Yingli Dismantling Its Vertical Integration

| About: Yingli Green (YGE)

On March 20, Yingli (NYSE:YGE) announced that the company had entered into a non-binding strategic cooperation framework agreement with GCL-Poly Energy which is a polysilicon and wafer supplier listed in Hong Kong. GCL-Poly is also a coal-fired and solar photovoltaic (PV) power plant investor and operator. Though agreement details were not disclosed, YGE would purchase polysilicon material and wafer from GCL-Poly that would, in turn, buy modules from YGE for PV power projects. This is said to leverage advantages in the whole PV value chain for both parties, but it is more important for YGE to move away from its vertical integration strategy and to seek partnerships for product manufacturing cost down with no quality compromise. YGE is a believer of the PV vertical integration business model especially when polysilicon is priced at high level. YGE is ambitious of capacity expansion and able to manage the whole PV value chain in terms of PV product pricing, cost control and project development in China. Under the circumstance of PV market demand/supply imbalance and consolidation, the weaknesses of vertical integration such as cost down constraints and process inefficiency are emerging. It is insightful for YGE to unfasten its supply chain and partner with top players at each PV segment to profitably achieve a 3.2GW shipment goal this year.

YGE is a perfect PV vertical integrator

From its inception, YGE has set up and expanded in-house manufacturing capacity from ingot to module at the same proportion. Each of YGE's manufacturing bases covers the vertically integrated value chain from ingot casting to module assembly, which benefits YGE cost effectiveness in terms of intermediate product transportation and manufacturing process optimization as a whole. From 2009 to 2012, YGE's ingot, wafer, cell and module capacities are expanded from 600MW to 2450MW each, as shown below.

In the ages of polysilicon shortage, YGE had a plan of 18K MT polysilicon facility build-up, and commercially launched Fine Silicon with 3000MT production capacity as phase I of the whole plan in 2010. This made YGE a true vertically integrated PV conglomerate that enjoyed more margins from upstream. In the following years with the sharp polysilicon price drop and Fine Silicon's production cost above US$30/kg, YGE wrote down US$361 million on Fine Silicon asset and almost gave it up by the end of 2011. Fine Silicon is the first lesson YGE learned that vertical integration might not mean more margins.

Low in-house manufacturing cost?

YGE really took in-house low cost manufacturing advantages before 2011. But since then, with the PV industry maturity and consolidation, large specialized enterprises throughout the PV value chain like GCL-Poly show economies of scale and are more competitive in terms of technology and cost. GCL-Poly has ramped up its annual production capacity of polysilicon to 65,000MT and wafer to 8GW by the end of 2011. Its production cost of polysilicon is below US$20/kg, which is in line with other top polysilicon suppliers. The GCL-Poly wafer business is far ahead of its competitors by manufacturing cost and product efficiency. YGE has no in-house manufacturing cost advantage with GCL-Poly. If looking at module total cost (silicon and non-silicon) of YGE, Trina (NYSE:TSL) and Canadian Solar (NASDAQ:CSIQ) in the 4Q12 earning report, we could find that YGE has higher cost than that of TSL and CSIQ. See below.

Both TSL and CSIQ have already established the same kind of cooperation with GCL-Poly. Almost on the same day in January 2011, TSL signed a 5-year 7.5GW wafer and polysilicon supply contract while CSIQ did 5.2GW. TSL and CSIQ are also both tagged as vertically integrated and have enough in-house capacity then, but they start outsourcing GCL-Poly's wafer, which is lower in price and higher in efficiency.

Vertically integrated vs. specialized

Vertical integration is linked to each segment's operating income, cost and their relevance on the value chain. Generally, manufacturing margins are reduced from upstream to downstream or from the initial life cycle of a product or industry to late stage. Therefore, vertical integration strategies work right with appropriate consolidation degree and product lifecycle timing.

For the PV industry at this stage, a full vertically integrated manufacturer from ingot to module such as YGE has exhibited more disadvantages and is less competitive than specialized ones. From prospects of PV industry development in the near term, the vertically integrated enterprise will gradually begin to fail and increasingly focus on its core competence. So YGE is moving to the right direction and the partnership with GCL-Poly is the first step to get rid of its vertical integration.

Disclosure: I am long YGE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.