September has been a tough month for the solar energy sector with the Claymore/MAC Global Solar Energy Index plunging by around a quarter since the end of August on expectation of a fall in average module selling prices. NASDAQ-listed Chinese photovoltaic cells and modules producer Solarfun Power Holding Co (SOLF.NASDAQ) has also been hit hard in the rush to divest solar holdings. However, Vice President of Strategic Planning Paul W. Combs tells The China Perspective that Solarfun is well placed to ride out the storm. Not only will the fall in selling prices be lower than expected, it will be more than offset by an even greater fall in the cost of raw materials.

Can you give us a brief introduction to Solarfun’s business, the type of solar cells you produce, who your typical end customers are and what markets your products are sold to?

Solarfun Power Holdings Co Ltd manufactures ingots and PV cells and modules and supplies solar system integration services in China. The company produces both mono-crystalline and multi-crystalline silicon cells and modules, and manufactures the majority of its modules with in-house-produced PV cells. Solarfun currently has 360 MW of name-plate manufacturing capacity, and has announced its intent to add up to 120 MW of additional capacity in 2009. The Company is aggressively vertically integrating to the ingot and wafer level, and expects to have 300 MW of wafer capacity by mid-year 2009.

Products are sold to both OEM’s and distributors and, to a lesser extent, to “special projects”. Sales are primarily to Europe, especially Germany and Spain, where government incentives have historically driven these markets. Going forward, the Company sees increasing demand in other European countries, in addition to the Middle East, Northern Africa, the United States and Asia.

Solarfun recently inked a three-year supply agreement with Q-Cells International, a subsidiary of solar cell provider Q-Cells AG (QCE.FRA). Can you tell us more about this deal and what it means for your business going forward?

The Q-Cells agreement just signed was an important beginning of what both parties hope to be a solid and growing relationship, including technology cooperation. The letter-of-intent specifies a three-year agreement, whereby Solarfun will provide a minimum of 100 MW of modules per year, using cells supplied by Q-Cells. Specific financial terms have not been disclosed, but it is accretive to earnings and has a good return on investment. This transaction supports our ability to make high quality PV modules at competitive prices, increasingly so versus European incumbents as poly-silicon input costs are reduced significantly over the next few years.

The Q-Cells deal includes an agreement to co-operate on R&D into more efficient and lower cost PV solar modules? What can investors expect to see from Solarfun in terms of advances in solar module performance and pricing?

In order for PV modules to become more competitive with non-renewable alternatives like oil and coal, prices must be reduced, eliminating the need for government incentives. Many industry players forecast a 40% reduction in solar PV module prices over the next five years. This is driven by lower poly-silicon-based raw material costs and improvements in efficiencies. Higher efficiencies, combined with reduced breakage rates on the manufacturing lines, enable companies like Solarfun to remain competitive and narrow costs in tandem with lower prices. Cell efficiency is the key and Q-Cells is a world class player in this regard, so we hope our relationship with them and technology cooperation will lead to better and cheaper products for us. Currently our efficiencies are quite competitive at 15.4% for multi-crystalline and 16.5% for mono-crystalline. We believe we can improve these to 16% and 17% respectively in the near future.

Solarfun’s shares dropped late last month after it announced that the average selling price of its photovoltaic modules could fall by between 5% and 10% in 2009. Does the company have a strategy for riding out this pricing fall to limit damage to its bottom line?

We don’t comment specifically on movements in our share price, but I believe your question relating the fall-off to a forecasted 5-10 % decline in ASP’s (average selling price) in 2009 is incorrect. In fact, the “Street” was concerned that overall module prices in 2009 would decline 15% or greater in the industry due to incentive reductions in Germany and Spain. On our 2Q earnings call we mentioned the 5-10% decline (as indicated by signed contracts) which is actually better than anticipated. The strategy to offset these price declines and maintain, if not improve margins, is quite clear. Approximately 80% of our cost of goods sold are polysilicon materials, and these prices for us, and for others, are being reduced significantly beginning in 2009, 15-20% at a minimum. Additionally, we are making more wafers internally via our vertical integration expansion at LYG [ingot making facility at LYG Linyang] and we are confident we can make a wafer at much lower cost then we can buy it externally. So, these two factors combined, encouraged us to forecast a 500 basis point improvement in gross margin in 2009.

You have raised your guidance for 2008 shipments from 160-180 megawatts to 175-190 megawatts and have predicted 2009 shipments will be 50% higher again. Is this trend likely to continue going forward for 2010 and 2011 and can you provide shipment targets for those years?  

We don’t provide specific shipment guidance beyond 2009. But, industry growth for PV modules is forecasted to grow at least 30-40% by a number of independent surveys and we think those kind of numbers are reasonable. We all assume the market is quite price elastic – i.e. lower prices drive more volume – but no one can really predict to what extent with any accuracy. Suffice it to say, if module prices decline 40% or so in the next five years and fossil fuel-based resources like oil continue to escalate, demand should be strong. Once we reach the “holy grail” of grid parity, demand will be enormous.

A recent article in China’s Economic Observer suggests that sky high demand for poly-silicon along with limited supplies (China imports about 95% of its poly-silicon needs) has led to a major round of investment in poly-silicon production in China, much of which is due to come online in 2010. If all the planned projects meet their targets, annual production volume in China alone would be 140,000 tons against projected global demand by 2010 of around 80,000 tons. Many of the slated investments are from Solarfun’s competitors in the solar making business to ensure poly-silicon supplies. What is Solarfun’s strategy for ensuring its poly-silicon supplies over the next 3-5 years?

Clearly the tight supply situation for poly-silicon will begin to abate in early to mid-2009, and some of this relief will come from increased capacity in China. We think the volumes and time frames bantered about for new Chinese capacity are aggressive. Poly-silicon production is difficult, and requires recycling of some difficult materials to improve operating costs and protect the environment. Building capacity is one thing, producing high-quality poly-silicon consistently is another. Costs will clearly go down for us. Our contracted poly-silicon in 2009 is almost 50% less than quoted spot prices. Of course, spot is much higher than previously negotiated long term poly prices, but it’s a reflection of the big decline in poly pricing driven by new capacity.

Finally, to what extent is the global market for solar cells developed and how much further can we expect it to grow? What slice of this market is Solarfun hoping to capture?

The market for solar cells, in our opinion, is still in its infancy. Currently, its driven largely by government incentives in just a few countries. Once prices decline and we approach grid parity, demand can be multiples of what it is today. We have increased market share each of the past two years, but we are still in the overall scheme of things a small, yet meaningful player in a rapidly growing market. We think we can be a top three module producer in China and a top 10 player in the world within five years.