Nigerian spam email of the week

From: Dudley Caruthers Esq (Barrister at Law)

Subject: BP Related Agreement Entitlement

E-mail:

Dear Friend

I am the private solicitor for Mr Tony Hayward, the esteemed Chairman and Chief executive of British Petroleum.  My client has various personal and family related holdings of BP stock and options. Due to his faithful long standing service to BP the total value of his holdings amounts to in excess of 100m pounds sterling.  Mr Heywood is a British citizen but it has been my sorrowful duty to advise him that his personal and family wealth is at great risk of being wrongfully confiscated by US authorities acting extra-territorially under special powers authorised by the US government and with the secret consent of a supine UK political and legal establishment. 

Mr Heywood is also at great risk of losing his personal liberty and becoming another victim of the long reach of the politicised USA legal system in the same way that was meted out to other British subjects including, most egregiously, the 3 bankers from Natwest (see  http://en.wikipedia.org/wiki/NatWest_Three).  Unfortunately I am not able to advise or assist him in this regard as my expertise lies in the structuring of executive compensation schemes and the management of private endowments; but I am horrified at the witch hunt being perpetrated on my client by the Obama administration and its agencies and I will do all that I can to safeguard my client's financial position.

I am reaching out to you as it has become clear that Mr Hayward's holdings must be liquidated and held in trust for the benefit of himself and his family beyond USA or UK legal jurisdiction. Exercise of his options and liquidation of his stock is now complete but it has proven necessary to assign title to the ensuing 100m pounds of cash to a person such as yourself who resides in a non recognised tax haven country and where there is a sound basis for UK and USA authorities to recognise the legal validity of local agreements.  The taxation and legal recognition agreements between your jurisdiction of Australia and those of UK and USA present a unique opportunity to protect these assets whilst providing you with a benefit in accordance with your key role.  I am a keen reader of your blog and greatly admire your economic and political acumen.  I immediately recognised that, at this hour of great urgency and risk to my client, you are the man who is capable of securing protection of the Hayward estate.

It is with this in mind that I wish you to consider the possibility that you and I (as Mr. Hayward's agent) have previously entered into verbal agreements providing for you to become the beneficiary of all Mr Hayward's BP stock and stock option benefits upon their occurring a significant "force majeure" event affecting my client and British Petroleum.  It is my legal interpretation that such an event occurred with the sinking of Deepwater Horizon and that title to Mr Hayward's rights and holdings transferred at that time.

If you do recollect our agreement then it is now necessary to transfer the 80m pounds of  cash proceeds to yourself which are after payment of  a 20m pound advisory and arrangement fee for the services rendered by my firm. Transfer of the cash will only occur to you upon you executing the correct documents which are (i) the force majeure beneficiary transfer agreement  (ii) a statutory declaration that the force majeure beneficiary transfer agreement was properly entered into as a verbal agreement in January 2002  and (iii) details of your Australian bank account including account name, password and account number and most critically an agreement between yourself and myself as trustee for Hayward related entities granting the trustee the right to claw back  50% (40m pounds) of the transfer at any time and requiring you to escrow the 40m pounds in a separate account.

I sincerely trust that you will search your memory and recollect that we met in Sydney in 2002 and recollect the nature of our agreement.

Please contact me at my firm's Nigerian subsidiary's offices at the address below such that we can act with the speed required of us.

Weekend edition: In the tradition of Yves Smith’s – antidote du jour

I went to a free concert on the Opera House steps on the weekend.  The billing was very strange: Laurie Anderson (and possibly her partner Lou Reed) were giving a concert on the opera house steps for dogs.  Thousands of dogs.  It was billed as inaudible to the owners – and I could not tell whether Lou Reed was having us on.  After Lou Reed brushed off the Metal Machine Trio for an impressively loud show in the concert hall (earplugs supplied) – and he was going from something you could not listen to to something you could not hear.
I was pleasantly surprised. Dogs and family loved it.  Lou Reed did not appear but milled around the audience allowing this ridiculous photo of your blogger and his designer mongrel:


Lets call it a Walk on the Wild Side. 
Seriously though – how could I resist a connection – any connection – with the Velvet Underground and one of my favorite albums. 

