CSIQ

Canadian Solar (CSIQ): Financing of Growth Still a Major Concern

August 13th, 2008 by Yehuda Fruchter   |   3 Comments

This morning Canadian Solar (CSIQ) reported exceptional earnings results (on accounting basis of course), and yet I still remain convinced that the company will need to dilute shareholders significantly in the year ahead in order to meet their lofty 2009 expectations. As such, if financing cannot be obtained at reasonable prices (i.e. the stock price is not hyped up by Wall Street brokerage firms), the company will not be able to meet expectations.

Notably, in the company’s earnings press release the CEO stated:

“Our cash position is now excellent as well as our financial ratios. We have adequate resources for all of our planned H2 2008 capital expenditures and working capital purposes.”

Interestingly, management is comfortable with the cash position for 2008, but what about 2009, which is right around the corner? Can the cash position of a mere $180 million or so (and $140 million in debt) possibly finance expected shipments of 500MW+ in 2009, a more than doubling of current shipment capacity?

The answer is that there no possible way $180 million will be enough to meet these shipment expectations, especially given the fact that the company can’t produce the total 500MW in-house, and as such will be forced to buy a major portion of materials for its projected shipments from other suppliers. My opinion is that the company’s projections are simply ludicrous, in light of the fact that if they plan to meet these numbers, they will need to raise at least $500 million+ in order to pre-pay suppliers for raw materials. The prospects of continued financing will keep pressure on the stock.

In sum, as stated in the past, the accounting treatment for many solar PV businesses, like CSIQ, significantly overstates current profitability and dramatically understates future financing needs. As more investors recognize this game, the stocks will continue their decline. It should be noted, though, that the prime beneficiaries of CSIQ’s unprofitable expansion will be LDK and JASO, two companies from whom CSIQ purchases supplies (I believe CSIQ is JASO’s biggest customer). So in theory, whenever CSIQ raises money it will go into the pockets of LDK and JASO, benefiting shareholders of those companies. But a further analysis of JASO and LDK, is beyond the scope of this post.

Canadian Solar (CSIQ) Announces Share Offering: Is This Just The Beginning?

July 14th, 2008 by Yehuda Fruchter   |   No Comments

After the close tonight, Canadian Solar (CSIQ) announced plans to sell 3.5 million common shares, raising the company’s expected fully diluted share count to nearly 36 million shares (32.3 million shares as of last report + 3.5 million shares from the announced secondary) and its enterprise value to nearly $1.4 billion.

Given our past discussion concerning the financing needs of several polysilicon-based module manufacturers, we were not taken aback by CSIQ’s latest secondary announcement, however we were somewhat surprised by the company’s financing method. We were expecting a larger convertible offering, instead of a direct placement of common shares. Arguably a convertible is a better means of long-term financing, since there is no immediate dilution to common shareholders.


Financing Still a Concern

Notwithstanding issues surrounding the current financing method, though, we think it’s important for investors to realize that this latest financing nowhere meets the actual financing needs of CSIQ, and as such we expect continued financings for CSIQ over the next year.


$1.7 Billion in Purchase Obligations
CSIQ’s financing needs are a direct result of the company’s astounding $1.7 billion in purchase obligations (page 64 in CSIQ’s 20-F). Interestingly, this number may in fact be conservative considering the company’s recent initiatives. Since the company will have to pay the vast majority of these obligations up-front to suppliers in cash, and will not receive adequate cash receipts from customers prior to the necessary payments to suppliers, CSIQ will be in need of serious cash in order to meet its production goals. Ironically, the more CSIQ pursues contracts at any price, the more cash it will need to fund its supplier obligations, and the more dilution shareholders should expect.

Future Cash Needs Uncertain As Cash Receipts from Customers Remain Unclear

At this point, it’s extremely difficult to project CSIQ’s real cash needs, since, as opposed to purchase obligations to suppliers, the company provides little disclosure as to its current payment terms with customers. Therefore, notwithstanding rosy revenue projections, it is completely unclear what the company’s actual cash receipts from customers are, and what the cash payment cycles looks like for new contracts.

