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I attended the German Equity Forum in Frankfurt on November 12 - 13, 2012. For the second year in a row, I met with Dieter Manz, Founder and CEO of Manz AG (MANZF.PK, or M5Z.DE, €16.06, $20.72). Dieter is a solar industry veteran. You may find his anecdotes in this article to be insightful and entertaining.

The solar bubble from 2005 - 2008 attracted too many potential suppliers. One such group was venture-backed US CIGS (Copper-Indium-Gallium-Diselenide) thin-film start-ups. Dieter referred to this group as the "50/70 guys" - 50% cheaper and 70% better was their typical pitch. Companies like Solyndra, with its complex tube-shaped module, or Miasolé, which had to incorporate costly stainless steel into its CIGS thin-film module, could maybe compete when crystalline silicon (c-Si) modules were $3 per watt a few years ago, but were priced out of the market as prices fell below $1 a year ago, and are currently at $0.66 per watt. Thus, it is not surprising that Solyndra went bankrupt last year, and Miasolé was sold at a fire-sale price of $30M (or 6 cents on the dollar for its investors) last month. Both Solyndra and Miasolé each attracted over $0.5B in capital. There were other thin-film off-shoots like amorphous silicon (a-Si) from Sharp (OTCPK:SHCAY) and Applied Materials (NASDAQ:AMAT), that although were cheap to produce, had such low energy conversion efficiencies (the percent of sunlight input that is converted into usable energy output) that their cost per watt was not competitive.

Not just CIGS but all photovoltaic vendors were impacted by the oversupply and subsequent price declines of traditional silicon modules. Three major Asian c-Si cell/module vendors - Suntech Power (NYSE:STP), JA Solar (NASDAQ:JASO) and Trina Solar (NYSE:TSL) - are currently losing money at the operating line, and are heavily indebted.

Cadmium-telluride (CdTe) thin-film producer First Solar (NASDAQ:FSLR) appears to be the only major photovoltaic module maker that will be profitable this year, aided by a leaner project-focused business model that limits losses. But First Solar's backlog has above-market ASPs, which is a temporary phenomenon. First Solar's current production cost of $0.67 per watt equals the ASP of its c-Si Asian brethren. First Solar does not foresee production costs falling below $0.60 for twelve more months, which for the first time places First Solar at a slightly higher production cost than its large Asian peers. Thus, while First Solar looks cheap at 6.9x 2013 EPS, longer-term EPS could face downward pressure as lower ASP projects replace the current overpriced backlog. Also, First Solar's 30% capacity reduction announced in April limits volume upside if the solar cycle rebounds. For First Solar to do well over the medium-term would require a rationalization of photovoltaic vendors, forcing pricing to actually move up. But the Chinese government continues to prop-up the industry, and the more money it sinks into these Chinese companies, the less likely they are to abandon the effort, despite the tariffs. See here for more color on First Solar and the solar industry.

How long will this oversupply situation last in the solar industry? The European Photovoltaic Industry Association predicts that global photovoltaic demand will increase from 30GW in 2011 to as high as 77GW in 2016. The problem is that global photovoltaic capacity peaked in 2011 at 70GW. While that capacity may slip to 60GW by the end of this year, that still creates a supply glut for a few more years. Some of the less efficient manufacturers will be replaced by lower-cost producers, but among photovoltaic vendors there will be more losers than winners on aggregate.

(click to enlarge)

Despite the current supply glut, this chart demonstrates the accelerating growth of photovoltaic energy. Even with the decrease in government subsidies in the past few years, demand has continued to grow. While 2013 is expected to have more moderate growth, sharply declining selling prices should lead to 20%+ annual increases in photovoltaic consumption over the next few years.

The ultimate winner in the solar manufacturing industry will be the low-cost producer on an energy per watt basis. Product differentiation and premium pricing are not prevalent in this commodity market. The keys are technology advances in conversion efficiencies and lowering production costs. Below is a simplified view of where cost per watt is heading for each photovoltaic segment:

Cost/Watt @ >1GW prod. today

Cost/Watt @ >1GW prod. 2015

Confidence to achieve 2015 target

Conv. Effic. today in vol. prod.

