Solarfun Earnings Could be the Perfect Trigger for a Short Squeeze

Virtually all of the solar companies which have reported recently have reported better than expected earnings. Canadian Solar (CSIQ) trounced their earnings estimates. CSIQ is in a virtually identical segment of the business to Solarfun (SOLF). According to theStreet.com analyses on TD Ameritrade, SOLF has slightly better margins than CSIQ. This would lead one to believe that SOLF is likely to have much better than expected earnings this quarter. With the price of the stock currently sitting on (or near) the trigger point for most short sale buy backs, a move up with earnings might well trigger a big short squeeze. I note the current price of SOLF at this writing is approx. $18.50. Likely most shorts were sold at or below this price.

The current short squeeze situation was set up on Jan. 24, 2008. SOLF sold $150,000,000 worth of convertible notes priced at $19.13. At the same time, SOLF lent 7.8 million shares to Morgan Stanley to sell to the bond investors to hedge their positions. For instance, bond investors could collect the interest on the note, but short the stock close to the $19.13 price to prevent themselves from losing money as the stock went down in a down market. Apparently this is what happened. During the ensuing down market, the short positions on SOLF deepened further. TD Ameritrade currently shows approximately 15 million shares are shorted (about 35% of the float). Currently SOLF is trading at about 15 times 2009 earnings estimates, so it has room to move up. If SOLF guides higher after reporting good earnings, the stock may move much higher.

The possible downside view may be the margins. Both CSIQ and SOLF have low margins. Some people are wondering how they are going to do in the future as solar gets cheaper. Can they compete? Certainly a lot of people have shorted CSIQ, even though it continues to go up. What can make other people believe that CSIQ and SOLF have a good future?

The answer for CSIQ is that it is planning to start making UMG solar, which is much cheaper to manufacture. It is planning to ship 30-40MW of UMG solar in 2008. It will build this amount to 200MW in 2009. I haven’t heard that SOLF has any UMG plans yet, but it seems like just a matter of time. In addition Good Energies owns big stakes in both Trina Solar (TSL) and SOLF. Many are predicting solar company mergers, so companies can compete better. Many think SOLF and TSL are a marriage made in “Good Energy”. If that merger happens, it will likely help both companies. TSL recently scrapped its plans to build a poly plant. I think the UMG technology may have been part of the reason. The definitive work on UMG seems to be “Silicon LPE On Substrates From Metallurgical Silicon Feedstock For Large Scale Production” by M. Muller, R. Kopecek, P. Fath, C. Zahedi, and K. Peter from the University of Konstanz, Department of Physics. Apparently after upgrading the metallurgical silicon to PV-grade (PVG-Si), it can be used as feedstock without the need for complex high cost chlorosilane process to purify the product. Such low cost feedstock gives a reasonable efficiency solar cell [1], provided a high purity thin silicon layer is grown on the multicrystalline substrate wafers, which is made of PVG-Si by conventional ingot casting and wafering. Electrical grade silicon is 99.99999 plus percent pure, but it costs $150 to $250 a kilogram.
Only around 70,000 tons are manufactured worldwide. By contrast, upgraded metallurgical silicon is only 99 percent or so percent pure and goes for $20 to $50 a kilo. Approximately 1.2 million tons get made a year.

This seems to be the development path that CSIQ has elected to follow. Other companies such as SOLF and TSL are sure to follow. A company like LDK Solar (LDK) will likely use its coming poly plant to increase its margins. Then it will start on this new technology (perhaps before then) in combination with its poly plant to further increase margins. Ditto MEMC Electronic Materials (WFR). Both of these companies should be able to compete well with all of the other new technologies, such as CIGS. The solar made in this way has a slightly lower conversion efficiency. However, that efficiency is still very competitive with CIGS technology. Watch out First Solar (FSLR)! The competition is coming.

In sum, the UMG technology means that there is still a bright future for companies such as CSIQ and SOLF. It means that all of the polysilicone solar manufacturers will not suddenly be put out of business by newer technologies such as CIGS. It means that FSLR, which trades at 54 times 2009 earnings, may have lost its edge.

I think SOLF can be bid up in a short squeeze at its pivot point because it looks like it has a bright future if it just follows the crowd. If it can produce good results now, good results look very probable in the future. It has a lot of good contracts and good customer relationships. It just needs to execute. A merger with TSL might well help. Such a possible merger is another reason the stock price may rise.