Based upon our research, and a small dose of common sense when looking at businesses whose customers rely on government subsidies, our belief is that CSIQ currently receives little to no money up-front for customer orders and cash payments for these orders are being spread over ever longer periods of time. As such, we think that CSIQ’s reported accounting revenues and projections, greatly overstate the company’s actual cash receipts from customers, and hence significantly understate the company’s financing needs.

Our low-ball estimate is that CSIQ will need at least an additional $200 million in financing to support operations in the coming year. This cash may come from the Chinese banks (short-term loans) and/or Wall Street. In either case, the company’s enterprise valuation will increase even without a corresponding increase in the share price, leaving investors with little in the way of capital gains. Of course, if the stock price for some reason soars to irrational levels, the company’s financing issues may quickly evaporate. But, since we cannot forecast stock prices, we wouldn’t want to bet on this scenario.

Ignore Accounting Earnings and Wall Street Forecasts

Looking forward, since access to continued financing is CSIQ’s only means of survival, we would expect Wall Street analysts to continue recommending purchase of the shares based upon accounting revenue projections and paper profit (i.e. accounting earnings) valuations (e.g. P/E). At the same time, we anticipate that concerns regarding CSIQ’s serious working capital and future financing needs will receive little attention by analysts, though these are the main factors which will ultimately determine the value of the shares for longer-term investors. Therefore, we advise investors to look past these simplistic valuation models, and pay closer attention to CSIQ’s raw material and other purchase obligations, the outlook for raw material supply, and finally to the company’s actual/expected cash receipts from customers. These factors will surely play a greater role in the company’s longer-term share performance, than the other issues which may effect the nearly unpredictable day-to-day price movements.

Conclusion: Cash Flow Concerns Could Dominate for Quite Awhile and There are Possibly Better Alternatives

Ultimately, the bullish case for CSIQ rests on the assumption that because of escalating demand for polysilicon-based solar modules, the company will at some point become self-funding and will be generating more than enough cash to pay down obligations (both purchase and credit) and justify its enterprise valuation, even after dilutive actions.

However, since we remain reasonably certain that the suppliers of polysilicon-based solar modules (an extremely low barrier to entry business), will vastly exceed the suppliers of the raw material (e.g. polysilicion) for these modules (a very high barrier to entry business) for the foreseeable future, we believe that the suppliers of polysilicon-based solar modules will constantly be squeezed from both their customers and their suppliers of materials. As such, we do not believe that these companies will be self-funding any time soon and the future free cash-flow (if any) will not justify the current enterprise valuation. Investors looking to profit from the solar boom are probably best advised to research the investment potential of raw material and other suppliers to these polysilicon-based solar modules and/or stick to companies that have already proven their ability to generate operating cash-flow (i.e cash-flows prior to cap-ex).

Funding for Polysilicon-Based PV Manufacturers: A Look at Four Companies

July 6th, 2008 by Yehuda Fruchter   |   No Comments

In this post we will take a look at the future capital needs and funding requirements of four Chinese polysilicon-based PV Manufacturers.

Briefly, our conclusion, based on current low cash levels, high outstanding short-term debt as a percentage of total capital, and future capital needs, in the form of outstanding purchase obligations listed in recent 20-F filings, is that nearly all of the companies mentioned here will have a significant weakening of balance sheets in the near term, as short-term debt levels soar to support growing operating cash losses and purchase obligations. The prospect of immediate dilution via direct equity share offerings is clearly remote, as past history shows that these companies prefer to use convertible debt issues, as opposed to straight equity, as a longer-term financing vehicle.

Note: Subscribers can access spreadsheets on the company’s mentioned in this report by visiting this link:
http://spreadsheets.google.com/pub?key=pb-Z9URIzMG0KVo0cCO7QZw
We will update this link as earnings seasons progresses, as well as add additional companies, as time permits.

The current method of financing for these companies, in the absence of converts, is short-term bank loans from local Chinese banks, with much of these loans secured by related parties. The growing balance of short-term loans is apparently not seen as risky, even when they approach high levels of total capital, since these companies have, in the past, been able to quickly flip these loans into longer-term convertible issues, when, and if, share prices recover for short periods.

