First Solar: Large Intangible Assets and High PEs Go Together

Right before announcing Q4 2006 earnings of 7 cents First Solar (FSLR) had a market cap of $2.5 Billion. But how do you value a company with no earnings? The same way you value a company with earnings. Anyone who values companies based on earnings, assets, and growth alone is missing a large piece of the puzzle. Surely companies like Coca-Cola (KO), Nike (NKE), and McDonald's (MCD) didn't invest billions into advertising purely out of stupidity. Quite the contrary, they were investing in building a brand, yet another form of intangible asset. This intangible asset accounts for why you have to pay more for the six pack of Coke at Safeway than for the six pack of Safeway brand.

One might wonder, if First Solar's proprietary technology was worth only $2.5 Billion is Feb. 2007 why is it worth around $10 Billion now? This shows the speculative nature of intangible assets. When first solar was supposed to lose 7 cents in Q4 2006 and instead earned 7 cents, this was a sign of things to come. Speculators rightly bid the stock up over 30% the following day. Keep in mind that 7 cents a share is only a few million dollars, but it had a billion dollar effect on the stock.

It is true enough that high PE companies are unlikely to be able to sustain triple digit earnings growth for long. But as earnings growth shrinks higher absolute earnings also inflates the value of intangible assets. In other words, as the company delivers on it's promises the market revalues higher the value of it's technology.

Conversely, when a company misses on earnings it acts as a serious warnings much like brake lights on the freeway. When on the freeway you don't think, no big deal the brake lights represent a 1MPH slowing by the time I've processed the signal. Instead, you prepare yourself for further braking.

Personally I take it one step further and consider it a sign of poor driving and an early indicator of future over-braking when someone brakes on the freeway with little traffic. I make it a point to pass as soon as possible instead of being stuck behind the person in the future.

Real estate is a good illustration of this principle. If you want a positive cash flow yielding property chances are you'll be buying a small sub $200K property with minimal land valuation. This has typically been my strategy simply because I wanted to diversify into real estate as my income source. This maximizes the tangible assets of the structure while minimizing the intangible land value.

This also explains why more speculative properties, such as in the San Francisco area where I live, can show such astronomical price movements. The appreciation is in land appreciation. More accurately it's the combined value of the land and structure. Developers understand that where the land appreciates, the value of the structure does also independent from the value of the whole. Hence it may be possible, for example, to tear down an old 1930 1200 square foot $1.5 million house in Palo Alto (near Stanford university) to build a new 2000 square foot house for $200K resulting in a combined value of $2 mil.

The reason that intangible assets can skyrocket tenfold or even one hundred fold in a year is because their valuation is purely speculative. Arguing that a companies valuation is too high based on earnings without acknowledging the intangible aspect of valuation is to miss the point completely. No way disagrees that if Ford Motors or a similar company with small and perhaps even negative intangible assets (due to employee obligations) had similar assets and earnings they would certainly be valued far lower.

I've never seen a study showing any correlation between PEs and stock performance. In fact "value" and "growth" funds performed almost identically during Q1 2008. I do know, however, that the top 10 performing stocks over the last 20 years have all had above market PEs. So if you pick low PE stocks you will probably get an 8% annual return. If you pick high PE stocks you will probably get the same. The difference is high PE have a higher beta. Some go down sharply whereas others rise tenfold. For a good stock picker the decision is obvious. High PE stocks involve more risk and reward stock picking skills. Those that aren't good stock pickers should probably just buy the S&P 500 spiders (SPY) anyway.

Q1's earnings were below my expectations and reduce my 2010 and beyond outlook for the company although this is somewhat counteracted by an increased 2008 outlook due to a huge throughput gain. I'm slightly less bullish on the stock now, although the long term outlook is still bullish.

Disclosure: I have been heavily long FSLR since Feb 2007.