What is it with Carlo Civelli and George Soros?

Carlo Civelli is nothing if not controversial.  His name alone gets Canadian securities regulators into a lather as he was a major investor and a major seller (in advance of the crunch) of some of the most egregious stock promotes of all time.  Delgratia is the most-cited example - where Civelli was allegedly the main backer of a company which had a major gold find.  The stock plummeted on revelations that drill samples had been salted - or as the court documents sum up the engineering reports, "any [gold] detected had been introduced after drilling."  The salting was done by persons unknown and the chief geologist won a defamation suit when the Canadian press suggested he did it. 

Civelli was a backer of another over-hyped resource stock - Pinewood Resources – a stock which announced large finds and collapsed to pennies.  There was also Arakis Energy.  Arakis sums up what is good-and-bad about Civelli.  Arakis - through dealings with warlords - got prospective acreage in Sudan on which they found oil.  The quality of the finds was however grotesquely overhyped leading to a run-up and collapse.  The company was eventually sold to Talisman for roughly 15 percent of peak price.  The CEO - a longtime Civelli associated - agreed many of the nasty facts and settled for a twenty year ban from the Canadian securities industry.  The good bit was that there were real resources there - value was created.  The bad bit was that - as per many Civelli stocks - it was overhyped.

Note that Carlo Civelli was not charged – and only management received bans.  Overhyping is epidemic in the stock market.  Moreover there were plenty of good bits in Arakis.  There was real oil - and in commercial quantity.  Carlo Civelli has - contrary to what his critics have said - backed some valuable resource projects.  That Carlo Civelli has backed frauds does not imply that if Carlo Civelli backs it is a fraud.  Nor does it imply that Carlo Civelli was involved in the fraud.  Both of those are much more dubious propositions.

The most controversial current Civelli stock is Interoil - a company with real gas finds in remote Papua New Guinea and with well researched allegations that the finds are overhyped.

Still the Interoil bears (and there are plenty) were dealt a body-blow when Soros funds management purchased a large stake in the controversial company presumably after competent due-diligence.  Interoil is one of Soros's largest holdings.  Sure Buffett buying would confer even more credibility to Interoil - but Soros is a pretty good second best. 

This blog however does not want to comment on Interoil - it wants to raise the latest association of Carlo Civelli and Soros funds management.  Dear readers - I give you Manas Petroleum and its subsidiary Petromanas into which Soros has invested just over $40 million.

Manas/Petromanas is an unlikely candidate for a large Soros investment.  The parent trades on the over-the-counter bulletin board and has used paid stock promoters. It maintains its website in Vancouver rather than in its home base of Switzerland.  Petromanas (a listed subsidiary) trades on the Canadian venture exchange and their website is maintained in New York not where their business operations are.  Petromanas owns the Albanian prospects of Manas and it is that which Soros is investing in.

These companies are slickly promoted.  Here are three You-Tube videos detailing Manas Petroleum's prospects and management.  Money has been spent on them.

 

 

 

 

 

The use of paid promoters has been widespread - for instance a 34 page stock report by report by Cohen Independent Research Group (a penny-stock promoter) has the following disclaimer:

Cohen Independent Research Group Inc. (CIRG) distributes research and other information purchased and compiled from outside sources and analysts. This report/release/advertisement is an advertisement and is for general information purposes only. Do not base any investment decision on information in this report. All information herein should be viewed as a commercial advertisement and is not intended to be used for investment advice.  [Emphasis added.]

This is not the only example of paid-promoters shilling Manas though is by far the most prominent.

Penny-stock shills have - as many have noted - a poor record.  Paid penny-stock promoters poorer still.

