I must admit that I've never been a fan of SolarFun (SOLF). Good Energies, a Switzerland-based investor specializing in investments in the wind and solar segments, takes a different view. Good Energies has entered into an agreement to buy shares from SOLF's Chairman and other current shareholders to bring its stake in SOLF to 34.7% from 6.3%, making it the company's largest shareholder. The investment expands the relationship between Solarfun and Good Energies that began when Good Energies first invested in SOLF in 2006. The market loved the news: SOLF rocketed 27% in Tuesday's regular session, the day of the announcement. On Wednesday the shares traded higher in anticipation of the U.S. Congress approving an energy bill that is expected to be a big positive for renewable energy companies.
Why SOLF rallied on the news:
1) SOLF management will be beefed up: Given their solid track record, it would be fair to say that Good Energies' expertise will boost the efficiency of SOLF's management team. Good Energies is a member of the COFRA group and one of the largest investors in the renewable energy industry. Its globally invested portfolio has a market capitalisation of over €3 billion (value as per end of 2006).
2) Access to raw materials: Good Energies have reliable resources in the solar industry, and is likely to provide SOLF better access to raw material procurement. With the polysilicon shortage choking growth in the solar industry, this could provide SOLF with a competitive advantage.
But there's something fishy going on here, and it has already been picked up by the mainstream media (including his royal highness Jim Cramer): Insider selling is the first red flag. Why would an insider, in this case the company's Chairman, sell half the shares he owns? The Chairman's holdings are now at 16.1% from a prior stake of 32.2%, but so far SOLF has refused to say how much the shares were sold for.
To decide whether the market has overreacted to the news, we should look at the bigger picture: By investing in SOLF, Good Energies is betting on the downstream solar market. Essentially they are betting that the polysilicon shortage will ease sooner rather than later. At the start of the year Good Energy sold its sold its 34.4% holdings in REC (.pdf file), the world's No. 2 polysilicon maker, at well below market price, as they tried to move away from the upstream players.
Good Energy probably thinks the polysilicon shortage will end in 2008 (this seems to be the market consensus), which will lead to increased margin pressures for the upstream players, while downstream players like SOLF are expected to maintain margins. Investors are acting as if SOLF is going to take over the world tomorrow, but it will take a few years for Good Energy's investment to improve SOLF's execution. The market seems to have forgotten about the risks faced by SOLF in the coming months, and by "risks" I mean the ongoing polysilicon supply problem.
There are about 50 polysilicon plants waiting to be constructed worldwide, and they are all competing for financing. It has now become clear that tighter lending conditions will be the dominant feature of life after the credit crunch, and tighter lending will limit access to funds needed to expand polysilicon production. I believe that the credit crisis will extend the polysilicon shortage, and downstream players like SOLF will continue to struggle in the months ahead.
Many feel that solar will ultimately be based in China for all the same reasons that cellphones and computers are made there. Too many cooks spoil the broth and, with all of these Chinese solar companies coming to the market, I can't help wondering if this is the beginning of margin compression in the solar industry. An optimist will tell you the glass is half-full. The pessimist, half-empty. But maybe the glass (in this case the overcrowded Chinese solar space) is twice the size it needs to be.