Comments

[tessant:]

its tough to bet against this one. the pe, etc are high, but every few years there is a company and stock that defy the numbers...this could be one of them

-scott
solarfeeds

2008 May 07 10:42 AM

[Gumby:]

First Solar had been doing business only in Germany so far, but lately, it is now talking with utilities right here in America. Any news surfacing about First Solar supplying modules to an utility here would kick FSLR up another notch, wont it? This is the intangible you are talking about or are supposed to... Are u trying to buy time by poohing poohing FSLR so that you can scoop up as much FSLR as possible before everyone gets a whiff of it? Huh? FSLR a likely buy target? 500 presplit by next year... Sure FSLR will need to announce another expansion in manufacturing to address the newfound demand here in America. The only question is whether FSLR will keep on obtaining enough material as a byproduct from zinc mining to support production in the long term? Nah! FSLR is not here to end up short on that critical material. Can you name it? If not, you dont know what u talking about huh? Zinc is widely used as galvanizing agent for steel like cyclone fencing and outdoor nails as big as nine inch types hahaha

2008 May 07 11:59 AM

[EnergyFinan...:]

If you want to understand First Solar's investing strategy, you can meet their CEO Mike Ahearn in person at the Renewable Energy Finance Forum-Wall Street (www.reffwallstreet.com), in NYC on June 18-19. He'll be joining the executives of LDK Solar, Applied Materials, SunPower, Good Energies and SEIA, in addition to 35 other executives in other technologies. Last year, 40% of attendees where CFOs, CEOs or Managing Directors.

2008 May 07 12:21 PM

[Gumby:]

I would not worry about solar stocks even if oil pirices fall down . I figure we need the solar modules as many of them as we can make to muzzle Big Oil for a long time to come... Oh I forgot about coal, too. And firewood enthusiasts, too.. then lastly , dismantle the hydropower to restore the nature. It is a tall order, though. It may seem inponderable to you , but look, if we want to live in outer space, we would need lots of solar modules wont we? It is a good time to jump in certain solar stocks that will compete and win for a long time. Our government is not going to dole out bilions in subsidies. Our government will only help a few loser solar stocks while the real solar stocks will rake in the lion share of profits...

2008 May 07 12:34 PM

[Andrew Ling:]

Gumby, I don't expect oil prices to go down until they're so high that many people can't afford to drive. We're still far from those levels. As long as China's economy continues to grow and they continue to subsidize gas prices oil will keep going up.

I didn't realize until last quarter's earnings when margins shrank how high energy prices actually squeeze margins for the short term since sales contracts are at fixed prices but manufacturing costs are variable. This could potentially hit the silicon PV manufacturers hard as they use much more energy in their manufacturing process. In the long term, however, higher energy prices is obviously a positive for solar since it makes PV a better value. Today, that may take the form of new government subsidies as a political response to high energy prices. In the future it will mean we're closer to grid parity.

2008 May 08 02:54 AM

[Andrew Ling:]

Check out my article about why oil is likely to goto $400, written when oil was $60, and how FSLR is my peak oil play. An electric car manufacturer or a company with new lithium-ion technology would be better, but I'm still waiting for a Tesla Motors IPO.

seekingalpha.com/artic...

2008 May 08 03:04 AM

[dicki31785:]

Well as you probably already know Andrew I am not the biggest fan of FSLR...Though when you talk about good performing (Tech) Stocks such as AAPL,GOOG, or RIMM they all trade at high valuations and show excellent returns(unless the first time you invested in them was in Janurary)....so high PE's are not that bad if you perform....

In any case I am very bullish on Solar...Though they are some clouds on the horizon....In Germany, where I am from, we are discussing susidy cuts at the moment....a renowned economic Insitution advised the Goverment to cut sudsidy's by 30% this year...Current subsidies are €.43 per kwh (for each kilowatt hour)....The plan beforehand was:
2009=(9%) + €0.01= $.381
2010=(7%) = $.352
2011=(8%) = $.326
Which would leave us at about 33 cents subsidization in 2011 which is still way too much for the Germany tax payers too pay...if 30% were cut immediatly then obviously (.7 x .43)=.30 that would leave us at 30 euro cents next year which could be a margin squeeze for a lot of solar firms....The subsidy cuts are probably going to be in the middle of the two extremes...probably leaving us around 28 cents in 2011....