But hey - this is Soros - so there is always the possibility that Mr Soros and his organization have found the promote that someone thought was worth advertising with Mr Cohen (presumably so they could sell it) - but in fact represents a fantastic investment.

I see three possibilities:

• 1.  Soros has found the well promoted penny stock that really is worth your hard earned cash or
• 2.  The Soros organization have become active participants in penny stock schemes or
• 3.  That Soros organization has a rogue analyst/fund manager who is (knowingly or unknowingly) involved in stealing large licks of money by investing in dodgy promotes run by Civelli and his agents.

Stuffed if I know.  I have no position.  But I would be very wary shorting Manas – Civelli stocks have often gone for enormous runs before blowing up and Civelli has backed real finds like Arakis (even if they were excessively hyped). 

 

 

John

People like me in Thailand

This post is motivated by my local dead-tree (the Sydney Morning Herald) wasting good column-inches on Kriangsak Kittichaisaree – the Thai Ambassador to Australia.

Once upon a time I unfortunately purchased a stake in Bangkok Bank. The bank – a survivor from the Asia Crisis – is a run really well by a Thai-Chinese family. Its loan book was conservative – and was working through the last of the Asia-crisis problems.

Bangkok Bank’s biggest problem was that Siam Commercial Bank (a bank controlled by the Thai Royal Family) was trying to grow like topsy especially in consumer loans after bringing in some McKinsey consultants who thought that American style consumer lending was exactly what was needed in Thailand. Siam Commercial had imbibed the banking philosophy that was to lead the world to ruin. Bangkok bank was actually run by sensible people who behaved as owners. I never met them – but I suspect I would really like them.

As part of the research I chatted to the investor relations or CFO of every reasonably sized Thai bank. I also chatted to some people at GE Finance who had been involved in the purchase of Bank of Ayudhya.

My problem was that I failed to heed the elephant in the room. Every Thai person I spoke to identified what they saw as the risk - Thaksin Shinawatra. Thaksin was a populist and popularly elected politician who was modestly corrupt (at least by the standard of developing countries) but who had a patronage network outside Bangkok (especially outside the Bangkok elite). Stylistically the comparison (made by many and I do not think too unfairly) was to Mussolini. More fairly he was in the mold of Berlusconi – the richest guy in the country using his power as such to win elections and rig the game in his favor.

Every single person I spoke to hated Thaksin. These were the educated finance professionals and managerial class – people like me. Many of them were liberal-democrats in the soft-liberal sense – really like me. Sometimes the hatred stretched to loopy conspiracy theories – but generally they just thought it was something worth ear-bashing a foreigner for about twenty minutes on. Everybody had an opinion – and it was the same opinion.

The elephant in the room of course was not Thaksin – it was the views of the elite about him. It was a view tainted a little with racism or at least regionalism – with the Bangkok elite looking down on people from the provinces (especially those from Issan whose first language was sometimes Khmer but more often a dialect of Lao and who they would suggest had darker skin though I never noticed the skin tone). [For those who study these things young women from Issan dominate the sex-tourism industry in Thailand reflecting their origin from poor and less educated rural areas. These are not the Bangkok elite.  Rural lightly educated or uneducated poor were the core supporters for Mussolini too.]

Still – as a keen observer of the United States I was getting used to seriously polarized politics. There were plenty of liberals (sometimes liberal-elites) who hated George Bush with similar vehemence. There are plenty in America who hold similar ill-will towards Obama. The big difference was that in Thailand I could not find a single Thaksin supporter amongst the people like me whereas there are many conservative (or more commonly libertarian) people in the American financial elite.

When the coup happened I was not particularly surprised – and (foolish me) not particularly alarmed. After all the people who supported the coup – at least tacitly – were people like me. The military decorated their tanks with yellow ribbons – signifying their loyalty to the King (and hence – as someone who comes hails from a democratic-constitutional monarcy) to some loyalty to the framework of democratic-monarchy. 

