By Matt Daily and Nichola Groom
(Reuters) - Only four years ago, hundreds of start-ups optimistically built factories and churned out solar panels to meet rising demand. Now, closures and failure loom for many.
The brutal shakeout is a dramatic reversal for an industry that has seen overall global growth of more than 30 percent annually over the past decade and this year will reach new records for solar panel sales.
Only a handful of manufacturers are now profitable in the face of too much capacity, which has contributed to a plunge in prices, and as government subsidies have been curbed. European banks that lent billions for solar installation have also pulled back as they struggle in the euro zone credit crisis, and debt-laden Chinese solar companies are in danger of burning up.
Solar profit margins that often approached 50 percent in 2007 have in many cases disappeared altogether. The pain - namely bankruptcy for some key players in the sector - may get much worse before it begins to ease.
"When you look at some of those balance sheets and how levered those companies are, and you look at how thin their profit margins are, it can really make your hair stand on end," said Kevin Landis, portfolio manager of the Firsthand Alternative Energy Fund, whose top holdings include Swiss solar equipment maker Meyer Burger Technology AG and U.S. equipment maker GT Advanced Technologies Inc.
And while sliding prices are making solar more competitive, the prospect of new cheap supplies of natural gas around the world is undermining those gains.
The continuing shakeout is seeing many of the early entrants to the solar industry either fail or sell out. A whole new breed of big investors, such as Warren Buffett and Google Inc, or oil industry companies such as TransCanada Corp, are moving into solar power production. Some, including oil giant Total, have even entered the tumultuous panel manufacturing market. Its rival BP Plc, however, said this week it was exiting the solar business entirely.
Asian conglomerates that already have solar panel manufacturing operations, such as Japan's Sharp Corp or South Korea's LG Corp, could scoop up their smaller, struggling rivals, or simply allow them to fold and benefit from reduced capacity.
The rapid march down in prices and the Darwinian survival of only the fittest - without the aid of large government subsidies - is making solar power more competitive against conventional energy sources, such as oil, coal and nuclear power. That means that for homeowners, businesses and utilities, the choice to go solar is more attractive and attainable than ever.
Still, even the most efficient manufacturers are troubled. First Solar, the U.S.-based low-cost leader, last week announced job cuts, saying 2012 profits would be up to 50 percent below Wall Street forecasts. A week earlier, another big U.S. solar company, MEMC Electronic Materials Inc, said it would cut a fifth of its staff and idle some facilities.
At the heart of the downturn is a massive global glut of panels and huge excess production capacity that has driven prices down more than 40 percent in 2011.
"The prices that we're seeing today are likely not covering manufacturing costs in many cases," said Ralph Romero, director in management consulting for Black & Veatch, which provides engineering and due diligence consulting services to solar manufacturers.
The pain for the solar manufacturers has been acute, with most shares in the sector dropping more than 60 percent. First Solar, a one-time Wall Street darling, is the worst-performing stock in the Standard & Poor's 500 index this year, down more than 73 percent.
A number of companies have already lost their fight for survival, such as Germany's Solon SE and Solar Millennium, which both sank into insolvency this month. That follows U.S. companies Evergreen Solar, SpectraWatt and Solyndra, the last of which shut down operations in September despite its controversial gobbling up of more than $500 million of U.S. government support.
Even China's notoriously aggressive small, private manufacturers are closing factories. In fact, experts predict much of an estimated 49.8 gigawatts of global solar cell production will have to be shuttered so that companies can profitably meet expectations of far lower global demand.
A GLOOMY OUTLOOK
Prices for solar panels started 2011 near $1.60 per watt, but a buildup of inventory forced manufacturers into a fire sale toward the end of the second quarter that has pushed prices to near $1 per watt now. Romero said prices for polysilicon panels, the dominant technology, may stabilize around that level, though others see declines continuing well into next year.
SolarCity, one of the largest U.S. solar installers, is anticipating a further slide early in 2012. "I do think 85 cents is probably close to the floor," said Lyndon Rive, its CEO.
