1 UNIVERSITY OF OREGON INVESTMENT GROUP February 13, 2009 IME FIRST SOLAR, INC. RECOMMENDATION: HOLD Stock Data Price (52 weeks) $85.28-$ Symbol/Exchange FSLR/NASDAQ Beta 1.97 Shares Outstanding (million) Average volume (3 4,443 (thousands) month average) Current market cap $11.86 Billion Current Price $ Dividend NA Dividend Yield NA Valuation (per share) DCF Analysis $93.49 Comparables Analysis $25.23 Current Price $ (as of 2/6/2009) Summary Financials (Thousands) 2007A Revenue 503,796 Income 158,354 BUSINESS OVERVIEW First Solar is involved in the design and manufacturing of photovoltaic (PV) solar modules using a proprietary thin film semiconductor technology. First Solar was founded in 1999, began commercial production 2002, and began issuing shares on the NASDAQ Stock Exchange on November 17 th, 2006 under the ticker symbol FSLR. Today First Solar is the largest manufacturer of thin film solar modules, having reached an estimated capacity of 735 MW by the end of Covering Analyst: Milad Sedeh & Matt Doty The University of Oregon Investment Group (UOIG) is a student run organization whose purpose is strictly educational. Member students are not certified or licensed to give investment advice or analyze securities, nor do they purport to be. Members of UOIG may have clerked, interned or held various employment positions with firms held in UOIG s porfolio. In addition, members of UOIG may attempt to obtain employment positions with firms held in UOIG s portfolio.
2 BUSINESS DESCRIPTION First Solar is involved in the design and manufacturing of photovoltaic (PV) solar modules using a proprietary thin film semiconductor technology. The advantage of this thin film technology (as opposed to traditional crystalline silicon solar models) is the reduced raw material and manufacturing costs. Below is a more detailed explanation of the technology and process that FSLR uses to develop their solar modules. Photovoltaic (PV) Technology Photovoltaic technology revolves around converting sunlight into energy. Photovoltaic solar cells are made of semiconductor material, normally silicon. When the semiconductor material is hit by the sunlight it absorbs the sunlight and converts a portion of it into energy. This energy releases electrons which then create an electric current. This electric current produces the wattage that you normally hear in relation to solar energy production. Traditional Silicon Wafer Solar Cells versus Thin Film Solar Cells When discussing the energy conversion rates (how much sunlight is actually converted into usable energy) and the cost of solar energy, it is important to distinguish between thin film and traditional crystalline solar cells. Traditional crystalline cells use primarily silicon as their semiconductor material, while thin film uses 1% of the silicon but combines it with thin layers of compounds such as cadmium telluride (which is the thin film material used by First Solar). Because a much smaller amount of silicon is used, effectively lowering the cost and weight of the solar cell, thin film solar cells are much more effective on a cost per watt basis. This doesn t come without disadvantages though. Traditional silicon wafer cells are more efficient at converting sunlight into energy. For example, silicon wafer cells generally convert about 15-25% of sunlight into energy, whereas thin film cells convert around 10-15%. First Solar Manufacturing Process Below are the steps taken by FSLR to create their PV solar cells and modules: 1. Deposition Stage In this state thin sheets of glass are coated with a layer of cadmium telluride and a layer of cadmium sulfide (these are the thin-film semiconductor materials) 2. Cell Definition State Laser technology is used transform the semi-conductor panel into multiple solar cells 3. Assembly and Test Stage A glass cover sheet, lamination, and wires are added to the module which is then sealed and boxed. This is followed by a solar simulation and leakage test Customer Analysis FSLR sells their solar modules to two different types of customers. The first class of customer constructs, owns, and operates a solar power plant, and uses FSLR s modules to provide the solar energy needed to power the plant. The other type of customer is essentially a middleman. They develop turnkey solar power plants, and sell these plants to end-users such as owners of agricultural buildings, owners of warehouses, industrial offices, public entities and utility companies. These turnkey solar power plants also use FSLR s modules to provide the solar energy needed to operate their plants. FSLR operates their business using long-term customer contracts. Currently, there are 6 customers who make up nearly 100% of their revenues. These customers are contracted for $6.3 Billion of revenue from These contracts are structured so that the price that the customers pay per watt decreases each year by 5.5%- 2
3 6.5%. FSLR has successfully lowered the cost per watt by over 6.5% year over year to offset the negative effect of price decreases. During their 2008 Q3 conference call, FSLR announced that various contracts had been extended by a total of 525MW of production through Specific pricing details for these contracts were not disclosed. Geographic Distribution of Customers In FY2007, approximately 91% of revenues came from Germany, with the other 9% spread between various countries in Europe (primarily France and Spain) and the United States. 