Inherent Production Cost

Market Share - proxy for econ of scale today

CIGS

NA

$0.28

medium

14%

cheap

3%

CdTe

$0.67

$0.50

high

12%

cheap

6%

a-Si

NA

NA

NA

10%

cheap

nominal

c-Si

$0.63

$0.55

high

18%

expensive

90%

CPV

NA

NA

NA

30%*

expensive

nominal

*CPV (concentrating photovoltaics) have highest conv. efficiency upside with 44% in lab experiments in 2012

Thin-film, and CIGS in particular, has the potential to become the low-cost, high-volume manufacturing solution. CIGS are inherently cheaper as they use much less material than bulky silicon. But one should not underestimate the tenacity of silicon (e.g. very-thin c-Si). The semiconductor industry serves as a reminder of how the massive global silicon ecosystem dominated gallium arsenide and other materials outside of a few niche markets. First Solar's high-volume manufacturing and simplified processes should serve as a model for CIGS which some of the 50/70 guys lost sight of.

The distress CIGS sales of MiaSolé and Solibro to China-based Hanergy, as well as HelioVolt to Korea-based SK Group, may indicate a changing of the guard. Thin-film solar requires massive capital investments to create a global ecosystem that contains a single, low-cost, non-proprietary process that all producers can benefit from, just like in the semiconductor industry. In retrospect, the Silicon Valley approach of several proprietary CIGS models did not work. Currently, only one CIGS company has established volume production, Japan-based Solar Frontier. None of the Silicon Valley CIGS that are left have been able to ramp up volumes.

The next generation of thin-film CIGS will come from Hanergy, SK Group, Samsung (OTC:SSNLF), and a few other major flat panel/glass producers, as well as Solar Frontier. These companies will invest a lot of money to establish high-volume manufacturing of large-area glass substrates, requiring precise process controls and subsequent high yields. In the end, there will only be room for a few large CIGS manufacturers who establish grand economies of scale.

The challenge with CIGS is to simplify a fairly complex chemical and production process while maximizing energy conversion efficiency. The two approaches are sputtering deposition and co-evaporation. Sputtering works in a solid phase, and has the advantage of highly precise layering of materials. Co-evaporation works in a gas phase, and has the advantage of being able to work with glass at higher temperatures, which leads to higher conversion efficiencies. Working with multiple materials simultaneously at temperatures as high as 1600 degrees centigrade is challenging. But if these issues can be overcome, co-evaporated-manufactured CIGS would be a real game-changer. It is this process on a float glass production line that would yield a cost of only $0.28 per watt.

Concentrating photovoltaics also has interesting potential. In CPV, a large area of sunlight is focused onto a solar cell with the help of optical lenses. Concentrating sunlight onto a small area has two inherent advantages - higher conversion efficiencies with the help of multi-junction solar cells, and less photovoltaic materials to capture the same amount of sunlight as non-concentrating photovoltaics. Concentrating light, however, requires direct sunlight, limiting CPV to sunny, arid locations. Also, there are additional cost constraints of sun-tracking equipment, more expensive multi-junction solar cells, and higher maintenance/lifetime issues. Nonetheless, CPV could be a compelling solution in sunny, arid climates for larger energy grids, which is still a substantial opportunity. Major CPV suppliers include SolFocus, Amonix, Soitec (SOI.PA), and Emcore (NASDAQ:EMKR).

However, if I was to highlight one company with the most substantial long-term upside in the photovoltaic industry, it would be Manz. Based in Germany, Manz AG creates integrated manufacturing lines, serving display (64% of Jan-Sep 2012 revenues), solar (10%), battery (4%), printed-circuit-boards (13%), and other industries (9%). Manz core competencies in robotics/automation, metrology, wet chemistry, vacuum coating, laser processing, and printing are combined into integrated turnkey manufacturing solutions for its customers. For the full 2012 year, total revenues should reach about €190M ($245M), EBITDA of €12M ($15M), and an expected net loss of -€8M (-$10M).

Manz had net debt of €45M ($58M) as of September 2012. Interest coverage is fine at 7x, but total debt is 3x EBITDA, which is uncomfortably high.

A few years ago, the bulk of Manz revenues came from solar energy production lines before that industry's devastating cyclical downturn. But solar revenues declined 74% so far in 2012, and were nearly non-existent in Q3. In order to survive, Manz has diversified away from solar. Manz has transferred its knowhow from c-Si cells to smart phone, tablet and display production for companies like Apple (NASDAQ:AAPL). Manz and Trumpf GmbH have a fast-growing laser cutting tool for small sapphire wafers that protect the underlying CMOS image sensor (camera) on mobile phones. While display revenues were a bit soft in Q3, Manz received a €21M ($27M) display order in early November that will support 2013 revenues. Manz lithium-ion battery revenues should grow substantially, albeit from a small base, given a large order backlog and demand from customers like Daimler Benz (OTCPK:DDAIF). 2013 could see an uptick in revenues to about €250M ($323M), EBITDA of €28M ($36M), and net income of €3.5M or €0.78 per share ($4.5M or $1.01 per share). Visibility on these estimates, however, is limited.