That price could spell difficulties for some major names, including U.S.-listed Chinese companies Suntech Power Holdings , which has the biggest capacity for making panels in the world, and LDK Solar Co , one of the largest makers of polysilicon wafers used to make panels, industry analysts and investors say.
LDK did not respond to questions about its financial health. A spokesman for Suntech emphasized the company had cemented its position as the largest supplier of panels globally, and that it is increasing its market share.
Like other China-based companies, Suntech and LDK won massive credit lines from state-backed banks. Two years ago, that was seen by many in the industry as an unfair handout that allowed them to outflank rivals in Germany or the U.S.
But now that debt, about $2.2 billion for Suntech and $3.6 billion for LDK, is proving a huge burden.
"Maybe because (LDK) are so big they get some kind of sweetheart debt deal that prevents the company from going under, but I would find it really hard to believe that the current equity holders are going to be spared," said Morningstar solar industry analyst Stephen Simko, who added that Suntech also looks particularly vulnerable.
LDK's debt has swelled $800 million in the past 12 months to almost three times its net asset value, and analysts see it showing negative free cash flow of about $1.1 billion this year and $375 million in 2012, Thomson Reuters I/B/E/S data show.
On the same basis, Suntech negative free cash flow is likely to approach $800 million this year, and $200 million in 2012.
Concerns are also swirling in the debt markets, where LDK's 4.75-percent bonds due in April of 2013 are priced at around 68 cents on the dollar, according to Thomson Reuters data. Markit data, however, shows that issue priced at 47 cents to 51 cents on the dollar. Suntech's debt that matures in March of 2013 is priced at 41 to 42 cents on the dollar, according to Thomson Reuters and Markit.
"We exceeded both our shipment and gross margin guidance for the third quarter and ended the quarter with over $560 million of cash and restricted cash," Rory Macpherson, Suntech's director of investor relations, said in an email.
"We are also implementing a range of initiatives that will strengthen our financial position over the next 12 months. These include accelerating cost-down programs, improving working capital by $200 million by the end of the year, reducing operating expenses by 20 percent in 2012, limiting capital expenditures to maintenance only, and monetizing non-core assets."
THE GAS THREAT
First Solar's projects have drawn the interest of large corporate partners such as U.S. utilities MidAmerican and NRG in part because the company's panels are the cheapest - making them ideal for large projects. First Solar makes panels from cadmium telluride rather than pricey polysilicon, the key component for more than 80 percent of global supply.
First Solar has said its costs are expected to drop more than 10 percent to 65 cents per watt by the end of next year, excluding the costs of running production below capacity.
That might be just enough to allow it to sell its panels at a discount to its polysilicon-based rivals - a discount it needs because its panels are not typically as efficient at turning sunlight into electricity, a fact acknowledged by both the company and industry experts alike.
Only three others, China's Yingli Green Energy Holding, Trina Solar Ltd and Jinko Solar Holding Co, are expected to get costs low enough to sell profitably at 85 cents per watt next year.
Recognizing the darkening market economics, First Solar's CEO Mike Ahearn has said the company will shift sales away from Europe, a market that had been supported by subsidies.
Germany, the world's top solar market, has gradually been ratcheting down its solar subsidy, while other large markets such as Spain, Italy and the Czech Republic dramatically cut back subsidies that had led to a boom in demand.
First Solar plans to get more power out of each panel and cut building costs for solar power plants to get the cost of electricity production down to $100 to $140 per megawatt hour in the next three years. That would be less than half the price a year ago and near the $90 per megawatt hour cost of a new nuclear plant.
However, it has a long way to go still to be competitive against other energy sources - it would still be nearly double the cost of a coal-fired power plant and triple that of natural gas plants, according to U.S. Department of Energy data.
And those natural gas plants represent one of the biggest threats to solar power in the United States, since the advent of hydraulic fracturing drilling technology has opened up decades' worth of gas supply. Utilities are rushing to build new gas-fired plants that can produce electricity cheaply.