3 quarters into FY2008, approximately 75% of their sales have come from customers that are headquartered in Germany. The reason that Germany is accountable for such a large portion of FSLR s revenues is because the German solar market is amongst the largest in the world. The reason for Germany s large presence in the solar energy market is a law passed in the year 2000 known as the Renewable Sources Energy Act. FSLR has projected that revenues from Germany will decrease as a percentage of total revenues into the future as demand and business from other countries grow. Growth Strategies FSLR s revenue growth is dependent on the number of watts they can produce. They grow their manufacturing capacity as the demand for their solar modules grows. Increased capacity can come from capital expenditures, increased efficiency in their production lines, and increased rates by which their solar modules convert the sun into electricity. Growth can also stem from acquisitions or partnerships with related companies. Manufacturing Facilities The predominant growth strategy of FSLR is the construction of new manufacturing facilities in low cost regions. The company currently has four facilities operating at full capacity, and two others to be completed between now and the second half of By the end of 2009, FSLR will have one plant in Ohio, one in Germany, and four in Malaysia. All of the plants have 4 production lines. FSLR states that their approach to investing in additional plants is practical in that they will only invest when demand calls for it. At the end of 2006, FSLR had a manufacturing capacity of 132 Megawatts, and their capacity is projected to be 1.1 GW by the start of Increased Efficiency in Production Lines A second way in which FSLR is realizing greater capacity is through increased efficiency of their production lines due to economies of scale. In 2007 FSLR s annual production capacity per production line increased from 25MW to 44MW. In 2008 they saw another increase to 48MW per line. These increases are a byproduct of organizational learning as the company improves their production efficiency. Because FSLR is such a young company operating in an emerging industry, expect to see further increases in the future. Conversion rate FSLR s solar modules currently convert just over 10% of the sun they absorb into energy. However, the theoretical capacity of this technology has been estimated to be upwards of 20%. Comparatively, traditional silicon wafers convert between 15-25% of the absorbed sunlight into energy. FSLR will continue to refine its technology into the future to improve this conversion rate. As they do so, the number of sellable watts per module will increase. Acquisitions In November of 2007, FSLR acquired Turner Renewable Energy LLC, a designer of solar projects for utility companies in the United States, for $34.3 million in cash and stocks. It is believed that this acquisition gives First Solar an opportunity to offer solar energy projects to utility companies as renewable energy requirements 3
4 are increased. Acquisitions of this type are an opportunity for FSLR to increase their presence in various geographic areas while also increasing the size of their customer base. At this point in time, FSLR has not indicated any potential acquisitions in the near horizon. However, going forward additional acquisition opportunities may present themselves, especially as the solar industry continues to grow. Partnerships In the fourth quarter of 2008, FSLR reached a deal with Solar City to make a play on the residential market in the United States. In the deal, FSLR entered into a 5 year contract to supply 100MW of power to Solar City, and also made a $25 million equity investment into the private firm. Solar City leases solar electric panels to residential households looking for a renewable energy source in Oregon, California, and Arizona. This partnership was also FSLR s entrance into the distributed generation market. Distributed generation refers to groups of smaller power plants located closer to the power s end user, rather than one centralized plant generating power for a large geographic area. Therefore, the amount of electricity lost in transmission is decreased as the plants are located nearer to the end user. FSLR sees these distributed generation and residential markets as a growth opportunity in the future. RECENT NEWS First Solar to Supply Modules for Masdar City Solar Power Project (Jan 16, 2009) First Solar reached an agreement to supply 5MW of its solar modules to Masdar Abu Dhabi Future Energy Company who is constructing the largest grid-connected photovoltaic system in the Middle East. Masdar City s goal is to become the world s first zero-carbon city running entirely on renewable energy resources. This agreement is reflective of First Solar s position within the solar industry, as well as the increasing demand for First Solar s thin film modules. First solar completes first 10MW Thin Film Solar Power Plant for Sempra Generation - (Dec 22, 2008) First Solar completed the construction of their first 10MW photovoltaic power plant for Sempra Generation. The plant is the largest thin film solar powered plant in North America, and was FSLR s first utility scale engineering, procurement, and construction project. The construction of this plant illustrates the growth opportunity in the US market as renewable energy sources become more viable. The project took only six months to complete. First Solar Breaks Ground on Expansion of its Manufacturing and Development Facilities in Ohio (Oct 6, 2008) First Solar added a fourth production line to their manufacturing facility based in Ohio. The line increases the total capacity of the facility by 48MW. As demand for their modules continues to increase, First Solar will continue to develop new manufacturing facilities and production lines. Now, all of First Solar s manufacturing facilities have four production lines for a total capacity of 192MW each. INDUSTRY First Solar operates within the solar industry and more broadly the renewable energy industry. The discussions in this section pertain specifically to solar energy. The solar industry includes module/cell manufacturers (such as First Solar), system owners and designers, installers, and equipment manufacturers. The industry has experienced large growth in recent years due to increased attention to renewable energy and increased efforts to reduce global warming by traditional fossil fuels. Below we have outlined factors that we deem significant in the solar industry. 4
