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Investors in First Solar (NASDAQ:FSLR) keep getting more bad news. The recent earn­ings report was dis­ap­point­ing and pend­ing changes in Ger­man sub­si­dies will make that a dif­fi­cult mar­ket for a long time.

First Solar is now in a tran­si­tion from subsidy-driven growth to a more sus­tain­able value propo­si­tion in sun­nier cli­mates and more rapidly grow­ing economies. This tran­si­tion is going to be expen­sive and take time. Mea­sur­ing investor patience won't be easy. Although solar cell effi­ciency has a long way to go, First Solar remains at the fore­front of what is pos­si­ble (14.5%) using production-scale technologies.

Part of what is tan­ta­liz­ing about solar tech­nol­ogy is the poten­tial for an effect like Moore's Law to begin to accel­er­ate improve­ments in per­for­mance. At this point it's a fan­tasy but there have been some encour­ag­ing expe­ri­ence and sci­ence that sug­gests the cur­rent tech­nol­ogy could be at least 5x more effi­cient in the very long term. That would result in a rather dis­rup­tive 15 entc man­u­fac­tur­ing cost per watt. As it stands now FSLR sees 50 cent cost per watt in their cur­rent 3-year plan which is a mate­r­ial advance.

Gross mar­gins at the com­pany are also suf­fer­ing more than nor­mal due to higher war­ranty costs that will even­tu­ally be worked out, cre­at­ing an oppor­tu­nity for expand­ing gross and net mar­gins that investors will appreciate.

First Solar's mar­ket advan­tage is build­ing large scale sys­tems which util­i­ties demand for solar to "make a dent" in energy sup­ply. We won't go through all the obvi­ous advan­tages of solar for many use cases but they are sub­stan­tial and lower pre­vail­ing costs will con­tinue to drive adop­tion and ROI for mul­ti­ple play­ers in the market.

The revised First Solar strat­egy will take years to play out and investors will focus more on the risks to near-term rev­enues and prof­its rather than the ulti­mate achieve­ment of large unsub­si­dized instal­la­tions in growth economies.

What we like about the cur­rent turmoil:

1. Man­age­ment isn't whistling past the grave­yard like some other pre­vi­ous mar­ket lead­ers (Research in Motion (RIMM) and Nokia (NYSE:NOK) come to mind!)

2. The com­pany will con­tinue to grow and gen­er­ate sub­stan­tial earn­ings and cash flow dur­ing this dif­fi­cult period.

3. Ulti­mately costs and effi­ciency could cre­ate a sus­tain­able growth busi­ness with­out the depen­dence on subsidies.

4. It appears that other large play­ers are scal­ing back invest­ments and their aspi­ra­tions in the solar mar­ket. This would help restore a healthy supply/demand balance.

5. The val­u­a­tion is low. Our IV sug­gests a $90 stock price on an 8x P/E. FSLR doesn't pay a div­i­dend now but we could see it hap­pen­ing dur­ing our invest­ment horizon.

What we don't like:

1. The shares could be "dead money" or worse for most of 2012. The stock may be pres­sured by con­tin­u­ing news about reduced sub­sides and fund­ing chal­lenges for planned projects.

2. New CEO could be a pos­i­tive or neg­a­tive cat­a­lyst. We don't know who it will be but in the past peo­ple with great resumes have been dis­ap­point­ing. Will they be a level-5 leader or a dud?

3. Cut­backs in R&D and alter­na­tive tech­nolo­gies could jeop­ar­dize the tech­nol­ogy lead­er­ship that First Solar enjoys. They still have sub­stan­tial resources to buy com­pa­nies that show promise but at 15% effi­ciency there is lots of room for improvement.

4. The mar­ket reminds one too much of the DRAM mar­ket. The "gorilla" back in the 1990's was Micron (NASDAQ:MU) which had a mas­sive run based on favor­able indus­try con­di­tions that not only didn't last but never returned thanks to com­pe­ti­tion and the com­mod­ity nature of memory.

5. Esti­mates still seem high. The rela­tion­ship between reduced or elim­i­nated sub­si­dies and cur­rent esti­mates is not clear. For exam­ple the ramp down on sub­si­dized might be steeper than what ana­lysts expect and the uptake of new non-subsidized busi­ness might take longer.

Some wild­cards:

1. Energy prices are volatile. Higher oil prices and increas­ing envi­ron­men­tal costs for coal drive demand for alter­na­tives like solar.

2. FSLR is a fairly heav­ily shorted stock (14m short now out of 86m out) and there remains a con­tin­gent of "cloak and dag­ger" mar­ket play­ers around the name.

3. Alter­na­tive energy, global warm­ing and tech­nol­ogy lead­er­ship are all polit­i­cal themes and this is an elec­tion year.

Con­clu­sion

On bal­ance the cur­rent stock price ver­sus our IV esti­mate tends to dom­i­nate the analy­sis. It doesn't mean that there isn't more poten­tial down­side in the stock if near-term chal­lenges inten­sify but it does sug­gest that quite a bit is already priced in.

The CEO appoint­ment is likely to be the next poten­tial pos­i­tive catalyst but comes wrapped in con­tin­u­ing bad news about Ger­man sub­si­dies and cur­rent project financ­ing risks.

Source: Finding A Bottom In First Solar