By: Elliot Turner
With JA Solar's (NASDAQ:JASO) stellar earnings and guidance, the solar sector is enjoying a nice uptick the past two days, despite the broader market's weakness. First Solar (NASDAQ:FSLR), the sector's largest (as measured by market cap) and most cost friendly producer of solar power is enjoying a healthy bounce following the spark. First Solar made its 52-week highs in early May of 2009, just 2 months after the market bottomed, but since then it has severely lagged the market's run due to concerns over subsidy cuts in Europe and contracting profit margins. This week, Bronte Capital laid out the case for shorting First Solar. The trade is premised on the idea that "a technology, to be a really great investment, must do two things. It must change part of the world in a useful way....And it must keep the competition out." Bronte argues that FSLR will not be able to compete as other solar technologies become more efficient in terms of cost/megawatt. While FSLR's wafers cost the least/cell those cost savings do not necessarily transfer into the lowest cost per megawatt of energy. Over the long run, Bronte believes that this will result in FSLR's.
While I do not disagree with some of Bronte's points--mainly that FSLR's cell efficiency will ultimately have to improve relative to its peers--I do disagree with the conclusion and will lay out my reasoning below. This argument is not predicated on the recent strength in solar stocks (see FSLR’s chart near the end of this writeup for a visual). Rather it is predicated on a long-term fundamental shift into a new growth industry that is both a cutting edge technology and highly profitable.
First Solar's History as a Public Company and Technology
From 2005 to 2009 the company focused on increasing its production capacity of cadmium telluride photovoltaic cells. In that time, the company expanded from a maximum capacity of 25 megawatts of production to 1,282 megawatts. That was a very capital intensive process that required the building of production plants in the U.S., Germany and Malaysia. Much of the proceeds from the company's IPO and subsequent new share offering went towards building up this infrastructure. Now that the company successfully expanded its production capacity it can use its improved cash position ($9 cash/share) to invest more heavily into research and development--the true source of capital and value for a tech company. In 2007, the company invested $15.1 million in R&D, by 2008 that number reached $33.5 million and in 2009 it more than doubled again to $78.1 million.
The Technology (What is Cadmium Telluride and why is it different?)
First Solar uses Cadmium Telluride, rather than the traditional polysilicon prominent throughout the solar industry. Cadmium telluride is a molecule that consists of both cadmium and tellerium. The cost of tellerium could end up substantially decreasing due to the newfound commercial success with the element. In response to FSLR's success, researchers have discovered that tellerium is a far more abundant element than originally thought. Previously tellerium supplies had come from mining extracts in search of copper. To date, there have not been supply constraints on FSLR, and nor should there be in the near future. Large supplies have been located in China, as well as vast and plentiful supplies in undersea ridges which alone "could supply more tellurium than we could ever use for all of our global energy" needs. While the undersea supplies will not be accessible in the near-term, the future potential in this area is enormous and when investing in technology, potential is worth a nice premium in price. Some scientists speculate that tellerium might just be the "most abundant element in the universe with an atomic number over 40."
The efficiency level of First Solar's thin film semiconductor has leveled off, in contrast to silicon. However, before First Solar there was no commercial use for tellurium nor were there significant investments in further developing the thin film wafer technology. Prior to First Solar's commercial success few scientists focused on enhancing the efficiency of cadmium telluride in converting the Sun’s energy into energy fit for consumption. Cadmium telluride "has the optimal band gap for single-junction devices" and could achieve efficiencies in excess of 20%. This would make the technologically even more cost efficient and could very well enhance FSLR’s already robust profit margins down the road.