5 Projected Growth The solar industry is expected to grow rapidly over the next twenty years. This growth can be attributed to the decreasing costs of solar power accompanied by the worldwide movement toward renewable resources. There are multiple estimates projecting growth levels. Moderate estimates predict average yearly growth of 30% through 2010, 21% from , and 12% from More optimistic estimates that assume continued governmental support programs to spur additional growth predict yearly growth averages of 40%, 28%, and 18% over the same respective time periods. Estimates for U.S. photovoltaic growth range from an average of 50-65% over the next five years. Note that these growth rates refer to the amount of solar power generated, not revenues. Grid Parity The primary factor holding back the solar industry is its cost. While the draws to the renewable energy source are undeniable, traditional energy sources such as coal continue to be much cheaper. The ultimate goal of the industry is to reach grid parity, or the point at which the cost of producing solar power is equal to or less than the cost of grid power. However, it is difficult to determine just how large the gap is. The costs of electricity vary by region, as does the intensity of the sun. Therefore, sunnier areas with higher electricity costs will be the first to reach grid parity, such as California or Japan. Therefore, it is more feasible to view grid parity at costs of production to the manufacturer rather than price to the end user. First Solar has stated that they believe grid parity to be at a cost of $0.70 per watt. The United States has set the goal to reach grid parity by 2015, and the US Department of Energy Solar America Initiative has committed $148 million to reach this goal. However, other estimates believe grid parity will be reached sooner. Julie Blunden, the Vice President of SunPower Corp. believes that grid parity will be reached by Likewise, First Solar has stated they are confident that they will lower their production costs to $0.70 per watt between Companies are decreasing the costs of their current manufacturing processes, and it is believed that there does not need to be a technological breakthrough to continue to decrease costs to grid parity. There are three main ways in which the cost of solar power can be decreased. First, if demand increases then photovoltaic cells could be produced on a mass scale, decreasing manufacturing costs per watt. Second, architects could design buildings that include solar panels as part of the infrastructure. In other words, solar panels would not be placed on top of the roof, but would instead be the roof. This would ultimately save labor costs for the total construction of the building with solar installation. Finally, costs will decline as the conversion rate of solar cells increases. For example, if the conversion rate of a solar cell doubled, then the same amount of power could be generated by a cell that is half the size, greatly decreasing material costs. As companies continue to put money into research and development, their manufacturing processes will become more efficient and their costs will decline. Politics Investment Tax Credit The United States offers a tax credit of 30% to both businesses and individuals that invest in solar power technology. This credit was just recently extended through There is no cap on the benefit from solar electric property expenditures, though there is a $2000 cap on solar water heating. Unused tax benefits are permitted to roll over into succeeding years. Since this tax benefit was implemented two years ago, the US Solar Industry has grown by 45%. With the extension through 2016, projections predict the US Solar Industry will gain $325 billion in investment. 5
6 The American Recovery and Reinvestment Act The new stimulus package, which has passed a House vote and is awaiting a vote by the Senate, is another key legislation for the solar industry. Highlights for the renewable energy industry include (taken verbatim from the summary of the act, authored by Representative Dave Obey): Reliable, Efficient Electricity Grid: $11 billion for research and development, pilot projects, and federal matching funds for the Smart Grid Investment Program to modernize the electricity grid making it more efficient, secure, and reliable and build new power lines to transmit clean, renewable energy from sources throughout the nation. Renewable Energy Loan Guarantees: $8 billion for loans for renewable energy power generation and transmission projects. Local Government Energy Efficiency Block Grants: $6.9 billion to help state and local governments make investments that make them more energy efficient and reduce carbon emissions. Energy Efficiency and Renewable Energy Research: $2 billion for energy efficiency and renewable energy research, development, demonstration, and deployment activities to foster energy independence, reduce carbon emissions, and cut utility bills. Funds are awarded on a competitive basis to universities, companies, and national laboratories. Energy Efficiency Grants and Loans for Institutions: $1.5 billion for energy sustainability and efficiency grants and loans to help school districts, institutes of higher education, local governments, and municipal utilities implement projects that will make them more energy efficient. Renewable Portfolio Standards As concerns over environmental issues increase, states and countries are developing renewable portfolio standards that require a certain percentage of electricity to be generated by renewable resources by some future date. Currently, 29 states have required renewable portfolio standards, while five other states have renewable goals. For example, in Oregon utility companies will be required to meet a 25% renewable energy standard by Six countries have nationwide renewable portfolio standards. As regulations like these become more prevalent, investment in renewable energies will continue to increase. This bodes well for the solar industry, especially if grid parity is reached in the near future. Solar in Germany and the Renewable Sources Energy Act Germany comprised over 90% of FSLR s revenue in FY2007. Because Germany is a world leader in solar energy we believe it is valuable to take a closer look at their activities in the solar industry. Germany ranks first in the world in terms capacity, with a capacity of 3,800 MW (2007). This is following an increase of 1,100 MW in Below are the MW capacity the world s solar energy leaders. 6
