather take the full cost rather than cash cost.The $20/kg will rapidly kill most poly producers and stop investments leading to FLSR advantage

4) Solar technology is rapidly evolving.Thin film technologies like CIGs have a better potential of cost reduction and efficiency improvements than c-Si technology.In the future it might be that CIGs dominates like c-Si is doing now,FSLR has more experience in thin film than commodity producers of c-Si.

Anonymous said...

John,

That is a long way to go to basically attempt to time a stock price to the short side.

Get ready for more pain, my friend. A lot more.

"Looks like I picked the wrong week to quit amphetamines".

-Steve McCroskey

Brennan said...

With a more middle of the road set of cost assumptions, the entire bet revolves around the bet on long term efficiency.

A fast rule of check is to just look at max efficiencies in research: NREL (US) has nice graphs of comparative efficiencies. Make a bet on reaching 90% of research efficiency, and compare.

It is entirely possible for production type CdTe cells to get another 3% or so efficiency: the issue for first solar is full line conversion, and proving a new technology (a better conductive transparent oxide, smoother films, loewr base defectivity) while ramping. I wouldn't bet against the change: they are 3% under research efficiency in their design today.

Crystalline solar, however, has much more room to increase: production efficiencies are around 15%, while research efficiencies are 20-24%, and >25% in concentrators: there is lots of room to grow.

So..A bet on future efficiency gains for first solar is happily in the ~3% potential efficiency. It is conceivable that c-Si will see 4-6% in that time, and concentrated (which is better utility business) will go to 20-25% even at the low cost producers. That is almost double the area efficiency. Call it a 50% advantage over time (from todays 35%). The net disadvantages will increase over time for FS.

Risk is pretty high. I like the bet.

Anonymous said...

Even if you are right on fundamentals, there's plenty of other reasons that this trade could blow up.
Have you considered a rise in the price of crude oil?
Look what FSLR did during the commodity bubble in '08.

The chart doesnt' look terribly comforting either for a short position. What's holding it back from going to $142.50? It looks very "inverse head and shoulders'ish" back in Feb/March.

I can only imagine you have a very long time horizon on this trade as there's probably a lot of pain along the way even if you do have the fundies right.

Hopefully you at least have this thing hedged/paired. I'd hate to be naked short FSLR.

Anyway, good luck and keep up the great blogging. :-)

Steve

C. Fuzzbang said...

Here's my issue with the kickback arguments and why I think the short is correct (timing aside).

The disadvantages/advantages of FS's product are irrelevent. For the most part silicon PV is a substitute and thus the two products are priced accordingly given all other cost and output variables. Unless they are moving relative to one another then these are moot points.

Re: poly. The cost curve does look like that but the incumbents (where the supply curve is flat and reasonably similar among participants) are increasing output significantly over the next 2 years. The marginal Chinese poly manufacturers and their costs are irrelevant. The incumbents said the same thing back in '97 but they completely overbuilt. I believe MEMC still has i-beams sticking out of the ground in Panang from a factory that ultimately got canned. I do think $20 is too low. I'd be morecomfortable with $30 given historical bottoms in the industry.

You are spot on with the efficiency commentary. It's something to watch closely.

You do not pay enough attention to Germany and the FIT cuts. You're analysis is similar to mine but timing is important here and also the politics of the FIT. There are some bullish rumors regarding a lower than 16% cut right now.

There's no point in talking to a particle physicist because they can only tell you theoretical max not the trajectory there. Plot the trajectory of the CdTe and PV cost reduction all in and use a percent drop q/q not a cent drop. FS declines are slowing.

2. Two points worth mentioning in favor of the short. First, FS started giving terms on contracts. Go look at DSOs. Second they got into the project business. This never works out. The market can serve demand on its own. You can't create fake demand through projects.

Anonymous said...

I mentioned this point in the last post and will repeat it again:
COMPETITIVE ADVANTAGE IN SOLAR ISNT JUST MODULE COSTS ANYMORE. IT IS COST TO DELIVER ELECTRICITY.

