LDK Solar: 50% Markdown Appears Excessive

Solar energy has been an attractive area for 2007 with many new companies entering the playing field, and many more established companies listing on US exchanges. While governments have subsidized the advancement in technology and provided incentives for solar energy producers and consumers alike, shortages have arisen in raw materials necessary to make the panels that harvest the sun’s rays.

LDK Solar (LDK), along with nearly every one of its competitors, has experienced difficulty in securing enough polysilicon to keep up with demand for the wafers it produces. Management finally threw up its hands and decided to produce its own polysilicon. This is no small decision as the investment to enter into polysilicon production is estimated at $1.2 billion dollars. Fortunately, the company has a healthy balance sheet and strong free cash flow to fund the expansion.

In order to build the production facility, the company needs to have access to four important resources.

• The facility needs to sit on roughly 13,000 acres of land
• LDK must have access to critical technology
• There are substantial equipment commitments
• The entire facility must have access to a major power plant

LDK appears to have found the necessary ingredients and construction is currently underway. Management has stated that they expect to start polysilicon production in Q3 of 2008 and ramp the production up sharply in 2009. Analysts are very skeptical with the production levels management offered, but the same analysts are quick to point out that even without the polysilicon production, the company is profitable and growing through its wafer production business.

One of the reasons the wafer production business is so strong is because of the companies ability to use recycled silicon as an ingredient. The company claims to only use 25% “virgin” silicon with the remainder made up from recycled material which is much cheaper. This allows the company to product the product at lower costs (30c per watt versus 43c for the industry). In turn, margins are much higher than competitors offering investors a better return on capital.

With all the optimism surrounding the ramp in business, there is also a large cloud hanging over the stock. In early October, the financial controller resigned after submitting allegations of poor financial controls to management, the SEC, and to the company’s auditors. The issue in question is whether inventory levels stated on the balance sheet are accurate. As the company holds and accounts for its levels of recycled silicon for production, there is question as to whether the majority of this silicon is actually usable. If it is not, the company would have to take a write down for the impaired value of the assets, and could be subject to fines and penalties if it is found that the company tried to cover up the issue.

With the bad news on the table, the stock dropped nearly 50% from its peak. It seems that investors should have placed a lower value on the company given the uncertainty, but a 50% mark down appears to be a bit excessive. With a future that still includes growth and expansion, and a management that is taking steps to review and correct the problem, one might expect to find value in the depressed level of the stock. While I don’t currently have a position in LDK, I am watching closely to see if the stock has stabilized and will likely work my way into a long position shortly.

Disclosure: Author does not have a position in LDK

Comments

[Michael Sha...:]

growthandvaluetrader.b.../

2007 Oct 24 12:43 PM

[Michael Sha...:]

growthandvaluetrader.b.../

2007 Oct 24 12:43 PM

[archer_id:]

According to SEC documents filed by LDK, they have about 7% virgin polysilicon. They may have a short term inventory problem which can hinder their production. Long term, they will build a facility that eliminates that problem just in time for an industry oversupply of polysilicon according to at least one analyst.

2007 Oct 24 10:27 PM