7 Fueling Germany s success in renewable energy has been the Renewable Sources Energy Act, passed in Under this law, utility companies are required to purchase electricity produced by solar companies at a markup (this mark up is known as the Feed-In Tariff ), making it easier for these companies to profit and therefore developing the PV market. In 2008 the tariff ranged from per kwh of electricity. Ultimately these costs are passed onto consumers through their monthly electricity bill, however, this cost is estimated to be minimal (the feed-in tariff added 1.25 to monthly bills in 2008). The feed-in tariff is reduced by 5% each year, but only for newly installed PV system. This is meant to place pressure on companies who create solar systems to continually lower their costs. S.W.O.T. ANALYSIS Strengths Industry cost leader at $1.08/Watt due to proprietary thin film technology and superior manufacturing processes Guaranteed revenue of $6.3 billion through 2012 from current purchase contracts. Industry leader for thin film technology Pragmatic approach towards expansion reduces risk of inventory surplus Weaknesses Small customer base with six customers making up virtually all of the company s revenues Limited number of raw material suppliers Thin film technology is relatively new, and little is known about performance over a 25 year life period Opportunities Further entrance into the residential sector Emergence of the US market as renewable energy portfolio requirements continue to be increased Reaching grid parity Expansion of megawatt capacity to achieve higher revenues Threats Declining government subsidies Weakening economy could reduce global demand Loss of major customers Interest rate and foreign currency risk Oversupply of megawatt capacity CATALYSTS Upside Decreases in manufacturing costs Achievement of grid parity and related milestones Increased efficiency in the conversion rates of their modules Downside Failure to decrease costs by a larger percentage than price decreases 7
8 Decrease in government subsidies for FSLR customers COMPARABLES ANALYSIS In choosing comparable companies, we looked to find companies with a similar business model to First Solar. Specifically, we looked for other solar module developers that would be privy to the same risks from the solar industry. Due to the lack of established companies in the solar industry, it was difficult to find any comparables of the same size as First Solar. Further, because First Solar s cost structure is at least two years ahead of its closest competitors, we were unable to find comparables with similar operational structures. Ultimately, the four comparable companies we chose were SunPower Corporation (NASDAQ: SPWRA), Trina Solar Limited (NYSE: TSL), Suntech Power Holdings Co., Ltd (NYSE: STP), and Canadian Solar Inc. (NASDAQ: CSIQ). SunPower Corporation (25%) SunPower Corporation is a vertically integrated developer of solar technologies including cells, panels, and inverters. Its products are sold throughout Europe, Asia, and North America. They also offer services to their customers such as maintenance, construction management, and development engineering. Their products are used in solar power plants to deliver electricity to both residential and commercial end-users. The solar cells developed by SunPower are of the crystalline silicon type. SunPower is a comparable company to First Solar based on their similar risk structures. SunPower s future growth is dependent on the emergence of the solar industry, as well as their ability to develop low cost solar power. Further, they operate in similar geographic regions, and are therefore subject to similar socio-cultural factors. In using SunPower as a comparable, we had to take into account both their A and B shares. To determine their market capitalization, we multiplied their total shares outstanding by a weighted average price based on the total number of A and B shares. Trina Solar (25%) Trina Solar is a solar product developer based in China. They manufacture both monocrystalline and multicrystalline silicone solar modules. Their modules range in power output from watts. Their products are sold worldwide to distributors and wholesalers to provide residential, commercial, and industrial power. Trina Solar s business structure is quite similar to First Solar s. They develop a competing solar module and are subject to the same risks related to the solar industry. Like First Solar, Trina Solar has seen high revenue 8
9 growth over the past two years as the solar industry has began to emerge. Their focus in the coming years will be to decrease input costs in an attempt to compete with other forms of energy. Should the solar industry not grow as projected, Trina Solar s growth will be adversely affected. Suntech Power Holdings (25%) Suntech Power Holdings develops both monocrystalline and multicrystalline silicon solar cells and modules. They also provide installation and solar design services to their customers. Like Trina Solar, Suntech is headquartered in China. Suntech is a comparable company to First Solar for much the same reasons as Trina Solar. Their products will directly compete with First Solar s, and they are developed for the same end users. Currently their focus is on developing higher powered modules, much like First Solar is doing. Suntech has grown over 500% in the past two years, and their future growth is dependent on the growth of the solar industry, as well as their ability to reduce production costs. Canadian Solar (25%) Canadian Solar develops solar modules to convert sunlight to electricity. Their multicrystalline silicone modules are sold to distributers in Germany, Spain, Canada, Korea, and China. They also develop specialty modules based on individual customer specifications. Canadian Solar s modules range in power from watts per module. Canadian Solar s cells are developed for residential, commercial, and industrial uses. Their revenues have grown 1500% in the past two years. Their risk profile is similar to that of First Solar, and their business will be facing the same market conditions into the future. Further, they operate in many of the same geographic regions that First Solar operates in, making them subject to similar geographic risks. We used three multiples in our comparables analysis. First, EV/Revenue was used to compare revenue generation to firm size. Second, because companies may be on different depreciation schedules, EV/EBITDA shows different companies earnings prior to depreciation expense. Finally, EV/OCF was used as higher levels of OCF are necessary for capital expenditures, which will be essential for solar companies moving into the future, and we wanted to see how much cash was being generated by each firm. When looking at our comparables analysis, there is obviously a large discrepancy between a) our DCF and comparable implied price, and b) FSLR s multiples and our comparable multiples. We believe these discrepancies rise because of a few interrelated reasons. The first reason is the glaring difference between the market capitalization between our comparables and FSLR. The closest company in terms of market cap is Sun Power. Second, we believe that investors are placing a premium on FSLR that they 9
