Wednesday, April 9, 2008

The Tellurium Supernova Has Erupted

In my previous article, The Tellurium Supernova, I discussed the rapidly expanding new applications of the extremely rare metal tellurium, and that looming global shortage of tellurium could threaten the very survival of the red hot solar company, First Solar Inc., which produces solar PV panels based on the CdTe (cadmium telluride) semiconductor material.

The Tellurium Supernova article caused quite some disturbance on the internet. Not every one agrees with me. But I am happy that Mr. Free Market does seem to agree with me. The chart show that tellurium price staged an incredible rally since mid January, raising from 860 yuan to 2100 yuan per kilogram, or US$300 per kilogram, a raise of 2.44 fold in less than three months. Tellurium went from US$10 a kilogram in 2004 to now over US$300. If such a stellar price rally does not indicate a severe global shortage of tellurium, then I don't know what does.

The Tellurium Supernova has erupted!

Does First Solar feel the squeeze of a tellurium shortage? Maybe not. The CFO claimed(22:58) "We have identified terawatts levels of tellurium availability"! So the ultimate limit to the growth is one terawatts? No! The CEO proudly declared "Are there issues there that limit the ultimate size of the company? We think the answer to that is NO." Wow! I only knew that Wall-E could go to infinity and even beyond. I never knew that FSLR can grow with no ultimate limit of size, even though they rely on a metal with extremely limited supply.

FSLR, as well as their dominant raw material supplier, 5N Plus Inc. (VNP), repeatedly reassured people that they are not worried about tellurium availability and they are actively "managing it". But I noticed that they would NEVER divulge anything specific or anything quantitative when it comes to their tellurium supply. In multiple occasions, analysts, including Michael Molnar from GS, explicitly demanded specific and quantitative answers, but got only the vague go-around answers. Why are they not willing to reveal any data on tellurium?

Fortunately, now VNP, the virtually exclusive high purity CdTe and CdS supplier to FSLR, is now a publicly traded company and must file regular financial reports, allowing us to dig out some useful information. You can go to and search for "5N Plus" to find all VNP regulatory filings. I think the VNP's Dec. 12, 2007 prospectus document is worth reading through carefully. It discusses a lot of details of the industrial use of high purity tellurium, and its relationship with FSLR. You might also listen to latest conference call. A few important things to note from the prospectus:

  1. VNP is the first to enter the market of high purity tellurium metal and compounds. They have years of expertise, large scale production capacity, business relationship with tellurium sources. They are the world's dominant CdTe supplier and all CdTe solar PV manufacturers purchase CdTe from them.

  2. VNP is a virtual monopoly in this niche market. The barrier of entry is too high for a second major CdTe supplier, the market is too narrow to provide enough economic incentive for competitors to enter this small niche market and compete with VNP. FSLR desperately wanted to diversify their CdTe sources but there is just no significant secondary supplier in existance in the world. They refuse to name the secondary supplier. Does it even exist at all? VNP already named all of their few potential competitors.

  3. It is safe to say FSLR gets virtually all of its CdTe supply from VNP. VNP has plenty of production capacity, 100 metric tons of CdTe annually, and under contracts with FSLR, they are building a new Germany facility, bringing the annual capacity to 200 metric tons and eventually reach 350 metric tons a year. Why would VNP expand if FSLR does not continue to heavily depend on VNP for supply?

  4. VNP noted rapidly expanding industry demand on tellurium. They meantioned 300 metric tons start metals per year for thermoelectrics applications (page 21). That number really strikes me. According to USGS, global tellurium supply can not be much more than 200 metric tons per year. Thermoelectrics usage of tellurium wasn't even meantioned a few years ago. Now that market alone consumes 143.4 metric tons of tellurium alone (48% of the Bi2Te3 thermoelectrics material is tellurium)
So we can pretty accurately estimate FSLR's raw material supply by looking at how much CdTe that VNP is selling to FSLR. VNP refused to provide numbers in kilograms, but they gave a price range of $300 to $500 per kilogram during the Q2 conference call, and suggested in Q3 conference call that the price may exceed the top of the range now. So using $500 per kilogram one can get some reasonable numbers. VNP also revealed that 60% of sales was to FSLR, and 65% to 70% in latest quarter.

Let me list VNP's quarterly sales revenue, as well as cost of goolds sold (in bracket) below. Note their fiscal year 2008 starts on June 1st, 2007. Q3,08 is the quarter ending Feb. 29, 08.

Q3,08 $8.359M ($3.905M) OP. Margin $4.454M
Q2,08 $6.796M ($3.519M) OP. Margin $3.277M
Q1,08 $6.394M ($3.417M) OP. Margin $2.977M
Q4,07 $6.549M ($3.442M) OP. Margin $3.107M
Q3,07 $5.555M ($3.419M) OP. Margin $2.136M
Q2,07 $4.890M ($2.779M) OP. Margin $2.111M
Q1,07 $4.903M ($3.122M) OP. Margin $1.781M

I noticed one thing curious. During the past quarters, even though the sales revenue see some growth, the growth is not impressive at all. The cost of goods sold see virtually no growth at all, while the operating profit jumps up rapidly!