The argument you put forward is valid 2005-08. From 2010, when you sit in the negotiating table with a US utility, the question is "At what cost can you deliver electricity". Here are the other variables beyond basic module cost/watt - 1. Availability of land and proximity to grid. Doesnt Optisolar's 500MW PG&E win over some very very players ring bells 'how the hell did they do it?'
2. Financing costs. If an investor decides to own and operate a solar power plant, the oft asked question by bank is 'whose modules are in there'. Yes, FSLR's panels are gold standard.
3. When you dont have EPC business and let someone else take panels and install, you are adding costs. Why do you think FSLR plans to have EPC at 0% Operating margins? The simple answer is utilities DO NOT care the costs for modules or the install it - all they care is what cost can the electricity be delivered.

This is what you need to consider for markets where PPA is standard. Once investors get this and/or FSLR runs away with the US market, watch out.

H

Anonymous said...

BTW, look at the progression of non-silicon costs in YGE? I am sorry, but a 5th grade kid can identify a nice progression there. Add that to the fact that <1% of Chinese companies management are truthful, I dont want to bet my house that truth is being told. THERE IS NO WAY ONE CAN ASCERTAIN THESE NUMBERS THEY THROW OUT - yes, same can be said about FSLR, but I am more willing to believe FSLR than YGE.

H

Anonymous said...

If you really want to short a solar name, go after SPWRA or ENER. You will soon realize $10+ and $5+ for these stocks are truly, a blessing. Try to do a cost comparison of YGE with SPWRA and there are some very, very results. Add accounting issues to the mix you have a perfect short!

H

Anonymous said...

I wouldn't believe that cost curve data for a moment. How would new entrants be on the wrong part of the curve? Are there big gaps in imput costs? electricity prices maybe? I don't know anything about wafers but I've never seen a capital intense commodity industry w/o differentiated input costs where new entrants were in that part of the curve.

Also full cost vs cash cost - well in an oversupply - which is essentially what you have its cash cost that matters. When times are tough its full cost that matters. If wafers were less than $20 and you were putting together a bullcase on the wafter guys then full costs matter - but in an oversupply sunk costs don't matter - you run the plant as long as MC<MR

Wai Chee said...

Here's some cost numbers: "Jiangsu Zhongneng adopts the most advanced hydrochlorination technology and the
modified Siemens process to produce polysilicon. Through hydrochlorination,
by-products from the polysilicon production process – Silicon Tetrachloride and
Hydrogen Chloride – are effectively recycled back into TCS, one of the major raw
materials used in the polysilicon production process. Not only is this process
environmentally friendly but it also helps to significantly reduce unit production cost.
Jiangsu Zhongneng’s production cost decreased from US$66/kg in 2008 to US$36/kg
for the month of June 2009, which is highly competitive versus its global peers."
http://www.gcl-poly.com.hk/attachment/2009092121055117_en.pdf

"Average selling price was US$65.4 per kg for polysilicon and US$0.83/W for wafers. It sells to Trina."
http://www.gcl-poly.com.hk/attachment/2010031723481317_en.pdf

Regards

Isam Laroui said...

John, I'm a trader, not a fundamental (this is the right spelling by the way, not "fondamental" which is the french spelling) analyst, so I'll say this one more time at the risk of greatly annoying you (in which case I apologize): at this moment, technically the stock does not look good as a short. It has based roughly around 100 several times in the last couple of years but the bears could not push it much lower than that. And now a nascent and nasty short-squeeze seems to be taking place. FSLR is trading above its 200-day moving average as I'm typing this and the 200 resistance level is beckoning.

That said, I don't know anything about your expected holding period or the way you got short or where you got short and thus how much heat you're willing to take, so my opinion is just that, an admittedly myopic opinion.

Jeff Matthews said...

John, I have no position in FSLR, and I have no worthwhile independent view of the business itself.

But I would be far more worried about your short if the push-back you got was about FSLR's manufacturing and research prowess than about their sales prowess.

Anybody can sell anything. Motorola once was a "sales machine"--they just financed their own customers, including some who had no intention of paying.

Selling is easy. Making stuff cheap and well is hard.

JM

Nick said...

As Abhishek points out, if poly is going to $20 you are way better to short WFR, WCH GR or other poly guys.
No need to worry about efficiencies.
You just need to be sure about their semi poly businesses, which unfortunately are enfuego right now.

Anonymous said...

