Consolidation in Chinese Solar Is Here

A Chinese solar company has defaulted on loans and has been brought into bankruptcy by Chinese banks. Many investors never thought this would happen. The free flow of money from state-run banks to the solar industry has been going on for years and a bailout from either a Chinese bank or a local government was always thought to be just days away.  

There was no such luck for Suntech Power (NASDAQOTH: STPFQ  ) , who held the title of largest solar module manufacturer for two years. The company defaulted on U.S. convertible notes on Friday, which triggered a default on Chinese debt and the end was near.

The last day of Suntech as we know it
We know that Suntech had over $2.2 billion in debt, most of it with Chinese banks who have long been forgiving of troubles in solar. So, when the company defaulted on U.S. debt and still refused to pay investors, the thought was that U.S. investors would force the company into involuntary bankruptcy. In fact, eight Chinese banks filed a petition for insolvency with the Chinese court.  

This may seem like a small detail of Suntech's bankruptcy but it's very important to other companies in the industry. The central Chinese government has said it won't bail out solar firms because consolidation and bankruptcies will be good for the industry. In December, the State Council said it would even ban local governments from propping up failing companies, as LDK Solar's (NASDAQOTH: LDKSY  ) local government did last year.

Until today, those words seemed hollow to companies and many industry observers. But the central government, local governments, and state-run banks didn't interfere with the bankruptcy of Suntech. In fact, the banks were the ones that caused it.

Where Suntech goes from here is currently unknown. The local Wuxi government now has seats on the board and it's likely the government will bail out local manufacturing, which accounts for about three-quarters of the company's manufacturing. Other assets may be sold to pay off other debts. We'll know more about Suntech's and the banks' plans in the next few days.

What this means for Chinese solar
Yingli Green Energy (NYSE: YGE  ) and LDK Solar should be watching the Suntech saga closely because with $2 billion and $3.3 billion of net debt, respectively, they could be heading for a similar fate. Neither company has the ability to pay back loans and if Suntech can go down so will they.

The balance sheet problems are bad, but there are also strategic implications. As the cost of solar panels has fallen, the less tangible qualities have become more important. Quality, service, warranty, etc. are now considered by installers just as much as cost. If these companies are effectively insolvent why would I trust a warranty? Why would I choose Yingli over a manufacturer with less debt that may be there to service my products in five years? LDK is a supplier to solar manufacturers and its challenge may be even harder.

I've singled out these two companies because of their debt loads but all of Chinese solar is going through a major transition period. Companies with either high debt or weak cost structures will have to begin looking for alternatives before the hammer drops on them as well.

How to invest in solar now
This doesn't change my investment thesis in solar, in fact, it only bolsters it. U.S. companies with strong balance sheets and differentiated products are what investors should be putting their money in. SunPower (NASDAQ: SPWR  ) is still my top pick and, with the stock up 4.5% today, it looks like the market is seeing the upside as well. First Solar (NASDAQ: FSLR  ) isn't as strong on the module side but a good balance sheet gives it the ability to be flexible and there's no company that does utility scale solar better.

If you're interested investing in solar, these two companies are currently at the top of the list. Meanwhile, I would stay away from everything in China.

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