Put it in a chart you can see the data more clearly. In the chart, black is FSLR's rapidly ramped up quarterly production in MWs, red is VNP's cost of goods sold, blue is sales revenue, green is gross operating profit.

Notice the gigantic contrast between how quick FSLR's production ramped up, and how there is virtually no increase in VNP's cost of goods sold? Logically, as FSLR ramps up production, they need to purchase way much more CdTe semiconductor material from VNP. And hence VNP needs to spend more money to purchase the raw tellurium feedstock, not to meantion the unit price of the feedstock raw material must increase dramatically as tellurium price went up a lot. Something is not right here! The rapid growth of VNP's gross operating profit, without much increase in the production cost, further enhances the logical wisdom that VNP enjoys absolute monopoly in this small niche market of high purity CdTe supply, and hence can demand higher unit price as they see fit, and FSLR has no where to go but purchase the bulk of their CdTe supply from VNP.

My suspicion is FSLR is not getting all the CdTe they need for their production. At 3 microns CdTe layer thickness, there's about 15 grams of CdTe per 2 feet x 4 feet panel of 70 watts. Allow some production waste, 0.25 grams/watt CdTe is reasonable. FSLR produced 77 MW in Q4,07, that's a consumption of roughly 19.25 metric tons of CdTe. At over US$500 per kilogram, that's worth $9.625M of purchase from VNP. Add CdS, which also came from VNP, total purchase should be almost US$11M for the quarter.

VNP's latest quarterly revenue is only $8.359M, with 65% going to FSLR that's $5.433M. Split it into $4.8M for CdTe and the rest for CdS, at over $500/kilogram, they sold about 9.6 metric tons of CdTe to FSLR. That's only about HALF of what FSLR would need!

From the VNP's cost point of view, about half of cost is salary, machinery and other fixed cost. Let's say $2M of the $3.905M cost in the quarter is on raw material purchase. FSLR's portion takes 65%, or $1.3M, tellurium price during the quarter probably averaged $250/kilogram. So that gives 5.2 metric tons of tellurium, enough to make 9.8 metric tons of CdTe for FSLR, consistent with the above estimate, and inconsistent with FSLR's 19.25 metric tons requirement for quarterly production.

My conclusion, based on the best information available to me, and the most logical and reasonable estimate, is that FSLR has already run into a raw material supply shortage, due to the global shortage of tellurium. They are either now producing from the raw material inventory, or they probably booked quarterly sales but really could not produce and deliver the quantity of products they sold. Later this year and next, when their new Malaysia factories start production, I really have no idea how they are going to get the tellurium supply they need.

I contacted FSLR investor relationships and raised the CdTe supply issues more than a month ago and asked for a clarification, and never got any response. I am hoping that FSLR can come out and clarify how and where they are getting their critical material supply, how much they have secured, and how much they need. Of course, if there really is a shortage, the investor community has every right to demand that the FSLR management disclose the information fully and publicly, as soon as they know it, as required by the SEC regulations.

P.S. The author is heavily invested in the stocks of PAL and SWC but holds a small short position in FSLR since April 4th. I plan to add to my short position when time is right.


Zachary said...

God I hope you are right..

Kenny said...

but he had good calls on pal and swc. i think he has extended knowledge in this field. don't u think?

Anonymous said...

Good analysis. I just don't know if you noticed the tolling revenue recognition method used by VNP. It's mentioned in a Yahoo board post by
"See page 5 of the MD & A posted on the VNP website where they describe the effect of tolling revenues on their gross profit margins". If VNP use tolling for all their revenue accounting, then your argument about cost of good sold has a very serious flaw. Good luck!

JJ2000426 said...


Thanks for the comment. I also become aware a portion of the VNP sale is tolling, where FSLR provides its own raw material and VNP just process for them for a fee. If you listen to the conference call, they meantion that the mix (percentage ratio) of tolling and none-tolling sale has NOT changed in the last few quarters.

So the conclusion is still the same, they are not producing more, tolling or non-tolling. They just make more money by charging higher unit price and ask for higher tolling fee.

D Pickard said...

Hey, great research!

Personally, I think FSLR and Wall Street have plenty more hype to go before they start talking about this issue, but I think ultimately, you're research is going to be found to be sound.

BTW, any chance I can get a link on your page? I've added a permanent link on mine back to you.

JJ2000426 said...

D Pickard:

Your blog has some nice discussions. I added link to your blog and will read you from time to time. Thanks!

Anonymous said...

This is some stellar research. I plan to share this with some analysts that I know who work for some major wall street firms.

D Pickard said...

JJ, Thanks!

JJ2000426 said...

Found this mentioning of tellurium Thermoelectric News.

It also refers to this blog entry.

Anonymous said...

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Anonymous said...

Just a note on your production waste. Given the 19.25 metric ton production requirement you didn't use 0.25 grams/watt CdTe (which would have meant more was lost than was in the final product) but rather ~0.0357g/W or 2.5g/panel (2'x4')

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