John,

Suntech's non-silicon cost means something different than yingli's or trina's. Suntech purchases wafers, so the non-silicon cost refers to the conversion costs of wafers to cells and then to modules. The other players purchase polysilicon, and their non-silicon cost refers to the conversion of polysilicon all the way to module. Cheerios, Slurry

doggydogworld said...

Big improvement over your initial analysis. I still think you put too much weight on poly cash cost. All-in cost is what matters over the full cycle. Sure, spot poly will follow the cash curve in times of oversupply, but FSLR's long-term contracts partially insulate them from such temporary effects. The timing is key here, if spot poly is nearing an uptrend by the time the bulk of FSLR's contracts roll off you're hosed.

The 25-30 cent FSLR penalty sounds like a throwaway number -- i.e. 10% of module price back when the report was written. Why use a fixed percentage? It's not as if brackets get cheaper when module prices plummet, do they? Well, actually they do. It makes little sense to invest resource into reducing bracket cost from $0.20/W to 0.10/W if modules are 4.00/W. Different story when modules are 1.00/W. Add to this normal scale effects as cheaper prices grow demand.

Look at 2010 module and system price estimates on pages 24-25 of your NREL report. In 2008 they estimated system price at 4.75. In 2009 they cut the system estimate 50 cents. But they only cut their module estimate 15 cents. Balance of system prices actually fell faster than module prices!

For all their flaws, Nanosolar worked on balance of system cost from the very start. They knew a 0.30/W cell wouldn't revolutionize the world if BOS was still 3.00/W. They have some PR/white paper stuff dealing with BOS, including head-to-head comparisons with FSLR. Might be worth a read.

Nacraphiliac said...

You are a hand-wringin', mouth-breathin', thumb-suckin', bed-wetter! Have the courage of your convictions, sir!

Anonymous said...

STP's non-silicon cost refers to the cost of processing a purchased wafer into a module, that is why it is so low.

chitra seshan said...

Efficiency is key to First Solar's cost goals. I reached the same conclusion some months ago-- and the efficiency needed doesn't seem in the realm given their past performance. The follow on question should be: If I were FirstSolar, and have a bunch of money, what would I do to get those efficiency goals while best leveraging internal expertise? My conclusion was: They would switch to CIGS-- and have assumed that in my projections for FirstSolar going out to 2015. Recent reports (see links) indicate that this is likely and possibly by end of 2010 (which is sooner than I had expected, to be honest-- I thought by early 2012)

http://guntherportfolio.com/2010/03/first-solar-skunk-works/

http://www.reuters.com/article/idUSTRE6374W620100408

Chitra Seshan

Kevin said...

John,

I'm a thin film expert in the US and, as much as it pains me, I agree with your assertions. In my view, even if the polysilicon price bottoms out in the $30-40/kg range, the g/W figure will continue to decrease as new and innovative ways to efficiently cut thinner wafers are developed. This will certainly place significant pressure on FSLR over the next 5-10 years.

As a fan of FSLR and, quite frankly, as an American citizen, what's frustrating to me is what seems to be a very non-level playing field when it comes to the competition between FSLR and the low-cost Chinese manufacturers you cited. Many of these Chinese companies have been given extremely generous subsidies from the central government (free land, low-interest or no-interest loans, etc.), have access to extremely cheap (and dirty) electricity, and most importantly, benefit from an imbalanced exchange rate between the two countries. All of these factors contribute to the low non-poly costs you referenced, thereby making FSLR's path that much more difficult.

As a citizen in a country where consumption has long outpaced production and manufacturing, I for one would be happy to see a tariff put in place to level out the playing field and give companies like FSLR a fair fight. But perhaps this is a story for another day.

keiran said...

Hi John,

As a molecular physicist turned banker I cringed a little at your time series of conversion efficiency. First, though,
solar electricity is not a particle physicist's domain. I can put you in touch with some mates at Fermilab if you want but semiconductors in sunshine is a slightly lower energy scale from smashing protons into anti-protons at the speed of light.

Second, the one thing you know for sure is that technology innovation proceeds in fits and starts. Engineering process improvements are often incremental which I think is what you were quoting, but a small change in thin film composition or structure could easily lead to a large jump in conversion efficiency.

If your short on First Solar comes down to betting against sharp increases in conversion efficiency then you're playing the reverse of a VC strategy. These are classically long odds high payoff. Who knows, you might win but the expected returns are slim because of the skewed distribution of outcomes.

great blog btw
Keiran

John Hempton said...