Disclosure: Author holds a long position in SOLF

Comments

[GH]

How much will it cost to build UMG-based production, and how much will it cost to do so? If the costs to build capacity are equivalent to those for new polysilicon-based capacity, and if polysilicon prices are inevitably going to come down, why build capacity to produce cells which will ultimately be uncompetitive due to inferior efficiency? The scenario is only plausible if UMG-based capacity can be constructed more cheaply than polysilicon-based, or if the drop in polysilicon prices is still several years away. Seems like a small window of opportunity.

[GH]

Sorry, first sentence of above message should be:
"How much will it cost to build UMG-based production, and how LONG WILL IT TAKE to do so?"

[Jack Yetiv]

GH, UMG will continue to be cheaper than poly as poly comes down--therefore, there will continue to be a significant advantage to UMG-based panels (and remember, cost-per-watt ALREADY factors in the lower efficiency of UMG-based panels).

UMG is the sleeper than may lead to PE-multiple expansion for CSIQ.

Also, please note that whereas six months ago poly prices were predicted by many (me not included) to come down substantially by the second half of 2008, most people now realize this won't happen til 2009, and even then the fall will be relatively muted.

The main reason for this is that demand has been higher than most pundits (myself again not included) had predicted.

Jack

[wildeagain]

the squeeze is on. good call David. The squeeze will be enormous Monday if they report like CSIQ as you speculate David.

[larsson]

How should a merger between TSL & SOLF work out. Can't understand where you got this from and how this should work and which benefit it would have for the company's shareholders?

[larsson]

P.S. I think Davi & Jack (Predicted CSL & TSL !!!!) are the best analysts in the solar space! Great Job!

[User 194666]

i am new to the stock market. (retired on my r.e. gains). doing not badly day trading. (reading everything times allows). what does it mean short squeeze, and any suggestion to learn a bout long and short? Thank you for pointing out solar to me.

[Finding Beta]

Why I'm long LDK:
SAN FRANCISCO (MarketWatch)
By Wallace Witkowski
Last update: 4:29 p.m. EDT April 2, 2008 -- LDK Solar Co. LDK 37.08, +0.94, +2.6%) said late Wednesday it signed a 10-year agreement to supply solar wafers to a unit of Moser Baer India Ltd. Financial terms were not disclosed. Under the agreement, LDK will supply Moser Baer with 640 megawatts of solar wafers starting in mid-2008.

I'd have to look for a long time to find any other co. inking 10 YEAR contracts with anyone. Maybe Boeing?

[buygolly]

Although I can't dispute the Author's points, which I think make very good sense, I have taken profits on a %age of my solar and wind positions today.
I have this uneasy feeling that, fairly soon, Congress will announce that they will reduce or eliminate the current Breaks awarded to Alternative Energy businesses when they expire at the end of '08. The incentive to renew these advantages diminishes, I think, as price parity with oil and gas diminishes.(JMHO)
I think the solar and wind names are pricing in that the Breaks will be renewed and extended for the next 2 or 3 years...Which of course is possible. But if Congress should pull the plug, all these stocks will experience a rapid and deep sell-off. The risks, short term, are mounting. Am I nuts ??? Opinions please!.

[mistermaumau]

Finding Beta, HOKU signed 10 year contracts with SOLF and another bigger player, we all know now that may not add up to much. It's the details of the contract that we don't hear that count. Everything always sounds great until we find out more.

[mistermaumau]

buygolly, most of the Chinese players sell more outside the US than in there. Even if they cut breaks, it may only be until the next term when another president with other visions comes to power (2 out of 3 should be favourable to us) and if that fails, there are plenty of other countries that will not stop breaks until alternative energy production makes for a significant slice of the pie (and with biofuels entering a crisis, solar and wind will surge ahead). Then there are all the new countries that will start, then there are all the poor countries that may end up producing for others the way Algeria is to produce solar energy for Germany. In 50 years time, solar and wind will be commonplace and no longer worth discussing, any company that's well run will not run into problems in our lifetime.

[buygolly]

Mistermaumau: I appreciate your comments---Thank you. I'm in the process of studying more deeply into solar, wind, and the worlds needs and opportunities outside the USA. Your comments are, indeed, helpful.

[wildeagain]

to the guy who asked about what a short squeeze is here's a quick answer for you. To short a stock is to put money in that it will go down. the shorter makes money when the stock loses value. SOLF had a 35% short interest. Those shorts are dumping their positions to save losing their money. To long something is to hope it goes up. To short something is to hope it goes down. To be a short squeeze is to have to sell your position because the company is going up too fast. hope that helps.