10 are not placing on other solar companies. This might seem puzzling at first as our comparable companies revenue figures are close to FSLR s, but we believe this distinction lies further down the income statement. The key distinction between FSLR and our comparables is the cost of production per watt. Because of their thinfilm proprietary technology, FSLR has been able to produce solar modules at an industry leading $1.08/watt. The key issue in making solar a viable replacement for traditional fossil fuels is lowering costs, and we believe that FSLR is trading much higher than its competitors because they are the industry low-cost leader and have grid parity in their sights. Another reason is the higher growth potential of thin film solar cells. Thin film cells/modules, because of their low raw material cost; light-weight; and thin appearance, are growing faster than solar modules made with traditional silicon wafers. DISCOUNTED CASH FLOW ANALYSIS Because of FSLR s business and youth, it wasn t feasible to project every line item as a percentage of revenues. Many line items were calculated and forecasted using capacity, including production lines and watts. Revenues To project revenues for FSLR we developed a forecasting model centered on the amount of production capacity (in watts and megawatts) that FSLR would possess over the next 10 years. FSLR frequently discusses their revenues in terms of price/watt and their costs in terms of cost/watt; therefore we felt that projecting revenue and other line items in this format would be appropriate. We took the following steps in ultimately arriving at our revenue projections 1. Project the amount of plants (production lines) FSLR would develop over the next 10 years 2. Project the amount of MW per production line over the next 10 years 3. Project the price per watt for each watt We also took into account analyst estimates, industry research, and company guidance in projecting the revenues. In making our projections, we made a number of key assumptions regarding the above steps. These assumptions will be identified and explained below as we continue our revenue discussions. Projecting the amount of plants (production lines) In their annual report, FSLR included a schedule through 2010 that outlines when certain plants and production lines would be operational. They currently have plants in Ohio (1), Germany (1), and Malaysia (2), each with 4 production lines (The Ohio plant is expanding to 4 lines in 2010). They are currently constructing 2 more plants in Malaysia. To project our revenues it was essential for us to project their MW capacity going forward, and the first step in doing this was projecting the amount of production lines. By the end of 2009 FSLR will have 23 production lines operating at full capacity. One of the FSLR s key strategies is to take a practical approach to capacity by not increasing supply until they have determined that demand has increased. Therefore we have projected FSLR to always be selling modules at full capacity. The solar industry is projected to have high growth in the future. We believe that demand will increase substantially between as solar module producers are able to produce and sell energy at grid parity. Use of solar as an energy source will increase as the prices of solar energy become more comparable (and eventually less expensive) to regular electricity prices. FSLR has projected that they will reach grid parity sometime from This brings us to our first assumption. We have projected that FSLR will increase 10
11 their capacity by 8 lines per year (equivalent of two plants) in those years and subsequently till From 2015 through the terminal year, we estimate that they will increase capacity by 6 production lines per year. We believe this is reasonable because as the industry and demand grows, FSLR will have to increase their capacity to sustain growth and to achieve economies of scale. Projecting the amount of MW per production line At the end of 2007 FSLR s run rate was 44MW per production line, meaning that each line was capable of producing solar modules amounting for 44MW of solar energy per year. To achieve economies of scale, FSLR has estimated that they will continue to increase throughput (the amount of MW that each line produces). This is evident in the increase of MW per line through the 2 nd quarter of The run rate at the 2 nd quarter was 48MW per production line, an increase of 9% in less than a year. This leads us to our second assumption. We project FSLR will increase their run rates each year (at a decreasing rate) till We believe this is a realistic forecast because of FSLR s past ability to increase run rates by large amounts and because of their stated intention to increase throughput to realize operational efficiency. Projecting the price per watt At the end of FY2007 FSLR was involved in contracts with 6 customers that constitute virtually 100% of their net sales. These contracts contain certain covenants, namely that FSLR reduce their price per watt by approximately 6% per year. At first this may seem detrimental to operations, but FSLR has continually been able to reduce their cost per watt by more than the 6% price reduction, effectively increasing margins on each watt sold. We predict that FSLR will continue to decrease prices annually by 6%. We feel that this is feasible because they are locked into some of these contracts past 2012, and since they