Manz has a current market value of €72M ($93M) and enterprise value of €119M ($153M). Based on 2013 estimates, EV/Revenues are 0.5x, EV/EBITDA is 4.2x, and P/E is 20.6x. While this appears cheap, it is in line with depressed equipment supplier peer valuations. Similar to Manz, most peers are expected to bottom-out in 2012 with heavy losses, with an uncertain recovery starting in 2013.

Company ($,M)

Ticker/ Price

MV/ EV

Revs 2013e

EBITDA 2013e

EPS 2013e

EV/ Revs

EV/ EBITDA

P/E

First Solar

FSLR/ $24.27

2,130/ 1,943

3,700

640

3.50

0.5x

3.0x

6.9x

Suntech Power

STP/ $0.81

146/ 1,943

2,030

-5

-1.50

1.0x

NA

NA

JA Solar

JASO/ $0.61

123/ 600

1,220

40

-0.67

0.5x

15.0x

NA

Trina Solar

TSL/ $2.35

191/ 801

1,270

-38

-2.40

0.6x

NA

NA

Solar Group

0.65x

9.0x

NA

Rofin-Sinar

RSTI/ $19.60

560/ 481

559

73

1.42

0.9x

6.6x

13.8x

Centro-therm*

CPHVF/ €0.707 ($0.91)

19/ 76

384

-77

-3.62

0.2X

NA

NA

Singulus*

SGTSF/ €1.085 ($1.40)

68/ 73

177

12

0.026

0.4x

6.3x

54.3x

Meyer Burger*

MYBUF/

CHF6.00 ($5.58)

268/ 186

588

56

-0.40

0.3x

3.3x

NA

Manz Peer Grp

0.45x

5.4x

34.0x

Manz*

MANZF/ €16.06 ($20.72)

93/ 153

320

36

1.01

0.5x

4.2x

20.6x

*primary tickers - Centrotherm: CTN.DE, Singulus: SNG.DE, Meyer Burger: MBTN.SW, Manz: M5Z.DE. US investors interested in these Germany-listed shares can access them through almost any major US retail broker such as Charles Schwab as they all provide access to locally-traded foreign shares. We recommend purchasing the local shares versus their less-liquid US OTC counterparts.

So why is Manz interesting? Manz is the sole supplier of turnkey co-evaporation CIGS production lines, which includes sputtering for contact layers. Veeco (NASDAQ:VECO) was a direct competitor before exiting the industry. Centrotherm provides a turnkey sputtering CIGS solution. Singulus is a single-equipment sputtering CIGS vendor. Meyer Burger works mainly on c-Si production lines. While there may be some small single-equipment co-evaporation competitors, Japan-based Ulvac (OTC:ULVAF) is the only large single-equipment co-evaporation vendor. Manz has the only CIGS volume manufacturer - Solar Frontier - as a reference customer.

One issue is that these $0.28 cost per watt CIGS facilities require huge 4-5GW manufacturing plants. It will take extra time for solar energy conditions to improve in order to justify such a large capital expenditure. Another issue is that historically, large photovoltaic manufacturers preferred a best-of-breed approach from various single-equipment vendors. Dieter countered that co-evaporation is highly complex, and integration is not easy; he added "you can have all the ingredients, but you still have to know how to cook the food". So, in a rosy scenario, Manz can have the same exponential revenue and stock boost that Aixtron (NASDAQ:AIXG) experienced in 2009-2010 with a similar integrator business model. Like Aixtron, Manz stock corrected sharply over the past 18 months due to the same general industry malaise.

This potential photovoltaic nirvana is a few years away. In the interim, Manz had the wherewithal to transfer 90% of its revenues into some fast-growing non-solar areas, while still preparing for its bigger CIGS initiative with the acquisition of Würth Solar's CIGS production technology in 2010. But in the words of Tom Petty - "the waiting is the hardest part".

Source: Solar Industry Overview: Manz - Large Upside Potential