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First Solar Capitulates, Sort Of


First Solar (FSLR) made it clear in its 2012 guidance call on Wednesday morning that the crisis in the solar industry is existential. That shouldn't have been news to anyone who follows the solar sector, and the 20% drop in First Solar shares to its lowest share price since its early days shouldn't be a surprise either -- in fact, with First Solar down to under $35 on Wednesday it was in range of a target that we set for the stock some months ago.

But what did First Solar really tell us Wednesday, when it guided to 2012 earnings so low that they even surprised noted First Solar bear Gordon Johnson?

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There are important questions for investors trying to read between the lines of the First Solar commentary: Did the company just capitulate to reality, that it will never again be able to sell solar panels on the open market profitably? Will it become a project developer only, with a multiple of an industrial stock the best that it can ever again expect to command from the market?

Yes, and no. First Solar also set the earnings bar so low next year that it has set itself up for a huge beat as well. This could -- in classic First Solar fashion -- send shares back up after this bottoming-out, which probably is the "expectation reset" from which it won't fall much lower in the short-term.

First Solar isn't going to be operating in the rooftop market, the subsidized European market that made every company a fat cat over the past few years, likely ever again.

Subsidized markets are more or less over, with overcapacity so extreme in solar that any company reliant on subsidized solar is going the way of the dinosaur (if and when the Chinese government decides to call them on their cheap bank debt).

None of this should be news to anyone, either, but this call was First Solar's official capitulation to this reality. It's the difference between a classic First Solar investor presentation Powerpoint slide that we once mocked because it showed a straight line up from subsidized markets to "transitional" markets and finally sustainable markets, to today admitting that the "transitional market" phase is just a "phase of desperation" for everyone.

First Solar will have to focus on its project pipeline business and return on capital to investors, and not the go-go momentum past of solar, in which one fat quarter from Italy could prop up gross margins for the industry. Nothing new there, either, and of course, that's a self-serving argument too, which can make First Solar look better positioned than the Chinese solar industry. The First Solar project business has always been about being "better insulated" than the Chinese.

"I think this was definitely a clear-the-deck call -- and I don't expect additional clear-the-deck calls -- and they focused on the structural changes that will create a long-term sustainable business," said Paul Clegg, analyst at Mizuho Securities. "The only way to survive in solar is sustainable markets and pulling back from high-efficiency rooftop. But everyone also thought (interim CEO Mike) Ahearn would do something negative, and by negative I mean cautious. He has every incentive to set the bar low," said Clegg.

Ahearn, who recently stepped back into the role as interim CEO of First Solar, had a history when he was the company's first CEO of setting expectations very low and then smashing earnings estimates.

The First Solar guide was in fact so much lower than expectations that it suggests a major project like AV Solar Ranch One or Desert Sunlight could be pushed out to 2013. If that's not the case, though, First Solar is once again setting itself up to impress the market.

And there's the rub for investors. First Solar could rally during 2012 if it is able to pull in earnings from major projects that it excluded from its current guidance, but that's not "sustainable earnings." It's earnings from a type of high-priced PPA (power purchase agreement with a utility) that even First Solar acknowledged is also going the way of the dinosaur.

"Next year will continue to be really tough for solar and for First Solar any positive data point around the cost structure or pipeline, if they can outperform on either, there is room for the stock to move because they set the bar low," Clegg said.

Even if there is one more short-term trade up in First Solar if its current guidance does turn out to be overly cautious, it only masks though the larger question of what First Solar shares are really worth if its business is limited to building solar projects for utilities.

And that's where the homework still needs to be done on First Solar's future. It's whether the $35 mark to which First Solar slipped on Wednesday is its new long-term reality.

It could be. In fact, it could be a generous rendering of the future.

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