[User 194768]

Why short SOLF when a person considers the following information presented by the CNBC site:
SOLF Highlights
First Call expects 1.12 EPS for next quarter.
The current Price Target for SOLF is $108.31.

[User 194666]

to wildeagain. thank you for your answer. hope you make money on solar. i called china to make sure the company was not in earthquake zone. it is north of bejing so they are ok.

[David White]

To short a stock is to sell the stock without really owning it. You are betting the stock will go down. Then you can buy it back at a lower price. You then pocket the difference. If the price is starting to exceed the price you sold it short at, then you are beginning to lose money on the short sale. You would want to buy the stock at that point to close out your short position (so you won't lose more money as the stock rises further). If people who have shorted a stock believe the stock is likely to go higher, they would likely wish to buy the stock to close out their short positions. This creates a short squeeze in which people are buying the stock because they believe it will go higher, and other people are buying the stock in order to close out their short positions. In the case of SOLF there were 15+ million short positions recently. I am guessing many people closed out their short positions today. I am not sure what the actual number is at this moment.

[wildeagain]

thanks david for a much better explanation, and more accurate.

[User 194967]

Is the 1st year SOLF projected value of 108.53 (Yahoo) in U.S. or Chinese currency values? Thank you for your help. and thank you for your very VALUABLE articles. They have added to my children's college fund. Allan

[deepvelvet]

Something is out of kilter with SOLF. The earnings estimates are science fictional: 5$ a share for 08, $8/sh for 09? And yet a huge short position. What exactly is the bear argument here? Margins going down? Outdated technology?

[User 194768]

I think the huge short position has to do with a very large quantity of bonds issued by SOLF in January 08 that can be converted to stock to sell at a profit -- and the bond holders bought shorts to protect their value. So here is my question:

If the stock has the potential to rise significantly in price, why would the bond holder convert and sell at a much lower price (not maximize their return)? Isn't it likely that the shorts would need to be covered next week and the rising price would delay the bond holders from converting/selling until they feel there is a peak reached that is much higher than Friday's price???? That would really put the squeeze on the shorts !

[deepvelvet]

Sorry, I now see my mistake. Yahoo has figures in RMB, not $. Very strange of Yahoo to do that. The figures make much more sense now.

[tessant]

if the small guys like solf are kickin butt, i cant imagine how well the big boys will continue to do in the months and years to come. so pumped!

-scott
solarfeeds

[GH]

My understanding is as follows.

The bond holders explicitly own the right to buy N shares of the stock at a certain price. Many holders have chosen to short N shares of the stock to nullify this right, because they only want to own the bond and collect interest, they do not want to accept the risk associated with the stock's price changes. Since this set of holders do not care whether if the stock price goes up or down, they also will not care whether there is a "short squeeze" - it will not involve them, because their *net* position in the stock is ZERO SHARES.

The sole impacts of this situation are:
1) It increases the "short interest" number, misleading the unsophisticated
2) It decreases the number of shares available to short

When a bond holder decides they no longer want to hold the bond, they first exercise their right to buy the stock, thus erasing their short position. They then sell the bond.

If there is something wrong with this analysis, I will be grateful to whoever posts a better explanation.

[investorslive]

SOLF is setting up huge and quite the squeeze - I mentioned it here: www.investorslive.com/.../

It could test $25 on the squeeze

[User 187530]

what do you think about wind energy companies like NCEN?

[David White]

NOTE: There have been some postings on the WEB, especially on Yahoo, which seem to have a mix of U.S. Dollar amounts and Chinese currency amounts with regard to SOLF. I do not actually know if the projected value of the stock is valid. However, I doubt it in the current market. The margins are very slim on SOLF right now. That is why you have seen the shorts take over again in the last couple of days, even though the earnings were great.
As I pointed out in the article, CSIQ has already started to move into UMG manufacturing, which will allow it to raise its margins. SOLF has not made such an announcement that I know of. They likely will go this route eventually. Still they have not yet, so CSIQ has a leg up on SOLF. Currently the pricing on solar is holding up well. Some people are predicting an over supply next year. If that happens, SOLF will get hurt because its margins are low. If that happens a company like LDK or WFR with substantial long term contracts (much at fixed prices) will do well. FSLR also has good margins, but it is currently overvalued in my mind. WFR has great margins. LDK has good margins which should almost double when LDK completes its polysilicone plant (perhaps by the end of this year). LDK is currently the best solar bargain in my mind. Of course, I believe they should be able to complete their poly plant approx. on schedule. Jesse Pichel from Piper Jaffray believes LDK's poly plant will take 2 years instead of one. Time will tell who is more correct.