IPO Darkens China's Solarfun

Such unorthodox payments may not catch the attention of regulators, but they feel dodgy in an investment climate where dozens of U.S. executives have resigned in the wake of options-backdating scandals.

And if investors don't feel encouraged by the footnote disclosures in Solarfun's prospectus, they may also not like the things the company says when it discusses its handling of the protracted silicon shortage. Silicon is a key material not only in computer chips but also in solar modules and panels.

A key to appraising solar companies is looking at their risk sections. Everyone knows rising silicon prices is a risk; what's important are the tactics companies use to get around the problem. Solarfun is relying on costlier short-term contracts and prepaying silicon suppliers, which is risky if its suppliers can't get their hands on suppliers.

This already happened in 2006. "Some of our major silicon-wafer suppliers failed to fully perform during 2006 on their silicon wafer supply commitments to us, and we consequently did not receive all of the contractually agreed quantities of silicon wafers from these suppliers," Solarfun said.

While its rivals have taken resourceful approaches to the silicon shortage -- Trina is buying scrap silicon at bargain-basement prices, while Suntech Power (STP Quote) relies on long-term contracts -- Solarfun seems to lack a coherent plan. Like other China-based solar companies, it relies on lower labor costs (that is, when it's not jacking them up through discounted stock allotments).

So Solarfun sold more shares with a less-coherent strategy to manage silicon prices and some questionable disclosures in the footnotes of its income statement. If it had been the first Chinese solar play out of the gates, investors might have been more forgiving.

But it wasn't. Instead, it's vying for capital in a sector that's growing more crowded -- even as the industry's prospects remain challenging for a few years. That will keep investors cautious for the time being.