When the Thaksin’s party (the Peoples Power Party) won the post-coup election I suspected we would just get back the same politics minus some of the corruption.

Alas it was not to be. The Orwellian named People’s Alliance for Democracy - the Yellow Shirts who don’t want to accept that Berlusconi (sorry Thaksin) was democratically elected – set out to make Thailand ungovernable if elections were fair. [Remember the occupation of Bangkok airport which did not end with snipers and hail of government bullets.]

But be clear what people like me have done in Thailand now. They have subverted democracy with a military coup and a refusal to accept the result of the subsequent election. And they have shot people that have disagreed with them.

An American equivalent would be if (say) the Tea Party (displacing its predecessor Republican Party) won the US Presidential elections and – like many demagogues – turned out to be modestly corrupt. In response a coup was organised by the displaced elites (Democrats and non-Tea Party Republicans) and Tea Party protestors were subsequently shot in the street.

In most civilised countries the actions of the past-elites would be called Treason. In America the military leaders of any such attempted coup would be court-martialled and receive the death penalty. What is more – even as someone who opposes the death penalty I would shed no tears... the alternatives are Hobbsian.

And that is where people like me have got to in Thailand which is a rather sobering thought indeed.

 

 

John

PS.  If you do not think the Government looks like a collection of liberal-elite then look at on Kriangsak Kittichaisaree’s CV which lists amongst other things a specialisation in law of international human rights at Harvard.  I wonder where they taught him that it was acceptable to be the Ambassador for a Government that shoot in the streets people who want the re-establishment of a popularly elected (albeit corrupt) democratic government.  I look forward to his resignation on principle. 

Post script:  many people have complained about my analogy of Thaksin to various Italian leaders.  This analogy is often used by the Thai elite – and is not mine.  The fair comparison I think is Berlusconi – who used his control of the main media to get elected – whereas Thaksin used methods more akin to vote buying.  [My Italian friends – again people like me – hate Berlusconi with a similar vehemence but they would not have condoned a coup.]  That said the Thai Foreign Minister just the other day was using the Mussolini comparison.  I do not want to get into direct analogies of policies – because – frankly they fall down.

From the perspective of the Japanese household

Japanese bonds – yielding close enough to zero – have been a fantastic investment for about twenty years. 

After all seven year JGBs were yielding above 1 when I was (unfortunately) short them.  Nominal prices were dropping more than three percent per year.

So the return on owning JGBs was over 4 percent real per year.  Tax only applied to the nominal part of the return – so the post tax return was about 4 percent per year REAL.

Now how long did you need to hold stocks to get a 4 percent post-tax real return? 

Mrs Watanabe with her large JGB holding has seemingly done OK.

Just saying…

 

 

John

First Solar – a follow-up post the result

Such is the life of a short-seller.  The biggest short in our fund (First Solar) came out last night (Australian time) and – again to use the Australian vernacular – hit us around the head with a bit of 4 by 2. 

It was ugly.  The stock was up almost 18 percent and was the best performed stock in the S&P.  Moreover it has been up for a few days prior to the result.  This has not been a profitable position.

On the plus side we run a portfolio – and somewhat unbelievably the customers performed about with market despite this blow.  Obviously Bank of America – our biggest long – was up 5 percent – and that position is more than double the size of our First Solar short.  Also – and less obviously – our next biggest short (which I will refrain from naming) was down hard.  Those two more than offset First Solar and the rest of the portfolio was merely OK.  [Even the Spanish bank short – also a largish position – did not hurt us despite Santander’s blowout results.] 

If you just looked at the aggregate you would not even notice the “First Solar Pain” – but I don’t look at the aggregate – and I am hurting – if only via wounded pride.  So it is time to have a re-examination – a look at what went wrong or did not go wrong.  After all I need to know whether to persist in this loss-making position.  As I introduced you (dear reader) to my initial thoughts I will introduce you to my continuing thoughts.

