How Did Solyndra Spend All That Money?

I'm still trying to wrap my mind around just how much money Solyndra managed to spend in just two short years.  By my count, Since September 2009, they borrowed $535 million from us to get their second fab up and running, raised $219 million in a private equity offering, got $175 million from issuing convertible promissory notes after their IPO was pulled, received $75 million in the last-ditch round where the DOE allowed their seniority to be subordinated, and maybe got a loan from a different bank.  By the time they filed bankruptcy in August, my understanding is that they were basically out of cash.

The Washington Post's rather scathing new account, full of employees saying that post-loan, Solyndra started spending money like it was about to be discontinued, says the new facility for which we loaned them all that money cost $344 million to build.  So it seems that in the space of two years, Solyndra managed to spend $344 million building a factory and $660 million . . . doing what?

I asked a hedge fund/private equity friend of mine if the burn rate is as crazy as it seems.  These were his thoughts:

Trina Solar in their last conference call talked about average selling price per watt dropping from $1.71 to $1.46. A 15% drop. That's almost certainly a wholesale price as Trina doesn't sell to end users. Since then (August 23rd, a month ago), a hedge fund blogger named John Hempton has found retail prices of AUD$1.30 (USD$1.27) per watt. (see here).

So pricing is down about 25% in a little over a year.

A lot of this is due to China and Chinese companies like Trina Solar. Here's a NY Times piece from late 2010: "But as the companies finally begin mass production -- Solyndra just flipped the switch on a $733 million factory here last month -- they are finding that the economics of the industry have already been transformed, by the Chinese. Chinese manufacturers, heavily subsidized by their own government and relying on vast economies of scale, have helped send the price of conventional solar panels plunging and grabbed market share far more quickly than anyone anticipated. "

So pricing is down 25% from late 2010 and in late 2010 the price had plunged from 2009. I think it was $1.95 per watt in late 2009.

These are not high margin goods. Solyndra's is/was actually negative, as this good piece by Bruce Krasting points out, but they were not at scale.

At scale, under old pricing, gross margin was probably in the 30-33% range. Call it 33% to be generous. On $100 in sales you have $67 in cost and make $33 in gross profit (out of which you pay your other operating costs). Take pricing down 25% without cutting cost of goods, and your $100 in sales becomes $75. Your cost of goods is still $67 so your margin is now $8 -- or just 8%. You've just killed your profitability. If you started with $33 in gross profit, you likely had $20+ in operating costs, leaving you with $13 in pre-tax profit or a 13% pre-tax (not gross) margin, which is great for a manufacturer. Now with $8 in gross profit (8% gross margin) you can't pay your $20 in operating costs and have negative pre-tax margins and are in big trouble. And that's just one year of 25% drops.

How do you rescue the business?

Take $100 in sales to $400. Then even at an 8% gross margin you're making $32, which is about what you were making before in dollar terms when margins were 32%. If you can sale up to this level without adding to much to your $20 in operating costs, then you can survive.

Further, the additional scale should bring some manufacturing efficiencies. Maybe your 8% gross margin can go up to 10 or 12%. At $400 in sales that's $40-48. If that can happen, you are actually making more absolute dollars than before, even if percentage margins are lower than when you had $100 in sales and $32 in gross profits.

But for the above to happen you almost certainly need to build bigger factories, making large-scale purchase commitments for your inputs, etc. etc. You can spend hundreds of millions of dollars on this effort. You're on a treadmill, running full-speed. It might save you. But it's likely to kill you.

Note that this uses generous assumptions about Solyndra's margins.  More realistic pessimistic results give you an even worse cash pickle.

This story roughly accords with what a purported Solyndra insider wrote to Bruce Krasting:

The original plan was to have Fab 1 operating on a "almost at profit basis" (a proof of concept + - type level), then use an IPO to fund the next push into economies of scale. Or use strategic partnerships and sovereign relationships to that.

The S-1 had been filed in the Nov Dec 2009 time frame, and I had heard that at the fateful Board meeting that preceded the putsch, that it had been announced that that financial situation of the country and the position of the Solyndra's strategy had led the I-bankers to tell the execs that any IPO would be a failure and they should expect a lead balloon from the market. The I bankers then told the e-team that *if* Fab 2 was finished in time, and brought to good production, *and* the solar prices should at any point start to pull out of the crash, *then* they would recommend the IPO. The "recommend" was their words, but I believe that this is the way of saying that they would in no way do the IPO at that time.

The Fed money was explicitly tied to being *solely* used to build Fab 2. Solyndra could not use the loan proceeds for *anything* else.

So . . . they built Fab 2.  Even though they were under capacity at Fab 1; according to the Washington Post, "As the $344 million factory went up just down the road from the company's leased plant in Fremont, Calif., workers watched as pallets of unsold solar panels stacked up in storage. Many wondered: Was the factory needed?"

As I've said before, I don't think this is going to end up being a story about corruption.  I think it's going to end up being a story about bad decision making: at Solyndra, among its investors, and in the Obama administration.  People took large bets with low expected values, because the alternative was admitting that the money they'd already spent was gone, and not coming back.  They doubled down, just like some chump who lost his stake at the Vegas blackjack tables.

This does happen in the private market, of course.  The difference is, when Argonaut Ventures takes a flyer on a longshot, they're not doing so with my money.  The administration was supposed to have the economic dream team.  Couldn't they have spared a moment to sit down with the folks at DOE and explain the concept of sunk costs?