It is very hotly debated in Germany at the moment since we are already producing 3% of our energy consumption from solar energy....our goal by 2020 is 20% renewables which is very much so possible....the problem being it is time for other countries to step up and create a bigger market it cant be that Germany and Spain pay for it all...

Because we need a break from installation in our country because basically we are producing (and importing a whole lot) "first" generation solar which is nice since it is clean...but also inefficient at this point(in two-three years everybody wishes they had solar stocks if they dont already)so we need to let some other countries pick up our slack for a couple years...such as Italy, France, Greece, USA, China, Australia, India etc...Because the market has to keep growing at least 20 more like 30% for many solars to survive...surely excluding FSLR due to its margin strength but surely they will lose some of their valuation....

Basically what I am saying it is time for other countries to step up we have been pushing the sector for a long time now and got it to where it is today...now we are in the last stages before grid parity....it is time for other countries to pay some of the bill as well we already did most of it so there is not too much left to pay:)...For example the "leader" of the industrial world, USA, doesnt find it neccesarry to give any substantial tax breaks on solar or renewables in general...they rather subsidize traditional energy sectors...In Germany we then speak of an "Armutszeugnis"...with kind regards from across the pond

CW

PS. LONG CSIQ, LONG STP

2008 May 08 05:08 AM

[dicki31785:]

The #'s for 2009, 2010 and 2011 are meant to be €

2008 May 08 05:10 AM

[steveny:]

Anyone ever been to the NE??? The sun doesn't shine here. Solar does not work at night, wind does. Who is going to shovel the snow off the panels every morning in the winter? It's a lot of surface to clean. FSLR is not building solar cars they are building panels for the electric grid so FSLR is not solving anything with oil or transportation. Eventually GE will either crush FSLR or just buy them out when they fall back. If FSLR is such a screaming value why is almost every single insider selling and selling like crazy? FSLR is way over valued.

2008 May 08 08:21 AM

[KCInvestor:]

I'm not sure I get the intangible asset comparison. You really think First Solar is in the process of building a brand image the likes of Coca Cola or Ford as opposed to a product that will inevitably become a commodity (if it isn't already?). They have some competitive advantages, but the move in market valuation can hardly be justified by intangible asset appreciation. You know what happens to goodwill and other intangibles...they get amortized and vanish in a blink of an eye. Focus on long-term earnings quality for a company like FSLR....not the brand they may or may not be building.

Disclosure: Waiting for the market to break and will be shorting FSLR near-term. Long term, sure we probably haven't seen a high in FSLR as prices can stay irrational for years.

2008 May 08 09:19 AM

[Jack Yetiv:]

I think FSLR is ridiculously priced as I have indicated in many comments on other SA articles written recently (see Frankola article about 10 days ago).

However, because of all the boosters it has, I think it's dangerous to short. In addition, in the next few months, if not sooner, I will bet FSLR will announce some big contract with a US utility (maybe Southern Calif Edison--see their 3-27-08 press release on their website), and I think FSLR, given its crazy following, could go up easily 10-20% in one day.

Nevertheless, IMO, this stock is not worth more than 40X 2008 earnings, which puts its fair value at about $100-130 in my view.

As to solar in general, I am very bullish on it and would say to dicki that the US, Australia, Italy, China and others will pick up where Germany and Spain leave off.

Jack Yetiv

2008 May 08 03:54 PM

[Mark Anthony:]

Andrew:
How much you are margined in FSLR, and how big a one day plummet in FSLR would it take for you to lose all of your money in a matter of minutes if FSLR collapses? I warned you repeatedly on FSLR's tellurium supply shortage, but you simply choose to go back to sleep. So you will have no one to blame but yourself.
Move on to PAL and SWC, I put 100% of my 401K into these two stock and will keep them for the next 3 years, for very good reasons. I currently don't even own any FSLR shorts because I want to concentrate on the PGM metals sector, but I am getting ready to short FSLR again. I have no vested interest to gain if FSLR collapses before I could establish my shorts. But it is important to discuss critical information on FSLR. I see a disaster happening and I can not stand by without warning folks.

