In Solar Downturn, Governance Concerns Rise

NEW YORK (TheStreet) -- LDK Solar (LDK) said its audit committee chief and independent director Louis Tung-jung Hsieh was resigning, the latest in a recent string of negative headlines for Chinese solar companies involving finance officials.

Last week, JA Solar (JASO) announced the resignation of its chief financial officer. In the past month, ReneSola (SOL) and Hanwha Solar (CFO) announced CFO departures.

Trina Solar (TSL) announced a week ago that a board member and chairman of its audit committee was resigning.

In the least, "management departures are not helping sentiment," wrote Sam Dubinsky, analyst at Wells Fargo Securities.

While accounting scandals have become a major overhang on Chinese stocks, the Chinese solar sector in particular had been insulated from the woes. The recent spate of negative headlines has cast a cloud over a sector, though, and it's already suffering from a major downturn. Second-quarter earnings are expected to be terrible throughout solar, and some investors and analysts have feared that pressure increases on accounting officials during periods of weak sales.

"There is always more pressure in down markets and corporate governance always become an issue when times are bad. Things blow up when markets are bad," said Kaufman Brothers analyst Jeff Bencik, adding that he expects the second quarter will be the worst quarter for solar since the financial crisis. "Some companies won't be profitable and won't make it," the analyst said, but he added this doesn't necessarily imply accounting issues. He stressed that this was not an issue distinct to the Chinese solar companies, either. European high cost solar vendors face extinction, as well as Chinese solar companies that can't gain market share to make up for reduced profitability.

Analysts say that a general rule in sector downturns is that corporate governance risk rises as fundamentals deteriorate. Steven Simko, analyst at Morningstar, pointed to questionable transactions made by solar companies during the last major solar sector downturn in 2008/2009 as proof that sector pain often translates into questionable governance. Suntech Power (STP) created its Global Solar Fund during the last solar sector downturn, a solar project entity into which Suntech can sell its modules, but a business which remains an overhang on Suntech shares today due to its aggressive accounting method and affiliated nature of the transactions between Suntech and the fund. Yingli Green Energy (YGE) acquired a polysilicon business owned by its chairman during that same sector downturn, and the polysilicon business has consistently been delayed in its ramp and remains a headwind for Yingli today.

Shortly before JA Solar announced the departure of its financial chief, the company acquired a wafer business from a company 70%-controlled by the JA Solar chairman. Several analysts questioned the acquisition of a wafer company owned by JA Solar's chairman at a time when the wafer business is struggling.

Morningstar's Simko said these are exactly the kinds of transactions that investors need to be wary of during sector downturns, and he believes that the worst is yet to come for solar stocks in the current downturn.

"Now we will find out if the cost models stated by the Chinese companies are actually true. Some modules are now selling at $1.30/watt so your cost model better be $1.10/watt," Kaufman's Bencik said, adding, ""You can hide more stuff when the market is going well and when the markets turn bad, it's harder."

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