This ponzi-like cycle of financing can, in theory, continue indefinitely, until foreign investors become concerned about the continued cash losses, and deteriorating balance sheets. At that point business models may be questioned, share prices could plummet further, and investors could refuse to participate in the longer-term financings to replace the local bank loans. Chinese banks may conceivably continue to support these companies, but ironically their seeming refusal to currently finance these companies on a longer-term basis, does not bode well for their willingness to offer longer-term financing in the future if cash becomes scarce from foreign investors.

Alternatively, it’s conceivable that some of these polysilicon-based PV Manufacturers will secure enough financing to survive until they become self-sufficient on an operating cash-flow basis. However, as noted in past reports, the nature of the business implies that operating self-sufficiency is far off into the future for all these companies and given their position in the solar supply chain may, in fact, be a “pipe dream”.

Interestingly, though the “polysilicon supply/price situation will ease soon” meme appears to resurface every once in awhile, supporting improved cash-flow projections, it’s unclear where the source of optimism originates from. Every single 20-F from each of the mentioned manufacturers, and others, projects continued polysilicon shortages and high poly prices for the foreseeable future.

In sum, we continue to advise investors to avoid the shares of all of these Chinese polysilicon-based PV Manufacturers , until specific financing is announced and the longer-term financing and negative cash-flow issues facing these companies is addressed.

And now onto specific companies:

Trina Solar (TSL):

TSL is currently the company that is most heavily reliant on short-term financing, with $322 million in short-term loans as of May 2008 (see page 58 in 20-F), up an incredible 100% from $160 million at year end 2007. The current short-term debt figure represents nearly 50% of the company’s total capital. TSL had $38 million in cash as of 3/31/2008, but that cash level has been increased via the recent boost in short-term loans.

With an Envoy estimated 2008 EBITDA of approximately $145 million, and purchase obligations of roughly $245 million this year (including cap-ex), and $217 million in the next 1 to 3 years (page 58 in 20-F), we estimate that TSL has a funding gap of at least $180 million in the coming year. (Note that due to accounts receivable, and other financing, issues as discussed in previous posts, not all estimated EBITDA can be used for capital purposes).

As noted above, since TSL has already secured nearly $160 million in short-term financing already this year, it would appear that the company will probably only need to raise an additional $50 million or so in the next six months to support operations.
However, given the company’s already high level of short-term debt, one wonders how much more debt the local Chinese banks will lend to TSL. More importantly, it’s unclear why these banks will care to hold onto this debt, particularly given the prospects of continued cash losses for TSL in 2009. As such, it seems highly unlikely that TSL can carry such a high balance of short-term loans for much longer and the company must surely be facing pressure to refinance these loans. As such, we expect a convertible offering from TSL in the coming months, which will be used to pay off these short-term loans.

The higher proportion of short-term financing as a percentage of total capital, could be the reason for TSL’s lower valuation relative to the others in the group. At current prices, TSL trades for an Enterprise Value or EV (Market Cap – Cash + Debt) to estimated 2008 EBITDA of about 6.5 and EV/Sales of 1.2X. (Note: The level of debt at these companies necessitates an enterprise valuation, and market cap valuations, such as P/E’s, which do not take current and future debt levels into consideration, are highly misleading and unjustifiable).

Canadian Solar (CSIQ)

CSIQ has the highest relative valuation of the current group of companies, and at the same time highest purchase obligations in the next 1 to 3 years.

As of 3/31/2008, CSIQ had total debt of about $90 million ($71 million in short-term debt, up from $40 million at year end 2007) and $32 million in cash, taking into consideration the conversion of the company’s previous $75 million of convertible notes, which added about 4 million shares to the company’s share count.

Though, CSIQ’s total debt is still relatively low as a percentage of total capital, that situation will surely change dramatically in the coming weeks or months. That is because, CSIQ has $338 million in purchase obligations (including cap-ex) this year and an additional whopping $632 million is due within 1 to 3 years (see page 60 in CSIQ 20-F). As noted above, the company had a mere $32 million of cash as of 3/31/2008, to support these obligations. Moreover, CSIQ recently upped its cap-ex budget for 2008, so our estimates above could prove to be too low.