The fair value of FSLR is $20 a share. I honestly believe that. There is no guarantee I will buy it at $20 if it falls to there. Isn't FSLR's tellurium job posting on their own web site alarming enough?

2008 May 09 07:10 AM

[Andrew Ling:]

dicki, I saw a survey about a year ago where about 80% of Germans were willing to pay extra for their electricity if it were to come from renewables. I don't recall how much extra but it was probably about 50%. When faced with the same survey only about 10% of Americans were willing to pay extra.

This illustrates why with the exception of China the US is the most fossil fuel dependent industrialized nation. You would think that some action would be taken with oil at $125. Although energy prices don't have a direct influence on the value of PV due to a subsidized market, they should theoretically force politicians to take action. Also, when prices reach "grid parity" the correlation will be direct.

2008 May 09 07:10 AM

[Andrew Ling:]

parker and jack, I thought the article was quite clear. The intangible asset is the cdte manufacturing process. When customers of AMAT are willing to pay double the capex, totally almost $2 Billion for a higher cost/watt it indicates tremendous value in FSLR's process.

Since this is often close to 100% of the valuation of a company which does not yet have earnings, why would you focus entirely on earnings once the company is profitable? Earnings is merely added to the inherent valuation. This is assuming you want to apply valuation measures at all which most successful investors don't.

2008 May 09 07:17 AM

[Jmichael:]

I'm not sure if FSLR is overvalued. What I am sure about is how serious the Chinese are with their alternative energy development. I can't see putting my investment dollars in FSLR when LDK sits waiting to potentially explode to fair value. Looking forward if I owned First Solar I would be watching for the next IPO which already has over 1 billion dollars of AMAT equipment ordered to produce thin film panels.
The whole benefit of solar for me personally would be to have my own system someday. Being an American, I don't care if there is a solar farm down the road generating my electricity if I still have to pay someone else for it. I want my own system. I want my Freedom. Thin film will not be efficient enough to power my Mansion. My roof is only as big as my house. Just ask Al Gore.. : 0

2008 May 09 08:02 AM

[dicki31785:]

@Jack Yetiv..it is not only that you have to pick up the slack also the market has to grow at least 30% YOY...Looks like supply will be greater than demand in 2009...unless the demand side is spiced up with a little of artifical demand(create demand through tax incentives)...This could result in a margin squeeze for a lot of companies....but also possibly drive innovation...

By 2010(maybe 2011), on the other hand, this problem is already history...When the Solars almost are at grid parity...this obviously also has to do with cost of energy...but to be honest i do not think that we are going below 100$(ever again). When one looks at where this oil is going to be drilled(explored etc.) it is certainly not getting any cheaper...and the supply demand situation...do not get my started.... in short even if the US recession is deep the world demand of oil will keep on growing....which is great for renewables..

@Andrew Ling...Surely we do not mind paying extra for clean energy but one also has to look at it at least a bit economical(though also 40,000 jobs exist in Germanys Solar Sector)....i mean you cant just pour money into sector without thinking about the long term effects...A little less incentives wouldnt hurt the industry if others, finally, would finally follow our lead...spain has done so...but besides that their is not really other big markets as of yet....And to be honest i do not understand the american attitude towards renewables...i mean i lived in you country for a few years and know how much you have to have a car to get around,and the way you air condition, i mean i could give you millions of examples how you guys abuse the planet...and then the great chance of renewables comes around and you guys say "other energies are currently cheaper" i mean that shortsightedness is absurd and just plain ignorant if one takes into account what potential some of these renewables have....at least that is my opinion...with kind regards from across the pond CW

LONG STP, ABX and just sold CSIQ but planning to buy monday after a pullback again

2008 May 11 11:26 AM