Anyone reading my articles on Suntech Power, or Trina Solar may have done some research and figured out that MEMC Electonic Materials (WFR) is a leading supplier of wafers which are key building blocks for solar panels built by these companies. It would stand to reason that a supplier of these companies would therefore benefit from the growth in solar panels and might be a good additional place to invest in. While that logic makes sense on the surface, I have found that in digging a bit deeper into WFR’s fundamentals that there may be more cause for concern than opportunity.
It turns out that while WFR is listed as one of the leading suppliers to solar companies, it has only begun to ship wafers to this industry in January of 2007. Solar energy customers make up only 5-10% of the companies revenue and while that is expected to increase over time, the company’s primary customers include semiconductor manufacturers. While supplying the semiconductor industry is a viable business strategy, the overall sector is very susceptible to economic cycles which can become very difficult to predict. Currently, many are calling for the semiconductor market to pick up at any time, but these calls have been coming for quite some time and there has been little evidence of meaningful improvement in the area.
Besides supplying wafers to the solar and semiconductor sectors, the company also sells raw polysilicon to chip makers. Currently there is a severe shortage of polysilicon and while there is ample raw materials to make it (the primary ingredient is sand), there are few suppliers who have the capability to make high quality polysilicon. The company is expecting to double its capacity by 2010 adding a couple thousand tons worth of annual production over the next few years. The margin on this material is tremendous as users are willing to pay extreme premiums to have WFR guarantee delivery. While this is a definite benefit to the company at this point, economics dictate that when there is extreme profit to be made, additional competitors will enter the market and drive down the price. This is beginning to happen and while it will take some time to get additional capacity online, it will eventually cut down on the margins WFR is enjoying.
The stock trades at a premium to typical semiconductor suppliers and that is likely justified by their historical growth and healthy margins. However, I think the easy money has now been made and it is likely investors will become more skeptical as the economy may come under pressure, competitors enter the market in stronger force, and WFR has yet to prove it can ramp up sales to the solar energy market. Texas Pacific Group (TPG) which is the private equity company that has owned the majority of WFR in the past has been liquidating its holdings. At the beginning of the year the investment firm had a 25% holding in the company. At last check, the company now owns only 2% and one can probably safely assume that the private equity financier has an intricate understanding of the business prospects. This “no confidence vote” should not be the basis of any investment decision, but it fits with the picture I am seeing as I look closely at the firm and helps me feel a bit more comfortable with my short position.
FD: Author has short position in WFR
Additional Reading:
Barrons Tech Trader Daily notes CSFB upgrade
A wallstrip video report on WFR as it applies to their solar business
August 20th, 2007 at 2:23 pm
i have been working on an equivalent: Hoku Scientific-hoku. there was big news involving STP and others in past 60 days , a big run up in past 60 days, and then a gaint dip, almost back to square one. I will work on WFR.
August 20th, 2007 at 4:35 pm
Your analysis of WFR is interesting, but wrong (for one simple reason)!
Wafer’s current year and next year’s projected P/E ratios are in the mid and low teens, which is why it’s a terrible short play right now. Thus, each of your potential “weaknesses” in WFR stock, is already more than reflected in the multiple.
WFR is a great BUY here, not a sell…as you will soon find out…
August 20th, 2007 at 5:56 pm
Not so fast Zack. You did SOME homework just not ENOUGH. Using TPG as example of both fine business acumen and a barometer of sentiment is faulty. TPG has liquidated some of it’s postions in order to join KKR in the TXU takeover. In fact TXU is currently trading below it’s targeted buyout price of 69.25. Your Private Equity “smartest men in the room” theory is being drastically tested as financing deals becomes harder to get and
way too many paid too much for many of their deals as Equity Office Properties/Sam Zell illustrates. Their smart until their not smart anymore.
Maybe you didn’t get the memo, but MEMC has hedged a lot of their future solar sales with a $5-6 billion contract with Sun Group (STP holding company) over the next ten years. They just began shipments this quarter. If this contract alone was to represent 10% (the high end of YOUR est.)of MEMC’s total revenue and we use the low end of the contracted sales of $5B that would mean a minimum of $5B in sales averaged over the next 9 1/2 years and a maximum of $12B in average sales using your %5 of total revenue and $6B contract price. The projected earnings for ‘07 are between $1.93-$99B.
Your supposition of sluggish demand in semi’s is drastically different from most analysts. Credit Suisse’s John Petzer just upgraded INTC citing “Strong demand trends taking hold, including corporate PC upgrade cycle, virtualization and multi-core; he sees ASPs rising as a result.”
You also cite competition and an economic downturn in your thesis. Regarding the competition MEMC has hedged some of it’s future sales revenues with contractual obligations. Obviously you have taken into account that the financing of large plants required to make wafers has become much more expensive and harder to get thus some of the would be competitors will never get it done. As far as an economic dowturn is concerned, I think that is your best argument but even that is suspect at this point.
FD: WFR Long Postion
August 20th, 2007 at 9:03 pm
Please note that in the above reply in paragraph 2 it should read as “Projected for SALES for ‘07 is between $1.93-$199B.”
All of the assumptions in paragraph 2 are based on Zach’s assertion that MEMC’s solar sales being 5-10% of total sales. By using the contract with Sun Group I extrpolated total SALES revenue using both the 5% and 10% amount and the Sun Group 10 year contract of between $5-$6B.
August 20th, 2007 at 9:09 pm
Thanks for the comment RJ. One of the best reasons for doing this blog is getting opposing viewpoints and insights. Most analyst reports I have read are bullish and it does seem to me that investors are pricing in a robust outlook. Many semiconductor capital companies trade in the low double digit multiples. However, you raise some very good points that investors should keep in mind. Risk control is paramount and if my analysis is wrong (wouldn’t be the first time) I will quickly take my losses and move to cash rather than stick around and lose capital taking a loss. RJ, I hope you stay in touch and we can see how this turns out. Good luck with your position.
August 20th, 2007 at 9:44 pm
WFR actually looks quite undervalued to me. As you said, the growth forecasts seem to be quite high for WFR, possibly even too high, but even if they fall some the company still trades at a great looking PEG ratio and a discount to its peers. An economic downturn doesn’t hurt a company like WFR as bad as stocks in other sectors in my opinion. Love reading the analysis on the site, but have to disagree on WFR.