With an Envoy estimated EBITDA in 2008 of about $115 million, and increasing accounts receivable growth, we believe that CSIQ is need of at least $320 million relatively quickly, in order to support operations. It will be interesting to see how the company plans to finance these cash needs when the next earnings report is announced. If we had to guess, the company is currently being held on life support by Chinese banks until a very large convertible can be completed on Wall Street.

At over 10X EV/2008 Est. EBITDA and 1.5X EV/2008 Est. Sales (EV is calculated using the additional 4 million shares from the recent Note conversion), the shares appear quite expensive, especially considering the near-term financing issues.

Solarfun (SOLF)

As of 3/31/2008, SOLF had $85 million in cash, and $339 million in total debt ($143 million short-term and $172 million in converts due in 2018).

With an Envoy estimated $95 million in 2008 EBITDA, and nearly $550 million in purchase obligations (includes $150 million in cap-ex) in the next year and $350 million in the next 1 to 3 years (see page 65 in SOLF 20-F), we think SOLF is on the hook for at least another $400 million in 2008.

Given SOLF’s already high debt level as a percentage of capital and lower EBITDA prospects as compared to the CSIQ and TSL, we think the financing of $400 million for SOLF will be quite tricky in the months ahead. Luckily, the company completed a large convertible earlier this year, and the cash proceeds could conceivably support the company for one more quarter or two. After that, expect another large convertible.

At over 9.5X EV/2008 Est. EBITDA and 1.3X EV/2008 Est. Sales, the shares appear expensive and we have strong doubts about SOLF’s long-term viability given the already high debt level.

Yingli Enery (YGE)

YGE is seemingly the most vertically-integrated of the companies mentioned in this post, and therefore reports the highest reporting operating margins of the group. Nevertheless, despite the relatively better operating profile, the company is not immune to the cash-flow issues facing the industry.

As of 3/31/2008, YGE had $80 million in cash, and $290 million in total debt ($115 million short-term and $175 million in converts).
With an Envoy estimated $200 million in 2008 EBITDA, and nearly $585 million in purchase obligations (includes cap-ex of about $275 million), in the next year and $150 million in the next 1 to 3 years (see page 98 in YGE 20-F), we think YGE requires about $450 million 2008.

Given YGE’s lower overall debt level as a percentage of total capital, higher estimated EBITDA and lower capital needs looking out 1 to 3 years, it would appear that the company may have a somewhat easier time raising appropriate financing than the other companies mentioned in this report.

However, at about 10X EV/2008 Est. EBITDA and 2X EV/2008 Est. Sales, the shares appear to already reflect the company’s better relative positioning and financing “breathing room”.

Conclusion
In conclusion, for TSL, CSIQ, SOLF, and YGE, the same story should play out over the next few months and year. Balance sheets will continue to deteriorate as debts pile up to support operating cash losses (due to previously mentioned raw material purchase obligations and higher accounts receivables) and cap-ex. At some point, foreign investors will tire of financing these companies, particularly since none have them have any particularly unique/defensible technology and/or pricing power. Investors should continue to be suspect of valuations of these companies that utilize accounting earnings and revenues, and instead should focus more on operating cash-flow, balance sheets, financing options, and future purchase obligations.

Clarifying The Financial Issues Facing Polysilicon-Based PV Manufacturers

July 3rd, 2008 by Yehuda Fruchter   |   No Comments

In this post, I will address the two most common criticisms of our article last month on several polysilicon-based PV manufacturers and thereby hopefully clarify the financial issues that confront many of these polysilicon-based PV manufacturers.

Before getting to the criticisms, though, it is important to note that nearly all of the comments to the post fail to distinguish between cash outflows due to capital expenditure requirements and cash-outflows due to working capital management. However, these are two entirely different issues.

If the significant cash losses for some of the polysilicon-based PV manufacturers were just due to significant cap-ex needs, there would really be no major cause for concern as it would be a natural outcome of their growth and need to meet future capacity.

