Late last week, First Solar (FSLR) announced it would seek the sale and financing of its Topaz Solar Farm project due to the project’s inability to meet the Department of Energy's September 30 deadline for a $1.93 billion federal loan guarantee.
This announcement came two days after defunct Solyndra’s executives invoked their Fifth Amendment rights when summoned to testify before Congress. Solyndra’s recent bankruptcy clearly gave the US Government 535 million reasons to proceed with caution on current loan guarantee programs still pending. While all projects within the DOE’s Loan Guarantee Program should be properly vetted, the US could be compounding its mistakes by not proceeding with projects that do make economic sense.
Obviously the DOE’s endorsement of Solyndra with a $535 million federal loan guarantee in 2009 was a mistake. What is obvious now would have been obvious two years ago if proper due diligence was done. Since Solyndra was a private company, it was much harder for outsiders to get a full and accurate assessment on the company’s viability. However, even limited information disclosed in its 2009 SEC prospectus filing should have been enough to give investors reasons to stay away. Wall Street tried to pitch the company and with its failed IPO, it was apparent investors wanted no part of Solyndra. The US government should have done the same under the assumption it had even greater access to Solyndra’s financials than the general public.
In a financial sense, Solyndra was a mess. According to its IPO prospectus, the company had never turned a profit, and at the end of the third quarter of 2009 had accumulated a deficit of $505 million. In contrast, the majority of solar companies listed on US exchanges made money. First Solar’s retained earnings at the end of fiscal 2009 was slightly over $1 billion, while the two most profitable US-listed Chinese solar companies, Suntech Power (STP) and Trina Solar (TSL), posted retained earnings of $417 million and $208 million, respectively, at the end of the same period. Solyndra had already dug itself a huge hole before the company began wider-scale operations.
In one sense, a potential reason Solyndra never scaled linear to the solar industry's boom period in the past half-decade was because of the high unit cost for its solar modules. Since the company began collecting revenues for its products, it sold at negative gross margin. For the first nine months of 2009, Solyndra posted a staggering negative 45.7% gross margin. Quite simply, the more solar modules it sold, the more money the company lost.
Despite much higher module average selling prices of $3.42/watt during this period -- compared to FSLR, STP, and TSL, which posted module ASPs below $2.00/watt in 2009 -- Solyndra’s module unit cost was $6.3/watt. Regardless of whatever incremental advantages the company claimed, its CIGS-based modules possessed over FSLR’s CdTe or TSL’s silicon-based technology, Solyndra’s modules cost over 5 times as much to produce.
Unlike many similarly high-production-cost peers, Solyndra’s prospectus never gave indications regarding how low its technology could reduce unit cost under higher scale. Despite its recent bankruptcy, Evergreen Solar (ESLR) highlighted that its technology could reduce unit cost below $1.50/watt in the industry’s early years, when module ASPs were over $4.00/watt, which made its investment proposition quite attractive, at least on paper.
Unfortunately, accumulated debt (and more importantly, module ASPs dropping below ESLR’s production costs) ultimately doomed the company. Solyndra, in contrast, did not give any details on how or by how much it could reduce its cost of production. In an industry where demand is driven by pricing and profitability by costs, Solyndra appeared destined for failure.
The bigger question is how all of these figures escaped the DOE’s analysis. The loan guarantee was throwing good money after bad. Solyndra stated it would use the proceeds to expand production capacity. The problem, as indicated above, was that the company’s high production costs meant it would lose even more money as it produced and shipped more solar modules.
At least with the information presented in its IPO prospectus, the company presented no indications on how it could compete and become profitable in a very competitive industry. Either those at the DOE responsible for vetting Solyndra made a grave miscalculation, Solyndra misrepresented its competitiveness within the industry, and/or the system became corrupted to a point financial logic was dismissed. With its CEO and CFO both advised to plead the Fifth, the answers may not be revealed for some time.