When to persist with a loss making short

There are three reasons for covering a short – and only one of them is a happy reason. 

The first reason is that the thesis has played out and you have made your profit. 

The second reason is that your thesis is wrong.  At Bronte Capital we have a strict “no broken thesis” rule.*

The third reason for covering a short – one that happens all-too-often – is that the short poses too much risk and must be reduced for risk control.  This happens with shorts but not longs because when a long goes against you (that is down) it gets smaller and hence does not threaten the fund.  When a short goes against you (up) it gets larger and hence often must be reduced for risk control reasons.  This is the main practical difference between shorting and traditional long investing.  Positions on which you are wrong shorting hurt a lot because they get larger and you wind up wrong on larger positions.  (Leveraged long investing – which we do not do – requires risk management similar to shorting.) 

Anyway – there are only two reasons I will cover the First Solar short after this beating.  One is risk control – and that is more-or-less automatic.  If the position is too large we will trim it.  The other is that our thesis is wrong.

I am not going to tell you about the risk control process (unless you want to become a client).  I will tell you about the thesis.

Our thesis – and the the First Solar results

Our thesis for First Solar – run through in detail in the two earlier posts [here and here] has a few parts.

Part A - is that crystal silicon modules (c-Si) are becoming cheaper to manufacture because the Chinese are getting good at producing them and that the most expensive ingredient (polysilicon ingot) is becoming substantially cheaper as the market has become competitive and glutted.

Part B – is that the Chinese c-Si producers are competitive and that over time the price of modules will come – through normal competitive pressure – down to near the cost of c-Si cells – that is costs will determine prices.

Part C – is that the lower price of c-Si modules will compress First Solar’s margins (First Solar uses a thin-film CdTe technology) and competes almost entirely with c-Si manufacturers.  Moreover First Solar will not be able to reduce its costs because it is so efficient already – essentially that FSLR’s “roadmap” to lower costs is nonsense.

Bluntly – it is Part B above that I am wrong on.  The price of modules received by FSLR was very good and margins remained fat (and indeed got fatter).  In the original thesis Part B was the bit without a time-frame – and I might be right or might be wrong on it in the long run – but I am most certainly wrong on the basis of the last quarter.

Lets deal with the bits I am right on so far -

Part A:  There is no doubt that c-Si cells are becoming cheaper to produce.  First Solar said “the low end of guidance has resilience to $40/kg poly and c-Si processing cost of 75c/watt by Q4 for non captive demand”.  (See p23 of the results presentation.) 

I am going to come back to that sentence because I think it is central to what has happened – but for the moment note that these are assumptions about competitor costs that were unthinkable only 18 months ago. 

The cheapest of the competitors (say YingLi) will be below 75c/watt by Q4 – but it is unlikely the average Chinese manufacturer can get to that target.  As for the poly price I think it will be below $40/kg – but it is not there yet.  That said – it is obvious that they need to deal with competitors with much lower cost structures than previously.  The first part of my thesis is not broken. 

Part C: The company has an aggressive plan (“the roadmap”) for reducing their costs per watt by the end of 2014.  This plan was illustrated in the following (not to scale) picture:

 

Note – the vast bulk of the cost-saving (18-25 percent) was to come from “efficiency”.  Well the conversion efficiency of the cells remained unchanged at 11.1 percent (see p.28 of the results presentation).  They need – as my last post explained – to improve the conversion efficiency by approximately 15bps per quarter over four years to meet their target.  They are behind schedule.

The company states its cost per watt each quarter.  Usually they cite “core costs” (that is not including “stock compensation” and “ramp up penalty”).  Those costs were stable at 80c/watt.  This quarter they cited “total costs” in the conference call as those dropped 3c/watt to 81c/watt. 

They can’t meet their targets by dropping non-core costs to zero – they have to improve their core costs – and the main way that they plan to do that is via increasing conversion efficiency – and they are not on target.  The third part of my thesis is thus not broken.