The issue, though, is that many polysilicon-based PV manufacturers have significant cash outflows even before cap-ex needs and it is this problem which needs to be addressed, especially considering the mismatch between positive accounting earnings reports and this negative cash-flow before cap-ex. Basically, the existence of significant cap-ex needs merely aggravates an already tenuous cash-flow situation, but it is not the major problem in itself.

As noted in the original post, when looking at several of these polysilicon-based PV manufacturers, it is clear that the main reason for these cash outflows before cap-ex, is due to the fact that these companies need to shell out huge amounts of money to suppliers of polysilicon, well in advance of receiving any actual cash revenue from customers. As these payables are dramatically increasing, the competitive dynamic of the industry is causing much greater use of longer-term credit-based sales resulting in very high accounts receivables growth. It is in fact questionable whether certain types of longer-term credit sales should even be recognized as revenue.

This is the crux of the working capital cash issues and given the competitive nature of the industry and still very tight supply of polysilicon, it is a situation that would seem to be getting worse, rather than better.

With that said, we can now move onto the two most common critiques:

Criticism I: Every Young Business That is Growing Rapidly Drains Cash

Answer: Obviously, young and fast-growing companies in any manufacturing-based industry will need to expend cash in building out infrastructure to support the production of products and future demand. However, as noted above, the issue here is not about cash drains due to cap-ex, but due to working capital cash outflows, i.e. cash negative outflows before cap-ex.

There is not one shred of evidence or any economic rationale to the assertion that fast-growing companies should lose cash before cap-ex after they reach a certain sales level. I’m not sure how anyone can assert that a company nearing a reported $1 billion in sales, needs to burn thru tons of cash before cap-ex needs and yet at the same time report extraordinary accounting earnings gains. In fact, just to put this criticism to rest, one counterexample, in the same exact industry, should suffice.

The most valuable company in the solar space now is the thin-film manufacturer, First Solar (FSLR). First Solar is growing as rapidly as any polysilicon-based manufacturer, and yet it’s operating cash-flow, before cap-ex, is solidly in the black and has been for quite some time. Interestingly, as opposed to many polysilicon-based manufacturers, First Solar makes it quite easy to track cash flows into the company, as it reports its cash flow quite simply as Cash Received from Customers and Cash Paid to Suppliers and Employees.

Criticism II:
The Solar Industry Is Growing Rapidly and Therefore The Concerns Regarding polysilicon-based PV Manufacturers Is Misguided

Answer:
Apparently, many readers took the concerns raised against polysilicon-based PV manufacturers as an attack on the entire solar industry. However, this was not the intent of the article.

Even if one believes strongly in the secular growth of the solar industry, as I personally do, it is obvious, based on past business history in every other major growth industry that ever existed, that many of the companies participating in the industry will simply go bankrupt or fail to provide any return to shareholders for various reasons. There are countless recent examples of this (i.e. fiber optic component suppliers) economic reality.

The fact is that a growth of an industry does not benefit all players in the industry’s ecosystem, as certain business models simply don’t have economic viability and many companies fail to receive adequate financing.

In regards to the solar industry, despite the secular growth, investing in many polysilicon-based manufacturers in the current environment may turn out to be a losing bet. The situation could, of course, change if a wave of merger activity goes thru sector, consolidating the power of the industry into a few large companies, and thereby the improving the negotiating strength over suppliers and customers and eliminating much of the working capital cash issues.

In conclusion, the solar industry presents some very attractive investment opportunities, but investors still need to focus on those companies that can at some point be self-funding on an operating basis, and have a unique technology that reduces competitive pressures.

In the case of many polysilicon-based PV manufacturers the cash outflows raise serious and real financing concerns and it is incorrect to value these companies off of accounting earnings and revenues. It will be paramount for investors to gain a clearer understanding of these companies polysilicon agreements and customer credit/sales terms, two facts that are not often disclosed in public filings, but should be addressed by management.

Will Some Solar Companies Face a Cash Crunch?

June 12th, 2008 by Yehuda Fruchter   |   No Comments

Introduction

This post is devoted to some thoughts on companies in the solar industry, particularly the Chinese polysilicon-based solar module manufacturers. The basic issue I address here is the risk for a serious cash crunch at some of these module manufacturers given their working capital deficits and their capital expenditure requirements.