Kieren

I am not that stupid.

It is photons (massless, low energy) kicking out electrons from shells.

At least that is my understanding of the electro magnetic force.

And they need to kick the elctron out of the shell and it needs to find its way through a gate.

J

狂猪 said...

Hi John,

I really like your notion of how to be a well pay blogger. Here is an interesting presentation at Stanford that you may find interesting.

http://ecorner.stanford.edu/authorMaterialInfo.html?mid=2425

John Hempton said...

Keiren -

If you can solve (a) a thermal efficiency problem for me and (b) a fluid dynamics problem I would be appreicative.

Wall Street physicists are rare.

Give me an email.

J

John Hempton said...

Keiren - more to the point - this is a particle physics problem (although a low energy one).

The photons come with an amount of energy which makes an electron jump a shell in the dopant atom.

If the energy level is right it can jump through the gate of the semiconduct.

CdTe semiconducts are good because the band-gaps match roughly the energy levels of sunlight.

I am trying to educate myself about the band-gaps - but I am suffering. My business partner is an electrical engineer - so I guess he could do it for me - but it was fourth year electrical engineering two decades ago - so a pure physicist would help a great deal.

Please contact me.

John

doggydogworld said...

As Keiran mentions, innovation can improve in fits and starts. FSLR's huge cost advantage meant rapid production growth was the way to maximize profits. They put efficiency work on the back burner. With margins finally falling I imagine efficiency is now job #1.

As for CIGS, I think production would be years but away a stock-lifting PR blitz could come at any time.

keiran said...

Hi John,

Sorry, that was a bit harsh. You are completely correct, it is all about photons dislodging electrons. Photovoltaics is a fairly low energy process and modern physics is pretty much divided up by "energy involved". Particle physicist tends to mean the physics of sub-atomic particles, quarks and gluons etc.

My point, somewhat nerdily made, was simply that solar power is a lower energy process and is the domain of molecular rather than sub-atomic experts. Apologies for the fine distinction, please email me directly.

regards,
Keiran

Anonymous said...

Hi Jon. I posted this on GTM and edited here for you. I liked your reply/post on your blog.

The writer brings up some great points, and the readers bring up some great points. My guess is some of the comments have hardened his conviction and some have made him question his position. Here are some thoughts (from an investor who has been long and short solar companies.)

1. What would the cost of CSi be if the solar grade silicon were free? I get about $1.20 a watt, but I would love to hear other investor’s thoughts. [I have never gotten as low as the .80 Yingli is stating. One other development here would be the use of metalurgical grade silicon in place of solar grade. Timminico and Globe Metals were trying.]

2. What is the value of the glass in a FSLR panel? I view this as the lower bound of their pricing structure?

3. The writer rightly points out this is a commodity. However, in commodity companies, I think the cycle is more important than the player. Cycle and price trump management every time. Even a crappy paper company goes up when the price of paper goes up. Where are we in the cycle? Could a Chinese or US FiT change the cycle? What if electricity prices went up (i.e. natural gas) or solar dropped below grid parity? Those would cause a surge in demand? Would that change your thesis?

4. The writer might be attibuting too much emphasis on the space necessary of panels. The California Solar Initiative, probably a decent barometer for the world, shows that 90% of panels go to 10% of projects. Roof space is not an issue for large scale systems. Just a thought.

http://www.energy.ca.gov/2009publications/CPUC-1000-2009-033/CPUC-1000-2009-033.PDF

5. All the posters agree that FSLR is a very talented manufacturing company. This is a core stregth. What if FSLR put a magic CIGS process where their magic CadTel process sits? Surely they are trying. If we woke up and FSLR articulated a path to 16% efficiency and a 35% drop in cost per watt, would that get them to below grid parity and usher in a new era of solar demand?

Just some thoughts. I just know we are not at the top of the cycle right now and I know that every politician loves solar. THe politics are almost impossible to predict.

And finally, is there a way to play the MW cycle without the technology/panel risk?

I have been long SATC as a way to play the MW growth, but you will easily see that if the cost for inverters drops.... so will SATC. So far it has been steady for about 3 years. If the cost of small scale inverters drops, SMA (S92.de) will implode. Just look at what an SMA inverter looks like, kind of like a DVD player, and look at the hundreds of inverter companies. Maybe we should be looking at this as a short?