The problem part of my thesis

The problem part of my thesis is pricing.  And boy is that broken. 

In the fourth quarter of 2009 – a quarter that disappointed – First Solar had operating profit of roughly 145 million and production of 311 MW.  Some of the profit is for their development business – but – at a first approximation it is reasonable to think of this as operating profit of 47c/watt.

In the first quarter they had operating profit of 191 million and (nicely increased) production of 322 MW.  This is – at a first cut – operating profit of 59c/watt. 

Now operating costs per watt only changed 3c/watt (and all of that was “non core”).  Operating profit changed 12c/watt.  The company shot-the-lights out on price received.

Unless there is something peculiar about First Solar this will probably apply to every solar producer – including the marginal Chinese.  But whatever – competition has not driven down prices at least yet. 

Competition and prices

It is a core part of my world view that competition tends to squeeze margins – but it has not happened here.  There are short-term reasons that are easily identified.  The most obvious is that Germany has a concessionary feed-in-tariff regime which will be adjusted (down) from the end of June.  There is massive demand in Germany for panels to be installed by the end of the second quarter.  First Solar is sold out. 

That sort of demand pressure (sudden, urgent) is enough to delay what (I hope) is the inevitable reduction of prices to reflect lower Chinese costs. 

However whilst it is part of my world-view that competition tends to squeeze margins it is not universal.  Some things just don’t have much competition – I never notice margin squeeze at Microsoft.  Also some things that are ostensibly competitive (beverages) seem to maintain fat margins for very long times (for example Coca Cola).   I don’t see any particular reason why the third part of my thesis won’t be right eventually but I am open to persuasion otherwise. 

The prices received

I said I would get back to the mathematics of the guidance – in particular the comment that: the low end of guidance has resilience to $40/kg poly and c-Si processing cost of 75c/watt by Q4 for non captive demand.

Now c-Si cells use about 6.5 grams of poly per watt (a number that is reducing).  This means that the guidance is resilient until the c-Si makers have costs of (75c plus 0.0065*40c)/watt = $1.01 per watt.

Now c-Si cells should (and do) sell for more per watt than other cells (such as amorphous silicon) because c-Si cells are cheaper to install due their higher efficiency.   I thought that difference should be about 15c/watt – but I have seen numbers as low as 9c/watt and as high as 30c/watt.  The usually accepted number is about 25c/watt – but – to make the case as favorable to FSLR as possible I will chose a low (10c/watt) penalty. 

If we get to prices being set by C-Si costs at $1.01/watt (plus say 8c/watt profit for the Chinese producers) then we should get to 99c/watt (including profit) for FSLR.  FSLR’s costs are at 80c (core costs) and for the moment look pinned.  This implies margin at FSLR at 18c.  This could be higher if FSLR reduces costs – but is unlikely to be dramatically higher.

FSLR’s margin in the first quarter was 59c/watt.  Bluntly – if the Chinese get to the costs on which the FSLR’s guidance is based then FSLR’s profit crashes if FSLR has to match the Chinese prices. 

It would be hard to see how FSLR can maintain its guidance under these conditions.  Except that FSLR gives us an out – they say that they are resilient “for the non-captive demand”.  FSLR can maintain higher selling prices because it has “captive demand”.

FSLR has captive demand because it is also a project developer and it purchased another project developer (Next Light Renewable Power) very recently. 

The question is – is it sustainable to be selling to internal or captive power developers at prices substantially above Chinese costs?  Obviously it is in the short term because the solar panel market is “sold out”.  It is not so obvious in the long term.

In the long term either (a) the prices at which First Solar sells to “captive demand” has to match the Chinese prices or (b) First Solar is investing its balance sheet in high cost (and hence uncompetitive) captive projects. 

Obviously this can continue for a while – whilst prices remain high for solar panels.  But I think it will end – and FSLR’s earnings will crash when it ends.  I think Part B of my thesis is only temporarily wrong.  So I will (subject to risk management) keep my position. 

