JA Solar Deal: Better for Chairman or Holders?

NEW YORK ( TheStreet) -- This past week began and ended with deals showing business links between Chinese solar stocks and their senior executives that can bring out the skeptics.

On Friday, solar cell giant JA Solar ( JASO) announced the acquisition of a solar wafer company, Solar Silicon Valley, that is 70% owned by the Jinglong Group, which is controlled by JA Solar's chairman, Baofang Jin.

On Monday, LDK Solar ( LDK) said its board had authorized the repurchase of up to $110 million in what it views as "grossly undervalued" shares. LDK Solar's chairman has pledged 31% of the LDK Solar shares he owns as collateral to banks, and with the recent decline in shares, the buyback plans could be linked to the collateral issue.

It's part and parcel of the way Chinese companies do business for deals to take place between U.S.-listed stocks and affiliated companies held by senior managers. For the most part, it's been an accepted part of investment in these shares for most investors. Michael Sheppard, solar analyst at iSuppli, referred to the trend as "coopetition."

The iSuppli analyst said it's the status quo in the sector, and with the JA Solar acquisition, the usual mix of skepticism and acceptance was evident in the market reaction.

"The related party transaction is sure to raise investor questions," wrote Stifel analysts in a research note. The closing is expected by the end of the third quarter.

JA Solar established an independent committee of independent directors to evaluate the deal, and board members affiliated with the acquisition target did not vote on the approval.

JA Solar shares were down slightly on Friday after it announced that it would issue 30 million shares to finance the acquisition, shares priced at $5.82, a premium to the stock's closing price on June 30 of $5.55. The deal price is roughly 20% of JA Solar's market cap.

Here are some of the key aspects of the JA Solar deal to consider in assessing the 70% interest of JA Solar's chairman in the just-acquired company as an aspect of the transaction, vs. the benefit to JA Solar shareholders from the acquisition.

  • The acquisition valuation wasn't expensive.
  • JA Solar is paying $180 million in newly issued shares for the solar wafer company. This values the solar wafer company at 2.5 times 2010 net income, according to Stifel analysis, or 35 cents/watt for the acquired 485 megawatts.

    In 2010, Solar Silicon Valley generated about $300 million in sales and $68 million in net income. JA Solar says that the company it is acquiring has no debt. Analysts said they would be much more skeptical if JA Solar's chairman was not only moving the wafer company risk to JA Solar shareholders, but moving a high level of debt to shareholders also.
  • If the deal's not expensive, it's timing breeds skepticism.
  • Wafer pricing has been going over a cliff, and the business is not expected to improve considerably in the coming quarters. As Stifel said in a research note, that while valuation "looks reasonable on the surface relative to historic industry multiples, and vertical integration would add value in healthy end-market demand or tight wafer supply conditions, the acquisition is likely to face investor skepticism given the sharply reduced wafer pricing in recent months in a sluggish solar PV demand environment with large amounts of wafer capacity slotted to come online in 2011, which all should make purchases of 3rd party wafers attractive relative to adding in-house subscale production."

    Several other solar analysts said that with wafer pricing in freefall, even if the price paid is inexpensive, the deal would seem to benefit the JA Solar chairman right now more than JA Solar shareholders. This doesn't mean long term that the deal doesn't benefit JA Solar shareholders, but that the weakness in the wafer market has to make one skeptical of the JA Solar chairman cashing out right now.

    Stifel was also concerned about the lack of transparency related to the books of the private company being acquired. "We were also puzzled by the limited transparency provided on the manufacturing costs or financials for 2Q11 for Solar Silicon Valley, which makes it difficult to assess the attractiveness of the acquisition price paid."
  • JA Solar says it will gain margin and cost efficiencies as a result of bringing more wafering in-house.
  • JA Solar says the deal will be accretive to gross margins immediately. That's a positive, but pricing in the solar cell market has gone over a cliff, too. At the end of the day, JA Solar shares will rise or fall based on the company's overall execution and transition to a vertically integrated module sales company and high efficiency cell vendor. Even with a gross margin improvement from the wafer deal, it's not the type of transaction that will be a game changer for JA Solar in the current market.

    It's also going to be difficult to know what the margin benefit is because wafers are so cheap right now on the open market, for third-party purchase. Also, the wafer maker has capacity of 485MW, vs. total cell capacity of 2.2 gigawatts at JA Solar.

    While JA Solar said it would be accretive to margins, the company did not actually update its financial guidance on Friday when making that statement.
  • JA Solar says the deal was done to acquire an important technology.
  • JA Solar was asked on the Friday conference call "Why now?" with wafer prices in free fall.

    An iSuppli solar analyst, Michael Sheppard, said wafer prices will not go back up soon because of capacity continuing to increase, led by GCL-Poly at 6.5GW of capacity. "There's no room given the growing capacity for pricing to go back up," Sheppard said.

    The company responded that it's a time to consolidate operations with a focus on next-generation solar cell technology. In particular, while multicrystalline wafer prices are dropping, the monocrystalline wafer prices that support its newer, higher efficiency cells are not coming down as much. JA Solar is making the case that it needs a supply of high quality wafers as it expands the sales effort for premium cells and modules with higher efficiency for the rooftop market.

    Analysts suggested that this is a legitimate argument to make, but it could be some time before JA Solar is able to prove it.

    "You can argue either side of it," said iSuppli's Sheppard. "Monocrystalline wafering is a more expensive niche that requires higher efficiency, but we are seeing lots of companies focusing on it and all saying they will get a price premium price. In the long run, maybe it's gaining efficient capacity, and in order to get costs down, the company needs to implement new technology. But you can get lower cost wafers on the spot market right now."

    Bottom line: JA Solar doesn't seem to have overpaid for the wafer company, but with wafer business so weak, and the company's chairman so heavily invested in the company, it's impossible at least not give the deal a little scrutiny as it moves the risk of the wafer business from the chairman's private holding to JA Solar shareholders. As such, shareholders need to hold JA Solar's feet to the fire for future proof of the margin and cost advantages offered by Solar Silicon Valley.

    -- Written by Eric Rosenbaum from New York.

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    >To contact the writer of this article, click here: Eric Rosenbaum.

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