Moreover, despite seemingly positive accounting earnings reports from many of these companies, a more careful perusal of these companies balance sheets raises serious questions as to the viability of their businesses, given the continued cash outflows. Importantly, this post does not address thin-film solar manufacturers, and my basic points do not apply to these businesses given the different economics of the thin-film segment of the solar panel industry.

Accounting Operating Metrics Are Misleading

Wall Street’s propensity to value Chinese solar companies off of accounting earnings, MW produced, and other non-cash metrics, completely obfuscates the significant cash-flow problems that many of these companies currently face. The cash-flow issues are caused by significant working capital needs, and it’s hard to imagine how the working capital situation can be improved any time soon, even in the event that polysilicon prices ease. There is simply too much competition in the industry and therefore suppliers, as well as customers, will continue to squeeze these companies on payment terms and cycles.
In the meantime, these companies are only able to keep their doors open due to a continued influx of cash in the form of loans, dilutive equity offerings, and other financial vehicles that Wall Street investment banks arrange. At issue, though, is how these companies would fare, should financing become more difficult. The businesses continue to burn thru so much cash, that it seems very likely that without financing many of these companies would go bankrupt very quickly.

Additionally, since few investors are paying attention to cash-flow, and most reports on these companies focus on accounting earnings and sales, there is a very strong incentive on the part of these companies to engage in questionable sales practices and revenue recognition policies (Note: The evidence for this is somewhat speculative, but is based on countless past examples, in other industries, of major working capital deficiencies signaling suspicious sales activity, such as “channel stuffing” and the like – see below for some interesting comments in SOLF’s 20-F filing).

The Evidence: Risk Statements in SEC Filings

Before getting to specific financial evidence, I’ll address a basic question: Why don’t these companies make money (cash, that is)?

Well, it’s quite simple. They have significant working capital deficiencies that are, and cannot be remedied any time soon, even in the event that polysilicon prices ease.

Here’s how speculative favorite Canadian Solar (CSIQ) explains the situation in the company’s latest 20-F (Note: CSIQ’s situation, is by no means unique, and is shared by nearly every polysilicon based module manufacturer. I have chosen to focus more specifically on CSIQ since it is a company I am more familiar with and additionally it is one of only a handful of companies that has already filed a complete 20-F):

“Advance payments to our polysilicon and silicon wafer suppliers and credit term sales offered to some of our customers expose us to the credit risks of such suppliers and customers and may increase our costs and expenses, which could in turn have a material adverse effect on our liquidity. Under existing supply contracts with many of our multi-year silicon wafer suppliers, and consistent with industry practice, we make advance payments to our suppliers prior to the scheduled delivery dates for silicon wafer supplies. In many such cases, the advance payments are made in the absence of receiving collateral for such payments. Moreover, we offer some of our customers short term and/or medium term credit sales based on our relationship with them and market conditions, also in the absence of receiving collateral. As a result, our claim for such payments or sales credit would rank as unsecured claims, which would expose us to the credit risks of our suppliers and/or customers in the event of their insolvency or bankruptcy. Accordingly, any of the above scenarios may have a material adverse effect on our financial condition, results of operations and liquidity.”

And this from Yingli (YGE):

” Historically, we required many of our customers to make an advance payment of a certain percentage of their orders, a business practice that helped us to manage our accounts receivable, prepay our suppliers and reduce the amount of funds that we needed to finance our working capital requirements. However, this practice of requiring our customers to make advance payments has diminished, which in turn has increased our need to obtain additional short-term borrowings to fund our current cash requirements. In 2007, a small portion of our revenue was derived from sales that required advance payments from our customers. Currently, a significant portion of our revenue is derived from credits sales to our customers, generally with payments due within two to five months. In addition, other customers now pay us through letters of credit, which typically take 30 to 90 days to process for us to be paid. As a result, the general decrease in the use of cash advance payments has negatively impacted our short-term liquidity and, coupled with increased sales to a small number of major customers, exposed us to additional and more concentrated credit risk since a significant portion of our outstanding accounts receivable is derived from sales to a limited number of customers.”