The market of course has a different view – and that difference is painful.  Having a short go up almost 20 percent on a result is – to put it mildly – unpleasant. 

 

 

 

John

 

*The no-broken thesis rule was detailed in David Einhorn’s book on Allied Capital.  Its funny but in a book about a more-than-average difficult short the thing I most benefited on was some (very) wise words on portfolio management.   

The arithmetic of bank solvency – part 1

This is a post driven by Krugman’s many debates on  bank profitability.  In particular, a post from Krugman – about why banks are suddenly profitable – and the debates it engendered amongst my friends is the origin of this post.  Long-time readers of my blog will know I have explored these ideas before.

First observation: at zero interest rates almost any bank can recapitalize and become solvent if it has enough time. 

Imagine a bank which has 100 in assets and 90 in liabilities.  Shareholder equity is 10. The only problem with this bank is that 30 percent of its assets are actually worthless and will never yield a penny.  [This is considerably worse than any major US bank got or for that matter any major Japanese bank in their crisis.]

Now what the bank really has is 70 in assets, 90 in liabilities and a shareholder deficit of 20.  However that is not what is shown in their accounts – they are playing the game of “extend and pretend”.

Now suppose the cost of borrowing is 0 percent and the yield on the assets is 2 percent.  [We will ignore operating costs here though we could reintroduce them and make the spread wider.]

This bank will earn 1.4 in interest (2 percent of 70) and pay 0 in funding cost (0 percent of 90).  It will be cash-flow-positive to the tune of 1.4 per annum and in will slowly recapitalize.  Moreover provided it can maintain even the existing level of funding it will be cash-flow-positive and will have no liquidity event.  (It does however need to be protected from runs by a credible government guarantee.)

Now lets put the same bank in a high interest rate environment.  Assume funding costs are 10 percent and loans yield 12 percent.

In this case the bank earns 8.4 per year in interest (12 percent of 70) and pays 9 per year in funding (10 percent of 90).  The same bank with the same spread is cash flow negative.  

This is an important observation – because – absent another wave of credit losses – a marginally insolvent bank with a government guarantee will certainly recapitalize over time provided its funding costs are pinned somewhere near zero.  The pinning of the funding costs near zero is not a subsidy (except in-as-much-as the government guarantee is a subsidy).  Both these banks have the same spread and have the same profitability.  The answer depends criticially on whether you can pin the funding to a low interest rate. 

Banks and sovereign solvency

All banks more or less anywhere get their finances entwined with the finances of the sovereign.  No sovereign will (or in my opinion should) allow a mass run on banks but they can only stop such a run if their own credit is good.  But this link between sovereign solvency and bank-system solvency means that bank funding costs at a minimum are bounded at the lower end by sovereign borrowing costs.

It was pretty clear in the crisis where the US Sovereign borrowing costs were pinned.  I barely cared whether BofA was solvent when I purchased it (but I was pretty sure it was).  I cared that the US government was going to pin its funding costs.  Buying BofA at low single digits was – in the end – a bet on US Government solvency.

On the same token Spanish banks may go the way of Greek banks.  They can’t control their funding costs because the Spanish sovereign cannot control their funding costs.  The idea that European sovereigns can default is now front-and-center.  And the Spanish banks can’t control that either.

Extend-and-pretend (what Felix Salmon crudely deigned to be the Hempton plan) worked well in America.  It won’t work in Spain because you can’t pin rates at zero even with a government guarantee.  The scale of financial restraint needed to solve this problem is enormous.  But the alternatives are worse.

 

 

 

John

Quote of the day: Bess Levin on the Goldman hearings…

Bess Levin is truly wonderful:

Apparently Goldman didn’t just hurt its clients, it hurt everyone in the world. Take a moment right now to show us on the doll where Goldman touched you.

Was Sheila Bair reckless and irresponsible? I report – you decide

Here is an email exchange between government officials leading up to the confiscation of Washington Mutual – courtesy Deal Breaker.