Good luck.

Anonymous said...

By no means is the approval for First Solar's Topaz project in San Luis Obispo County a given. That 550MW plant will require CEQA-compliant environmental analysis and there are a host of issues there - from wildlife impacts to noise, traffic, loss of ag land, water and many other impacts and risks. The site is poorly chosen near a rural community and agricultural economy, and there will be a significant cost of bringing the power to market because the transmission lines will have to be upgraded.

First Solar is working on technology to replace Cad-tel. That means it will have a backlog of Cad-tel panels to get rid of. As a commenter said above, you cant create fake demand through projects.

Brennan said...

Because I enjoy this site, and maybe it helps, here is my quick primer (materials scientist perspective). If you know/remember a fair bit (and like equations), the wikipedia solar cell page is very good.

http://en.wikipedia.org/wiki/Solar_cell

--------

A quick note on band gaps, simplified grossly

The band gap is a measurement of the energy separating the conduction band electons (the metallic-type ones that can conduct electricity) from the insulative/valence bonding electrons.

In Si, the photon enters into the material, and if the energy and momentum is right, it pushes the electron from the valence band into the conduction band. That free electron then can conduct away.

If the system were completely symmetric, eventually, the atom would lose enegy, emit a photon (or phonons), and drop back into the valence band.

The trick of a photoelectric cell, then, is to make lots of transitions happen, and to make an assymetric barrier--so electrons can go one way, but not back. Thus, you sweep up the electrons going one 'way'.

Efficiency is the work in making sure that
1) you generate lots of electrons from the photons.
--this works well if the band is matched (so the band is less than the energy of a photon). Bands are moved using dopants.
--Si requires a bit more complicated transition, so is always less efficient than 'direct band' semiconductors. You need 2 things to happen to get silicon to give up the electron. having 2 things happen is always less likely than 1 thing.

2) you collect all the generated electrons efficiently
--have a good oxide
--dope effectively.

3) the conduction electrons aren't lost or converted accidentally.
--keep heat down
--have high conductivity and limited resistive losses
--keep defectivity down. Local recombination centers, where electrons are locally recombined due to material defects, are limiting.
--This is what manufacturing efficiency really gets you: defectivity, in a manner very similar to semiconductor.

That is a short version. Manufacturing efficiency improvements are to
a) improve the conductivity (contact losses, contact resistance, doping)
b) Reduce defects that contribute to recombination losses
c) Improve optical absorption efficiency.

Defects tend to follow exponential decats, optical absorption doesn't change quickly, and conductivity is mostly a cost question. So, that can provide you with a useful model. Max efficiency is then a property of the material system.

Nick said...

Citi out with bullish poly commentary on 10.4GW demand 10e.
Talking about stabilised $50 poly prices with some rising spot prices (for what that's worth)...

C. Fuzzbang said...

Okay maybe I wasn't being too cute getting out of the FSLR short. I think Q1 is interesting. It shows insane demand (priced up q/q! doh!) and yet their cost structure (core cost per Watt) and efficiency are flatlined. I'll still by my previous prediction. Place your shorts after the Q2 earnings call.

Abhishek said...

You were both right and wrong with your thesis at least based on Q1 earnings.As I said in my first comment ASP is just not a function of lower efficiency compared to c-Si modules,it is also bankability as FSLR improved its ASP in Q1,while other companies ASP's are decreasing

However regarding costs they disappointed me a lot as it was flat with last quarter and efficiency has almost stopped increasing despite higher throughput

I would short FSLR but would have a long position in a strong c-Si stock to negate the strong sector demand

Craig said...

The PolySirice would be very difficult to get below USD$30 a kilo as most producers cannot produce it at USD$30 a kilo. You will get the big cashed up players forcing the little players out and the price of PolySi will increase again.

Better advantages are to be made in improvements in the amount of Si required per Watt and increased efficiencies. Places where land is expensive will look to more efficient PolySi based modules to generate more electricity per acre.

Thin film will be attractive where land cost is not an issue so efficiencies need not be as high - eg the desert.

sabkon wells said...

hey. thanks for sharing such a detailed review with facts and figure. they were very useful . do keep on updating the post. will be here looking up for updates.

SMA Inverters

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