JA Solar And Its Oh-So-Forgiving Investors

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It takes guts to file for a secondary offering only days after you lose your largest contract ever. But that’s what JA Solar did, and investors, oddly, seem thrilled.

JA Solar (JASO), a maker of photovoltaic cells that went public in a $225 million IPO only six months ago, is back at the feeding trough already, hoping to raise close to $300 million. Given the growing demand for solar cells and JA Solar’s ambitions to grow market share, the idea isn’t as crazy as it may seem. But there are a couple of crazy things about how it’s being done.

Take this disclosure in the company’s prospectus, filed last week:

“In January 2007, we signed a customer agreement with PowerLight, a wholly-owned subsidiary of SunPower Corporation, under which we were to supply PowerLight with a total of 120 MW of solar cells through the end of 2009. This contract was terminated by mutual agreement in September 2007 due to an unanticipated quality problem with respect to metallurgical grade polysilicon which could not be resolved in the near term and unresolved pricing terms.“

That’s up high in the filing, on page 16. But you have to keep reading — another 169 pages, to be exact — before you find out that the SunPower (SPWR) deal was its “largest long-term customer agreement to date.” 120 MW is a big deal. In fact it’s more than three times the 38.4 MW of solar cells the company sold in the first half of 2007.

At its current valuation, JA Solar stands to raise $285 million ($180 million of which would go to the company itself, the rest would go to existing shareholders). Only some of that has been earmarked: $50 million for raw materials, $70 million for new facilities; $10 million for R&D. Where the rest will go is anyone’s guess.

And why does JA needs the money so badly, when as of the end of June it was sitting on $206 million in cash? It only spent $80 million on raw materials in the first half of the year, 77 percent of revenue and low enough to be replenished by the company’s profitable operations.

So why raise this money now? There are two answers, both of which are telling about the state of the solar-panel industry and the market for solar-panel stocks.

The first reason that JA Solar is raising more money is because it can. Its photovoltaic cells are efficient — energy conversion rates are generally between 16.1 percent and 16.9 percent, according to the company — and its profits are growing. Operating margins rose to 18.1 percent in the first half of 2006 from 17.1 percent in the first half of 2006, while net margin grew to 17.2 percent from 15.5 percent.

The second reason that JA Solar is raising money is because investors are letting it. And it’s here where things make less sense. A secondary offering of this size will dilute significantly the value of existing investors’ stakes in the company, as well as their share of future profits and capital gains.

So it’s strange that the stock has risen 13 percent since the offering was announced. And it’s strange that the stock is up 19 percent since the company said it lost the SunPower deal. Investors are either swept up in the momentum that’s pushing many solar-power stocks higher, or they’re betting that JA can profitably expand its manufacturing capacity -– estimated to reach 425 MW by the end of 2008, equal to total global solar systems installed in 2002.

The latter bet is a little risky at the stock’s current level. The former one is gambling, pure and simple.

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