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.