haven t provided any more guidance, we have no reason to think that future contracts won t contain similar terms. These contracts are denominated in Euros however, and FSLR reports their earnings in dollars after accounting a yearly weighted average currency conversion. Because FSLR s financial statements are reported in dollars while their contracts are in Euros, their revenues are subject to foreign exchange risk. However, it is not within our ability to predict exchange rates. Therefore, we extrapolated the 6% decrease in contract prices in Euros, and subsequently converted these yearly prices to dollars based on the most recent dollar/euro exchange rate of To illustrate FSLR s foreign exchange risk, consider that in dollars their contract prices decreased from $2.44 per watt in 2008 to $2.01 per watt in However, going forward we have assumed that the exchange rate remains constant, and therefore the dollar price decreases at the same rate (6%) as the Euro price. Summation By estimating the capacity and run rates of FSLR each year we were able to project the amount of watts that FSLR would sell each year. We multiplied the amount of watts sold each year by the price/watt figure to derive our annual revenue projections. We feel confident in our projections as the growth reflected in our forecasts is representative of the solar industry in the near future. Our estimates are also in line with analyst estimates (both from Factset and Standard and Poor s). Figures for our capacity and revenue projections can be found in the appendices. Cost of Goods Sold First Solar s competitive advantage is derived from their superior manufacturing processes. Their cost structure is estimated to be at least two years ahead of the rest of the competition for solar modules. Their cost of goods sold is comprised of raw material expenses, direct labor, manufacturing overhead, and depreciation of manufacturing equipment. Due to decreasing prices as part of FSLR s sales contracts, it is essential for them to continue to decrease their costs into the future. Their ultimate goal is to reach grid parity, which they are 11
12 confident will be accomplished by According to FSLR, reaching grid parity will require a production cost per watt of $0.70. FSLR s cost per watt in 2008 was equal to $1.12 (this is a weighted average). Contributing to decreasing COGS is FSLR s recycling program, implemented in They have entered into agreements with the end users of their products to remove the solar modules from their sites at the end of their useful life in order to be either refurbished or resold as used products. FSLR absorbs all costs of this recycling program. This allows FSLR to salvage raw materials to be used in future production. When FSLR sells a solar module, COGS are equal to the production costs of that module plus the present value of future estimated recycling costs. Our projections indicate that COGS will continue to decrease into the future. Because FSLR has stated that they are confident they will reach a cost of $0.70 per watt by 2012, we have decreased COGS at a constant amount (11%) over the next four years. From then onward, we have predicted that FSLR will continue to decrease their COGS by decreasing amounts each year. There are four factors contributing to this decrease in COGS. These include increases in the number of sellable watts per module, increases in the unit output per line, geographic diversification into lower cost regions, and increased efficiency due to economies of scale. Research and Development R&D costs are comprised of the wages, materials, products, and other services that are utilized in FSLR s research process. Because FSLR is involved in such a high-technology industry it is imperative for them to continually invest in R&D; especially if they want to continue to lower their cost per watt and achieve grid parity. R&D has also received grant funding from various entities such as the National Renewable Laboratory (a division of the US Department of Energy) and the Brookhaven National Laboratory to conduct research. FSLR projects that R&D will increase in absolute terms and decrease as a percentage of revenue in the future. This trend is reflected in our DCF projections. SG&A These costs include salaries, personnel costs, insurance, and various expenses associated with the administration of FSLR s business. In the near future FSLR has projected that SG&A will increase as a percentage of revenue as they need to support their rapidly increasing growth levels through increased marketing and sales, and improved information systems. Further down the road, FSLR has forecasted that SG&A will decrease as a percentage of revenue. These sentiments are reflected in our DCF projections. Tax Rate Because of the multi-national nature of FSLR s operations and their youth as a publicly traded company, determining an effective tax rate for them was extremely difficult and speculative. Other issues affecting FSLR s provision for income taxes are listed below Foreign exchange rate fluctuations 1 year tax holiday in Malaysia Deferred tax assets and liabilities Tax carry forwards Because it was beyond our ability to calculate the effect of these factors on the tax rate, we took the following approach to choosing annual tax rates. 12
13 FSLR stated in their conference call that they are estimating an effective tax rate of 11%, and effective rates in the low teens the next few years after that. We kept a 15% effective tax rate through the terminal year because we have not seen any evidence or reasons through our research to make us believe that it will trend towards the federal rate. For this rate to increase FSLR must repatriate their income back to the United States. FSLR has indicated that this is not in their plans for the near future. Production Start-up Production start-up costs include salaries, personnel costs, raw material expenses, and legal expenses prior to a plant becoming qualified for production. To project production startup costs, we looked at past trends based on total projection start-up costs in a given year divided by the number of additional lines beginning production in that year. Recently, costs per additional line of production average $5777. Therefore, these