First Solar is an entirely different story. It has been the most profitable photovoltaic module producer in the world, owed to its industry-leading low production cost. At the end of the second quarter of 2011, FSLR had accumulated earnings of $1.84 billion, or almost the federal loan guarantee amount for its Topaz project. More importantly, the company’s cost metrics vs. industry pricing implied it would continue making money for the foreseeable future. As arguably the most successful solar company in the world, and perhaps more meaningfully, a US company, First Solar should be an example the US government should proudly praise, not shy away from, as apparent in the recent headlines.
Of course, the loan guarantee for the Topaz project is not really an investment in First Solar. FSLR is only supplying the modules and fulfilling the engineering, procurement, and construction for the project. The project financing is really an investment in electricity generation, with the extra caveat of being additionally both clean and renewable. The solar farm’s peak 550MW generation capacity is estimated to produce 1,100GWh of electricity over a minimum 25-year period, for which PG&E announced a power purchase agreement. As long as the solar modules operated at specified levels, and as long as the sun shined at historical rates, Topaz would generate electricity, and thus revenues.
But was Topaz a good deal for investors? The economics depended on the project’s costs vs. the power generated. At 1,100GWh of power generation over 25 years, Topaz assumed to average roughly 2,000kwh of annual production per kilowatt of installed peak capacity. Thanks to the sunny Southern Californian climate, this translates to a capacity factor of about 23%, which is rather competitive with solar’s main renewable rival, wind power, which averages a 25-30% capacity factor. Over a 25-year period, each installed kilowatt would generate 50,000kwh of electricity.
Based on the data sheet provided on the Topaz project, the material cost for the 550MW solar farm would cost $1.2 billion, while another $400 million of initial construction and annual maintenance would add to this total. While not at the lowest installed cost witnessed in the industry, the estimated 2.9/watt installed cost is fairly competitive, especially relative to its location.
In this unlevered state, Topaz’s levelized cost of energy over its 25-year power purchase period would be an incredibly low $0.06/kwh, or roughly half the average electricity grid pricing in California. With a 6% discount rate, the cost with financing would slightly more than double, but would still remain within the average electricity rates, especially during peak hours. After all, one of solar power’s advantages is that it produces electricity during peak hours of the day, when consumption is highest. According to Sunpower (SPWRA), solar power, even using its relatively higher-cost system, was already cheaper than natural gas-powered generation during peak hours.
Thus from a purely financial standpoint, the Topaz project made sense. It made sense for investors who would either profit from the financing or the pricing difference between unlevered power generation costs vs. the price under PG&E’s power purchase agreement. In turn, it would also make sense for the DOE to support it. Unlike the Solyndra fiasco, where the US government was left to determine where all the money went, a default in Topaz project financing would provide valuable collateral which could continue to produce electricity (and thus revenues) during its existence.
This asset made losses, if any, extremely unlikely from an investment point of view. Of course, solar does not work everywhere, but in areas where sunshine is plentiful and electricity rates relatively high, the cost of solar power generation is already competitive -- at least at the grid level, if not vs. direct alternatives. The Topaz Solar Farm project is case in point.
The story behind the Topaz Solar Farm goes beyond a purely investment-grade standpoint. Unlike Solyndra, which had no conceivable ability of generating profits, First Solar is an American solar success story. While the company has plants in other parts of the world, it does manufacture in the US, and thus provides US manufacturing jobs. Additionally, any solar projects established in the US provides local EPC jobs in addition to upkeep employment during the lifetime of the solar farm.
Other financial benefits, as detailed by the company, include taxes which would be kept domestic and local. Quite simply, projects like Topaz should be examples the US relishes, especially given how large-scale Chinese competition, such as Suntech, Trina Solar, and Yingli Green Energy (YGE), have been running away with global market share. Hopefully the mistakes made with Solyndra can be realized quickly, such that its failure doesn’t inhibit future projects with higher odds of success. The US cannot afford to fall much further behind in the solar industry, which is still growing quite rapidly and has been extremely profitable for the industry’s most competitive companies.
Disclosure: I am long TSL, YGE. I have no position in FSLR, ESLR, SPWRA, or STP.
