Balance Sheet Wars: U.S. Solar Companies vs. Chinese Government

by: Financial Hippie

We all know the foot race that is going on in the solar industry - companies are trying to achieve the lowest per megawatt cost for an installed system. Until the next leapfrogging technology comes along, the most important factor to drive down cost is scale*. Here is where the US solar companies will have serious problems competing against the Chinese solar companies because the US solar companies lack cheap, indiscriminate access to capital like their Chinese cohorts.

Let's take First Solar (NASDAQ:FSLR) for example. FSLR is funded by private money. Even though the US government is offering tax incentives for installing solar projects, they are not however involved in the funding of the company in any way. Why would they? FSLR has one plant in the US, the rest of the plants are mostly in "low cost locations" - ie. Malaysia. Have you ever heard of the "United Solar Workers"? I would guess a few hundred out of the 3,500 FSLR employees are Americans. My point is... if they closed shop tomorrow, there will be plenty of companies to fill the supply void. I wonder if the Malaysian government has the capacity or the desire to step up and lend.

The Chinese solar manufacturers are a different story. Remember, the number one goal of the Chinese government is to maintain social stability. Suntech Power (NYSE:STP) employs close to 10k employees by itself, and these are "high quality" jobs that are looked upon favorably by the Chinese Government. If I include all of STP's peers in China, their upstream suppliers such as LDK Solar (NYSE:LDK) and the downstream system installers, I would guess the Chinese solar industry employs probably a few hundred thousand people throughout the value chain.

Now let's look at the banking relationships. Many of these loans are unsecured and covenant lite and represent roughly on average 25% of total capital. Top 3 Chinese solar related company by market capitalization and their respective government backers are:

  • Suntech Power (STP): China Construction Bank, Bank of Communication.
  • Yingli Green Energy (NYSE:YGE): Export-Import Bank of China, China Development Bank
  • LDK Solar (LDK): China Construction Bank, China Development Bank, Bank of China, Agricultural Bank of China, Export-Import Bank of China. (wow, so many backers, this company really needs help)

I'm not going to bore you with the detailed capital expenditures budget and liquidity position for each US and Chinese solar company. But in times like these, where both US and Chinese solar companies are using their own money to set up an off-balance sheet entity to buy their own products to show "earnings" (A recent Barron's article alluded to Enron, but I think it's more like Boston Chicken), who do you think is going to win that battle? Especially when the Chinese government can, just like recently, press "the lend button" indiscriminately with little regards to the creditworthiness or the investment merit of these projects?

If scale is the most important deciding factor of cost reduction in the long run... until a new breakthrough comes along, how are US solar companies supposed to compete with their Chinese counterparts when they don't have access to cheap capital? I believe they must come up with a breakthrough in technology. I'm confident the US will be at the forefront of that leapfrogging breakthrough, but I'm not sure if the current publicly traded US names will be the companies to provide it.

* Study done by Gregory Nemet at the University of Wisconsin - Madison. On page 15 of the document, Nemet breaks down the drivers of cost reduction very nicely for us.

Click here for slides

First Solar investor day from earlier this year - the "Cost Reduction Roadmap" slides. As you can see, First Solar will want you to believe "efficiency" or their continuing technology innovation will be the leading factor for cost reduction. I'm not saying it isn't an important factor, but if you add up the rest of the "Plant size" related items, "Low cost location" and "throughput", you would come up with 22-24% or a 1.35 : 1 ratio of plant size to efficiency (23% / 17%), roughly inline with Nemet's research of 1.4 : 1 (43% / 30%). Plant size is still the biggest factor.

Disclosure: Short FSLR