costs were projected as a plug based on the number of additional lines predicted to be developed in each year. Current Assets Projecting current assets was difficult due to fluctuating cash levels over the past five years. Therefore, we were unable to identify an operational level of cash as a percentage of revenue. However, we recognized that due to the high levels of projected growth, FSLR s cash levels would have to be increasing in order to fund future capital expenditures. Hence, we projected cash to grow from its 2008 levels with revenues. While this may result in higher levels of cash than necessary, we are not in the position to determine how much of this cash may be in excess of the operational level. We projected accounts receivable, inventory, and prepaid expenses as a percentage of revenue. Short term investments were removed from the current asset total and added back to firm value, as we viewed these to not be operational assets. All other current asset line items were zeroed out, as they were relatively insignificant, speculative to forecast, and would balance out over time. Current Liabilities Current liabilities include accounts payable, accrued interest payable, short term debt, and accrued expenses. Over the past three years, current liabilities have remained relatively constant as a percentage of revenue. We have projected them to remain at 37.5% of revenue into the future. Capital Expenditures First Solar takes a pragmatic approach toward expanding their operations. They look to increase their capacity with the rise of demand so that they sell all of the watts of power that they are capable of producing. Therefore, as demand increases so too will the need for additional facilities. Over the past two years, FSLR has completed or began construction on five new manufacturing facilities, equaling a total of 20 production lines. Going into the future, we expect this trend to continue. We project that FSLR will construct a total of 62 new production lines between 2010 and We further believe that the majority of these lines will be constructed between 2011 and 2015 as the solar industry emerges. To project the total costs of building these facilities, we looked to the most recent costs of production in Malaysia. The cost of constructing and preparing one four line manufacturing facility was $170 million, or $42,500 per production line. We took this $42,500 base cost, increased it by 3% per year for inflation, and multiplied it by the number of production lines projected to be built that year. Note that in 2009, FSLR has stated that they will not begin the construction of new plants, and therefore the capital expenditures in that year are only related to the completion of the two additional Malaysian plants currently under construction. Also, while FSLR may receive government subsidies for the construction of some plants, we have not projected these 13
14 into the future as subsidies are largely political and we do not know which specific countries FSLR will be expanding to. We also recognize that a portion of capital expenditures will be directed towards routine maintenance and upkeep of the plants. We have added a 0.5% of revenue premium to capital expenditures each year to account for this. Depreciation We project depreciation expense equal to 4.5% of sales declining to 4% of sales in The decline can be attributed to capital expenditures falling as a percentage of sales beginning in Depreciation expense should be correlated to the movement of capital expenditures. Interest Income We have not projected interest income as we cannot predict interest rates or the level of short term investments FSLR will have in the future. We have also added the current amount of short term investments into the present value of free cash flows. Cost of Debt First Solar s most recent debt issuance related to the construction of their manufacturing facilities in Malaysia. They entered into five fixed rate term loans at an interest rate of 4.54%. We believe this to be most indicative of their current cost of debt as it is the most recent loan taken out by the company. Beta To derive First Solar s beta, we ran a 2.5 year weekly regression of FSLR s returns over the S&P 500. First Solar has not been publicly traded for 5 years, so we elected to run a weekly regression rather than a monthly regression so we could capture more data points. The beta we arrived at was 1.97 with a standard error of This is a reasonable estimate as the solar industry is a high risk industry, leading investors to require a high rate of return. We recognize that running a weekly regression captures much more volatility in market prices, but felt that there were simply not enough data points to justify a monthly regression. Further, no comparable companies to First Solar have been traded for a significant period of time so the Hamada equation would have posed similar problems. Note that the beta derived from a monthly regression was 1.64 with a standard error of 0.72 which would not affect our recommendation. 14
15 RECOMMENDATION First Solar is a well positioned company in the industry as their low cost manufacturing, thin film technology, and expansion capabilities will allow them to capture high levels of growth in the near future. However, based on our analysis investors have overvalued this stock in the market. Our comparables analysis implies a price of $25.23, while our DCF shows the intrinsic value of FSLR to be $ Although we believe that First Solar will be a successful player in the solar industry for years to come, our valuation shows it to be overpriced. We therefore recommend a HOLD for the Tall First, Svigals, and DADCO portfolios. 15
