Read the article and discuss the question given

Article: http://webpage.pace.edu/pviswanath/articles/aeg4e4…

Summary:

Solyndra Inc. began their investment in a product that would absorb the sun’s rays and turn the sunlight into electricity. Renewable energy has been a leading force in the expansion of technology. Companies are competing to find new ways to save energy by producing energy efficient products. Although this technology is energy efficient, it is not economically efficient. Most materials used in Solyndra’s products are expensive. Other companies however, use cheaper materials to produce similar products in order to compete in the market while still having lower overhead costs. In order for Solyndra to make a profit on these products, the company would need to sell these products at a higher price. However, Solyndra Inc. marketed their products at an affordable cost and installation price. This tactic was used to lure more customers who want to save energy while saving money as well. The cheap cost of their products did not cover the costs of making the products, which began the downfall of the company. “In late 2009, Solyndra’s tubes cost $4 for every watt of power output to produce, according to company securities filings. The problem was the company could sell them for only $3.24 per watt.” Another factor that initiated the downfall of the company, was the testing of the products. New products go through a series of phases in which defective products are tested in order to make their product effective. An excessively high defective rate negatively impacted the company’s revenue because those products could have been sold, instead of being discarded, if they had worked properly. Solyndra was also facing an increase in competition as China’s solar panels were dropping in price. First Solar Inc., was making panels at less than a quarter of Solyndra’s cost then and today produces panels at about 75 cents per watt.

Solyndra still pursued their business regardless of these negative developments. According to the article, Solyndra had a “contractual backlog of more than $2 billion” orders; however a lot of these were subject to renegotiation by the customer. For example, its main customer, Phoenix Solar AG, renegotiated in its favor in early 2009, according to Murray Cameron, chief operating officer at Phoenix. Given the precarious nature of Solyndra’s order pipeline, Solyandra had to make a strategic choice – cut back or double down: either to cut costs to meet competition and focus on their existing factory, or to continue to expand and proceed with the construction of a brand new factory, hoping that economies of scale would help them reduce costs. Solyndra proceeded with the second option and began to expand and built their new factory. Unfortunately, the new factory produced more overhead costs for Solyndra, through their salaries of the new employees, their new lease plans and the product development costs, while demand dropped leaving most of their panels unsaleable. By this time, it was too late for a turnaround and Solyndra was left with unimaginable debt that their expected cashflows could not possibly pay back in the future. Solyndra later filed for bankruptcy and ceased all operations, liquidate their assets to pay back their investors.

Thoughts and Comments:

There may also have been questionable operating decisions that were made by Solyndra that led to its bankruptcy, but it’s easy to be critical in hindsight. One question that begs attention, however, is whether the management at Solyndra financed its overall operations in the best possible way. In March of 2009, under the Energy Policy Act of 2005 which was designed to “support innovative clean energy technologies,” Solyndra was granted a $535 million government guaranteed loan. Since the loan was guaranteed by the government, it had lower borrowing costs. However, the government also demanded priority in the event that Solyndra failed. This caused many investors to initially not lend to the company, as it meant that the government had senior debt (i.e., debt that will be paid back first). In early 2011 however, the Solyndra was successful in obtaining $75 million in loans that had higher priority than the government. Ultimately, though, it was too little too late. If the government had been willing to guarantee all the debt that Solyndra would need, obviously the guarantees would no doubt have been beneficial for the company. However in a capital intensive business that already had more than a billion dollars of equity, it could have been foreseen that further financing would be needed; the government priority on all repayments made new debt financing more difficult to obtain.

Perhaps, Solyndra’s focus on lobbying for government loan guarantees and depending in this way on non-market channels of financing led the firm to ignore capital market and product market realities. Perhaps this was the reason that the company made bad decisions? Perhaps their hope of a government bailout, led them to take the risky decision of adding excessive capacity? The rush to file an IPO and the hope of cashing out at a high stock price may also have led management to make expensive investments that increased the size of the company, but were otherwise risky. Taking on additional debt that had to be repaid, rather than equity that would be more patient, may also have been a decision caused by not wanting to share the wealth from a successful IPO. In the event, Solyndra was not able to fool the market and the IPO was not completed, while the additional debt simply sunk the company, since it had no way of paying off bondholders. As a result, a product that might have worked with a less aggressive capital structure crashed because of poor financing strategy.

QUESTIONS:

1. Why do you think Solyndra’s management pursued the financing strategies that it did?
2. ‘”We had a perfectly good factory,” said one of the investors. “That would have been a better size for the market.”’ Do you think Solyndra might have been successful without the expansion financed by the new debt that added to their initial loans?
3. Do you think the expansion would have been a good bet (although in hindsight undesirable because of the competition from China) if it had been financed by equity?
4. As an analyst, what are some strategies you would recommend when formulating a capital structure for a new company in a competitive environment? Can you use the capital structure theories that we learnt in Chapters 14, 15 and 16 to answer this question?
5. Would you have used government guarantees if you had been part of Solyndra’s management? Under what circumstances do you think a firm should not use government financing?
6. Was Solyndra’s IPO issue premature? What is the right time for a company to go for an IPO?