Another interesting quote, relating to the veracity of sales reported in earnings reports and collectiability of receivables, comes from SolarFun’s F-1 filing:

” With certain significant customers, we enter into framework agreements that set forth our customers’ purchase goals and the general conditions under which our sales are to be made. But such agreements are only binding to the extent a purchase order for a specific amount of our products is issued and certain sales terms may be adjusted from time to time. For example, we entered into a framework agreement with Social Capital S.L. under which it agreed to purchase 84 MW of PV modules in total from 2007 to 2008. However, since we could not reach an agreement with Social Capital S.L. on actual sales terms, Social Capital S.L. has not made any purchase order of our PV modules and it is unlikely that it will purchase our PV modules in the foreseeable future. In addition, we have in the past had disagreements with our customers relating to the volumes, delivery schedules and pricing terms contained in such framework contracts that have required us to renegotiate these contracts. However, renegotiation of our framework contracts may not always be in our best interests and disagreements on terms could escalate into formal disputes that could cause us to experience order cancellations or harm our reputation. “

The Evidence: The Financials

While CSIQ reported a huge earnings jump in Q1 2008 of $0.61 per share, the company, in fact, lost a significant amount of money and the earnings number is a complete mirage for significant cash-flow problems. If you compare the company’s balance sheet in Q1 to the balance sheet in the 20-F, the cash-flow issue is quite salient.

Specifically, as of 12/31/2007, CSIQ had approximately $38 million in cash, $59 million in receivables, and $71 million inventories. On the liability side, the company had $40 million in short-term borrowings, $8 million in payables, $75 million in convertibles, and $18 million in long-term debt.

On 3/31/2008, though, after a supposed record earnings quarter, CSIQ reported the following:
$32 million in cash, $119 million in receivables, and $81 million inventories. On the liability side, the company had $71 million in short-term borrowings, $17.5 million in payables, $75 million in convertibles, and $20 million in long-term debt.

Basically, in Q1, CSIQ had approximately a $60 million cash deficit (it’s difficult to get an exact number here since the company doesn’t release quarterly cash-flow statements) because of uncollected receivables. The company financed that huge loss via an additional $30 million or so in debt, and some non-strategic supplier loans (e.g. “accounts payable loans”). Even with all the financing, the company still managed to burn thru cash.

In case, this analysis sounds too shocking, perhaps it’s simpler to just point out that in CSIQ’s 20-F for fiscal year 2007, the company reported a mere $300K loss, or $0.01 per share, on an accounting basis. However, the cash-flow statement in the 20-F shows quite clearly that the company actually lost $80 million in 2007, due to accounts receivable issues and advance payments.

But, CSIQ is not alone. Industry heavyweight Suntech Power (STP) supposedly had earnings of $170 million, or $1 per share in 2007. However, actual cash-flow shows a slightly different story. In fact, STP lost $9 million in cash from operating activities in 2007.

And the list goes on: YingLi (YGE) lost over $300 million from operating activities in 2007, despite claiming a $52 million accounting earnings gain.

Conclusion

In conclusion, as is spelled out in the risk portions of polysilicon-based PV suppliers, and as is evident from annual and quarterly financials, working capital cash-flow deficiencies are a serious financial drain on many of these companies. As such, valuing these companies off of earnings is misleading and vastly overstates the underlying economic value of the companies.

Moreover, considering the tremendous amount of capital expenditures still needed by these companies to ramp up production to meet demand, it should be obvious that polysilicon-based suppliers are starving for cash. However, since the industry is currently oversupplied and suppliers have little differentiation, it seems clear that there is a significant risk that these companies could face a cash crunch should investors grow tired of financing these companies.

Finally, since these companies recognize that Wall Street rarely looks into actual cash-flow, they have every incentive to book unprofitable and questionable revenues, in an effort to produce strong top-line and accounting-earnings growth. Nevertheless, when certain contracts are called into question by customers, and other questionable revenue recognition policies are addressed, companies may need to restate earnings and erase past profits.

Disclosure: I hold no position, either long or short, in any of the stocks mentioned in this report.