16 UNIVERSITY OF OREGON INVESTMENT GROUP February 13, 2009 IME APPENDIX 1 COMPARABLES ANALYSIS First Solar SunPower Trina Solar SunTech Canadian Solar Weight 25% 25% 25% 25% 100% (in thousands, except per share data and volume) Current Price (as of 2/6/2009) $ NA $7.74 $9.90 $5.34 $14.67 Shares Outstanding 81,090 NA 25, , , , Beta Market Cap $11,863,445.1 $2,790,131.1 $198,221.4 $1,542,816.0 $190,264.2 $1,180,358.2 Enterprise Value $12,012,253.1 $3,015,131.1 $345,671.4 $2,624,706.0 $254,434.2 $1,559,985.7 Revenue (ttm) 1,013, ,434, , ,906, , ,205, EBITDA (ttm) 402, , , , , , Operating Cash Flow (ttm) 219, , , , , , Long Term Debt (mrq) 148, , , ,081,890 64, , Cost per watt (mrq) $1.08 Implied Multiple VALUATION MULTIPLES Value Weights EV / Revenue $ % EV / EBITDA $ % EV / OCF $ % Implied Price $25.23 Current Price $ Overvalued 82.75% SPWRA SPWRAB Total Shares Outstanding 43,752 42,033 85,785 Current Price $35.69 $29.23 Market Cap $1,561, $1,228, Combined Market Cap $2,790, Total Covering Analyst: Milad Sedeh & Matt Doty The University of Oregon Investment Group (UOIG) is a student run organization whose purpose is strictly educational. Member students are not certified or licensed to give investment advice or analyze securities, nor do they purport to be. Members of UOIG may have clerked, interned or held various employment positions with firms held in UOIG s porfolio. In addition, members of UOIG may attempt to obtain employment positions with firms held in UOIG s portfolio.
17 UNIVERSITY OF OREGON INVESTMENT GROUP February 13, 2009 IME APPENDIX 2 DISCOUNTED CASH FLOWS ANALYSIS Year Q123A 2008Q4E 2008A+E Net Sales 13,522 48, , , , ,300 1,250,950 2,001,276 2,459,421 3,334,098 4,179,410 4,971,247 5,687,107 6,307,167 6,623,246 6,834,902 7,039,949 % Growth % % % % 59.98% 22.89% 35.56% 25.35% 18.95% 14.40% 10.90% 5.01% 3.20% 3.00% Cost of Sales 18,851 31,483 80, , , , , ,899 1,152,968 1,479,875 1,756,401 2,066,947 2,364,587 2,650,294 2,842,326 3,026,769 3,230,769 % Revenue % 65.50% 59.81% 50.12% 45.31% 46.00% 45.55% 49.51% 46.88% 44.39% 42.03% 41.58% 41.58% 42.02% 42.91% 44.28% 45.89% Gross Profit (5,329) 16,580 54, , , , ,167 1,010,377 1,306,453 1,854,223 2,423,009 2,904,301 3,322,520 3,656,874 3,780,920 3,808,134 3,809,181 % Revenue % 34.50% 40.19% 49.88% 54.69% 54.00% 54.45% 50.49% 53.12% 55.61% 57.97% 58.42% 58.42% 57.98% 57.09% 55.72% 54.11% Operating Expenses Research and Development 1,240 2,372 6,361 15,107 22,437 10,958 33,395 50,032 61,486 83, , , , , , , ,439 % Revenue 9.17% 4.94% 4.71% 3.00% 2.76% 2.50% 2.67% 2.50% 2.50% 2.50% 2.40% 2.40% 2.40% 2.35% 2.35% 2.35% 2.35% SG&A 9,312 15,825 33,348 82, ,292 65, , , , , , , , , , , ,593 % Revenue 68.87% 32.93% 24.71% 16.32% 14.93% 15.00% 15.00% 15.50% 16.00% 16.50% 17.00% 16.50% 16.00% 15.50% 15.00% 14.50% 14.00% Production Start-up 900 3,173 11,725 16,867 23,727 23,108 46,835 46,216 46,216 46,216 46,216 46,216 46,216 46,216 34,662 34,662 34,662 % Revenue 6.66% 6.60% 8.69% 3.35% 2.92% 5.27% 3.74% 2.31% 1.88% 1.39% 1.11% 0.93% 0.81% 0.73% 0.52% 0.51% 0.49% Total Operating Expenses 11,452 21,370 51, , ,456 99, , , , , , ,782 1,092,644 1,172,046 1,183,796 1,186,343 1,185,694 % Revenue 84.69% 44.46% 38.11% 22.66% 20.61% 22.77% 21.37% 20.31% 20.38% 20.39% 20.51% 19.83% 19.21% 18.58% 17.87% 17.36% 16.84% EBIT (16,781) (4,790) 2, , , , , , ,243 1,174,528 1,565,987 1,918,519 2,229,876 2,484,828 2,597,125 2,621,790 2,623,487 % Revenue % -9.97% 2.08% 27.22% 34.09% 31.23% 33.09% 30.18% 32.74% 35.23% 37.47% 38.59% 39.21% 39.40% 39.21% 38.36% 37.27% Foreign Currency Gain (loss) 116 (1,715) 5,544 1,881 (468) 0 (468) % Revenue 0.86% -3.57% 4.11% 0.37% -0.06% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Interest Income ,648 20,413 16, , % Revenue 0.00% 0.66% 1.96% 4.05% 2.08% 0.00% 1.35% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Interest Expense, net (100) (418) (1,023) (2,294) (131) 0 (131) % Revenue -0.74% -0.87% -0.76% -0.46% -0.02% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Other (Expense) Income (6) 56 (799) (1,219) (1,179) 0 (1,179) % Revenue -0.04% 0.12% -0.59% -0.24% -0.15% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Income (Loss) Before Income Taxes (16,771) (6,551) 9, , , , , , ,243 1,174,528 1,565,987 1,918,519 2,229,876 2,484,828 2,597,125 2,621,790 2,623,487 % Revenue % % 6.80% 30.95% 35.95% 31.23% 34.30% 30.18% 32.74% 35.23% 37.47% 38.59% 39.21% 39.40% 39.21% 38.36% 37.27% Income Tax Expense (Benefit) 0 0 5,206 (2,392) 76,605 35, ,196 66, , , , , , , , , ,523 Tax Rate 0.00% 0.00% 56.71% -1.53% 26.22% 26.00% 26.15% 11.00% 14.00% 15.00% 15.00% 15.00% 15.00% 15.00% 15.00% 15.00% 15.00% Net Income (Loss) (16,771) (6,462) 3, , , , , , , ,349 1,331,089 1,630,741 1,895,395 2,112,104 2,207,556 2,228,522 2,229,964 % Revenue % % 2.94% 31.42% 26.53% 23.11% 25.33% 26.86% 28.16% 29.94% 31.85% 32.80% 33.33% 33.49% 33.33% 32.61% 31.68% Add Back: Depreciation and Amortization 1,944 3,376 10,210 24,481 40,400 20,600 61,000 90, , , , , , , , , ,598 % Revenue 14.38% 7.02% 7.56% 4.86% 4.97% 4.70% 4.88% 4.50% 4.50% 4.50% 4.25% 4.00% 4.00% 4.00% 4.00% 4.00% 4.00% Add Back: (1-TR) *Interest Expense , Cash Flows from Operations (14,727) (2,668) 14, , , , , , ,183 1,148,383 1,508,714 1,829,591 2,122,879 2,364,390 2,472,486 2,501,918 2,511,562 Current Assets 26, , , , , ,517 1,431,053 1,758,658 2,384,113 2,988,570 3,554,789 4,066,679 4,510,065 4,736,084 4,887,433 5,034,055 % Revenue 54.60% % % % % 71.51% 71.51% 71.51% 71.51% 71.51% 71.51% 71.51% 71.51% 71.51% 71.51% 71.51% Current Liabilities 33,913 52, , , , , , ,283 1,250,287 1,567,279 1,864,218 2,132,665 2,365,188 2,483,717 2,563,088 2,639,981 % Revenue 70.56% 38.58% 37.00% 36.62% 37.50% 37.50% 37.50% 37.50% 37.50% 37.50% 37.50% 37.50% 37.50% 37.50% 37.50% 37.50% Net Working Capital 0 (7,671) 336, , , , , , ,375 1,133,826 1,421,292 1,690,572 1,934,014 2,144,877 2,252,366 2,324,344 2,394,074 Change in Net Working Capital 343,800 47, ,029 (105,964) 42, , , , , , , , ,489 71,978 69,730 Capital Expenditures / Acquisitions 7,733 42, , , , , , , , , , , , , , , ,179 % of Revenue 57% 88% 113% 49% 41% 24% 35% 16% 8% 12% 10% 9% 8% 7% 6% 6% 6% FCF (22,460) (45,149) (482,323) (109,924) (222,583) 122,802 (99,781) 47, , , ,198 1,129,477 1,432,844 1,691,289 1,999,163 2,053,067 2,053,652 PV FCF , , , , , , , , , ,004 Covering Analyst: Milad Sedeh & Matt Doty The University of Oregon Investment Group (UOIG) is a student run organization whose purpose is strictly educational. Member students are not certified or licensed to give investment advice or analyze securities, nor do they purport to be. Members of UOIG may have clerked, interned or held various employment positions with firms held in UOIG s porfolio. In addition, members of UOIG may attempt to obtain employment positions with firms held in UOIG s portfolio.