Chinese Solar Star Burns Out

10/18/2007 12:00 am EST

Focus:

Robert Hsu

Editor, China Strategy and Asia Edge

Robert Hsu, editor of China Strategy, describes his change of heart about a once high-flying solar wafer manufacturer caught up in an accounting scandal.

Bad news about our solar wafer manufacturer LDK Solar (NYSE: LDK) keeps coming. Its share price fell sharply again after a Barron’s article (subscription required) made additional negative allegations regarding LDK Solar’s financial controls and technology.

A former LDK employee raised concerns about the company’s inventory. The stock dropped on the news as investors worried about the company’s future.

The article starts out describing China’s solar-power industry as a “red-hot bubble” and went on to describe conversations with an insider at LDK that pointed to serious manufacturing concerns.

According to the article, “the company's silicon ingots were indeed so impure that a recent production run had produced tons of them that were too contaminated for technicians to even analyze with instruments.” This is pretty damaging for the company and I don’t think the stock will be able to bounce back to previous highs in a reasonable amount of time.

(On Friday, October 12th, Barron’s Online reported that former controller Charley Situ “sent six megabytes of internal company records to LDK's auditors, the Securities and Exchange Commission and journalists—to support his allegations that LDK has misrepresented its level of inventories and profits”—Editor.)

I’m still bullish on the solar industry as a whole, which offers an alternative source of clean and renewable energy. Solar energy is a viable technology, and there are still plenty of opportunities in this industry. Chinese solar companies have a cost advantage in this commodity product, and unless a non-Chinese firm develops a major technological advantage, Chinese firms will continue to gain market share in the industry. This is why we will continue to hold our investment in Suntech Power (NYSE: STP).

LDK Solar addressed investors’ concerns, saying that it would soon report on its inventory levels. Chief financial officer Jack Lai said that the company would file a report with the SEC soon reconciling data from a management assessment and independent auditing firm KPMG. It will make a final determination of LDK’s inventory of polysilicon.

Regardless of the investigation’s results, it is clear that LDK’s management dealt with this situation in an unsatisfactory manner. This makes me question the company’s management capabilities and financial controls. Though the company has responded to inventory allegations, I view its conference call and subsequent press releases as murky at best. LDK Solar’s management team has yet to reply to the questions I sent them.

Although we do not know what the audit results will be, we do know that LDK’s management team does not have the required skills to handle crises effectively. Given the uncertainty surrounding the stock and the lack of clear leadership from the company’s management, we should exit our position. Sell LDK now. (The ADRs closed below $45 Wednesday, more than 40% off their 52-week high—Editor.)

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