Even with an 85-cent per watt price in sight for some, the industry will still need government support. And that backing will be available in fewer places and often under less generous terms.
"Without subsidies solar PV is still not in a position to be competitive across the board," Romero said.
Solar is competitive today in some places where power prices are very high, Romero said, such as California. That, as well as the state's mandate that it source one third of its electricity generation from renewable sources by 2020, has led to a boom in the building of solar projects there.
But the trend is "on the down slope" now as the state has fulfilled much of its requirement, said Ahearn. That's another reason First Solar and others are looking at new markets.
First Solar is betting that its 2015 cost will be low enough to drive business in India, and some other markets, to win new contracts that need no government subsidy.
It is not alone in trying to break into such markets. Suntech, Yingli and Trina have all said they would target places like India. The only problem is that it will take several years at least to develop enough business to be profitable in those markets and competition could be intense.
"Over 95 percent of historical demand for PV has come from subsidy-driven markets, principally in Europe. The strategy of shifting focus to frontier markets makes sense in the long run but demand there is quite limited for the time being," Raymond James analyst Pavel Molchanov said.
The new, promising solar markets most often cited by manufacturers include India, Southeast Asia and South Africa. Such markets not only enjoy abundant sunlight, which makes the economics of solar more attractive, they also have strong appetites for new sources of power and in many locations lack the grid infrastructure needed to build large power plants. That's another advantage for solar, which can be deployed on a small scale without the need for new transmission.
Also, in many emerging markets such as India, the use of diesel generators keeps electricity prices high - making solar more competitive.
"The economics in a lot of emerging markets makes solar very attractive without needing the incentives we have in the U.S. because of the cost of power in those countries and because solar eliminates the need for transmission," said Marty Klepper, co-head of the energy and infrastructure projects practice at Skadden, Arps, Slate, Meagher & Flom LLP.
The Indian government has a goal of generating 20 GW of electricity from grid-connected solar energy and 2 GW of off-grid solar by 2022 against just 54 MW installed at the end of 2010. India recently lowered its forecast for when solar would be competitive with grid electricity by five years to 2017.
In the U.S. though, conditions are worsening - and not just because of the threat of a cheap gas supply.
The industry is decrying the expiration at the end of this month of a program that allows solar project owners to recover 30 percent of the cost of construction in the form of a cash grant. The program will revert to a tax credit next year, making it useful only to those seeking to reduce their tax bill.
"Projects that have yet to commence construction are all at risk," said Darren Van't Hof, director of renewable energy investments for U.S. Bank, a unit of U.S. Bancorp. "Investors without a tax appetite are going to be challenged to stay in the market."
The chances that Congress will renew the cash grant program have dimmed, and that could hit demand immediately.
"We're projecting a big upswing in our business next year and I don't know if we'll get that if this goes away," said Tony Clifford, CEO of U.S. project developer Standard Solar.
One of the few bright spots is that despite the headwinds, there is new investment coming into solar power production.
Most recently, Warren Buffett offered the industry a major vote of confidence when his MidAmerican Energy Holdings bought First Solar's $2 billion Topaz Solar Farm, which at 550-megawatts is one of the two largest being built in the world. MidAmerican bought 49 percent of another First Solar project a week later, a move it said was part of a strategy to "aggressively" pursue opportunities in renewable energy.
Other big names, such as Bank of America and utility giants Exelon and NextEra, have also been investing in solar power projects. Bank of America has put its heft behind a plan to build more than $1 billion in solar projects on military housing with SolarCity, while Exelon and NextEra have each bought major First Solar projects.
Google has been an investor for several years and on Tuesday made its latest move, saying it would team up with private equity firm KKR to buy four California plants.
Winners are expected eventually to emerge but the question is how much more carnage there will be before that happens. "There is going to continue to be this natural rate of attrition where smaller companies sort of die off and the big companies who have been looking at the market and moving in will continue to make a bigger impact," said Firsthand's Landis.
(Reporting by Matt Daily in New York and Nichola Groom in Los Angeles; Editing by Martin Howell)