Who is the competition:
When talking about efficiency in solar energy there are two relevant varieties: one is efficiency in converting the sun’s energy to consumption energy and the other is the cost per wattage of energy produced. First I would like to cover technological efficiency in converting energy. The highest efficiencies produced in a laboratory to date are owned by a Boeing subsidiary named Spectrolab. Spectrolab has produced what are called concentrator multijunction solar cells, and have achieved efficiencies of over 40%, in excess of the previously known upper threshold of 37% for single-junction cells. However, this technology remains in the development phase and has essentially no chance of commercialization prior to 2015. The following is a chart from Wikipedia demonstrating the best known cell efficiencies: TSL) and Canadian Solar (NASDAQ:CSIQ) enjoying the highest profit margins and cleanest balance sheet.
Earnings for the sector have begun rolling in over the past two weeks and provide some interesting insight into the cost efficiency structure of polysilicon wafers as compared to the cadmium telluride variety. According to LDK Solar’s (NYSE:LDK) fourth quarter conference call, “the average cost of polysilicon…consumed was $69 per kilogram.” Notably, Bronte Capital asserted that polysilicon ingot prices were most recently $55 and falling. During the financial crisis, polysilicon did decline significantly in price (as evidenced by the collapse in share prices of memory drive makers, such as SanDisk (SNDK) and Seagate (NASDAQ:STX). The industry suffered from an immense oversupply of memory which triggered a demand slump for silicon. As global reflation has continued, these prices are once again on the rise, albeit they are well off their pre-collapse elevated leves. Notably, despite the collapse in polysilicon pricing, the wafer producers did not substantially improve their margins nor did they increase in profitability. While LDK earns $1.2 billion in revenues compared to FSLR’s $2 billion, LDK failed to generate a profit over the past year. The entire industry suffered from subsidy cuts in Europe, yet FSLR continued to benefit from the best pricing structure in the industry. Due to the contrast in efficiency, FSLR enjoys a $10.2 billion market cap, while LDK is worth a mere $876 million. Should the long-run cost efficiency structure of solar power shift toward polysilicon wafers, FSLR’s dominant market capitalization provides the ammunition necesary to strategically adapt in a dynamic and changing industry.
This begs the question, can the competition compete with FSLR over the long run?
Contrary to Bronte Capital’s argument, competition in and of itself does not spell doom for a technology company. In a growing industry, there is room for multiple competing companies and ideas to increase in market share. So long as the solar industry continues to expand, there will be room for many of the companies to exploit the new profit opportunities. An efficiency advantage in terms of price or technology can set one firm apart from another and to date, FSLR enjoys an advantage in both spheres. This advantage creates challenging headwinds for the competition (Evergreen Solar (ESLR) is one such example, as its own directors continue to sell millions of shares at less than $1.50/share).
Apple (NASDAQ:AAPL) is able to charge higher prices for its computers and sells fewer total units than the PC alternatives; however, despite this the company has been able to develop into one of the five largest companies in the entire country. That is because its products are innovative and its margins outstanding. Palm (PALM) is in the process of failure because it failed to stay on the cutting edge of product development. Apple had their failures (like the Newton), but they continued to develop and innovate, while Palm released one failure after another.
Ultimately in the solar space there will have to be some failures and some consolidation. There is a significant amount of overlap between the competing technologies and competition for the solar industry occurs on multiple levels. Not only do solar companies compete with other solar companies, the industry on the whole must distinguish itself from other forms of alternative energy including wind power, fuel cells and hydroelectric power. As the most abundant form of energy in the universe, the Sun provides the solar option with a significant catalyst for further technological advancement and success.
Since I am talking about a longer term investment here, I it is preferable to look at a higher time-frame than we normally do at T3Live. In looking at the weekly chart, we can clearly see the parabolic rise from its IPO in November of 2006 to its all-time highs in April of 2008. Since then, the stock has been building a solid base above the $100 price level and recently triggered a false breakdown followed by an aggressive snap-back rally. This effectively flushed out the weak longs, sucked in some momentum shorts, and triggered the break of a nearly two year old downtrend line. This is an intriguing place on the company’s chart to initiate a long position, using just under the $100 level as a stop level.
Disclosure: I am long FSLR and SPWRA.