 

“I cannot believe the continuing audacity of this woman.” – Email from OTS Executive Director John Reich to OTS senior official Scott Polakoff (referring to FDIC Chair Sheila Bair), 9/10108, Polakoff

—– Original Message —–
From: “”Bair, Sheila C.”" [SBair@FDIC.gov]
Sent: 08/06/200805:46 PM AST
To: Donald Kohn
Subject: Fw: W

This is pretty over the top

—–Original Message—–
From: Reich, John M
To: Bair, Sheila C.
Sent: Wed Aug 06 17:32:482008
Subject: Re: W

Dear Sheila, You really know how to stir up a colleague’s vacation.

I do not under any circumstances want to discuss this on Friday’s conference call, in which I mayor may not be able to participate, depending on cell phone service availability on the cruise ship location.

Instead, I want to have a one on one meeting with Ben Bernanke prior to any such discussion – as early next week as possible following my return to the office. Also, I may or may not choose to have a similar meeting with Secretary Paulson.

I should not have to remind you the FDIC has no role until the PFR (i.e. the OTS) rules on solvency and the PFR utilizes PCA.

You personally, and the FDIC as an agency, would likely create added instability if you pursue what I strongly believe would be a precipitous and unprecedented action. And ifit occurs without my consent, I will not sit quietly by and observe – there would be a public reaction. Put yourself in the PFR’s shoes in this situation. We have our responsibilities, including the right of primary supervisory determination of this institution’s condition, and until Congress changes the statutes under which we operate, our responsibilities as the PFR are not to be simply tendered to the FDIC in a down economic cycle.

It seems as though the FDIC is behaving as some sort of super-regulator – which you
and it are not. I also believe there could be a high potential for FDIC actions of the type you are contemplating to calIse irreparable harm to Wamu if, at any point in the near future, Wamu wishes to actualy seek a buyer. The potential harm could stem from the fact that any such potential buyer may have been allready been contacted by the FDIC.
If in fact any meetings or discussions have already taken place by the FDIC with either JPMC, Wells Fargo, or any other entity, in any capacity in which WaMu was even mentioned, I would like to see a copy of the signed confidentiality agreement signed by the bank – required in any resolution scenario before an institution is told the name of the failing bank.

This is an OTS regulated institution, not an FDIC regulated institution. We make any decision on solvency, not the FDIC, and I have staff equally as competent as staff at the FDIC, whom I know well.

The FDIC can do whatever internal contingency planning it wishes, but should in no way go outside the FDIC. This is a 3-rated institution. Are you also trying to find buyers for Citi, Wachovia, Nat City and others?

Finally, ifWamu were to learn ofthe FDIC’s actions, there may well be a question as to whether these actions may constitute a disclosable event. That, in and of itself, is a reason not to proceed with this approach for a publicly traded institution. The government should not be in the business of arranging mergers – particularly before they are necessary, and we are not at that point in WaMu’s situation.

I will attempt to be on the Friday conference call, and I am going to assume this notion is not going to be raised.

John

—– Original Message —–
From: Bair, Sheila C.
To: Reich, John M Cc: Murton, Arthur J. ; Polakoff, Scott M
Sent: Wed Aug
Subject: W

Dear John,

I’d like to further discuss contingency planning for W during the calion Friday. Art talked with Scott about making some discrete inquiries to determine whether there are institutions which would be willing to acquire it on a whole bank basis if we had to do an emergency closing, and on what terms. I understand you have strong objections to our doing so, so I’d like to talk this through. My interest is in assuring that IF we have to market it on an emergency basis, there is multiple bidder interest.
In any event, both the FDIC and the FRB agree that there needs to be a contingency plan in place, so let’s talk this through on Friday. I’d really like to develop a plan everyone is comfortable with.

Sheila

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).

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

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…

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…

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.

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:

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.

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.

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