Solar energy growing, but solar convertibles have variable power, Lehman Brothers report says

By Evan Weinberger

New York, Oct. 23 - With wild weather engulfing the United States and America's most prominent environmental activist winning the Nobel Peace Prize, alternative energy - including solar power - has been generating a lot of talk in recent weeks. A new Lehman Brothers report issued Tuesday focused the lens on one aspect that hasn't been covered prominently - convertible bonds issued by solar power companies.

"The solar market appears poised to triple over the next five years as ongoing government incentives and accelerated cost reductions make solar attractive in several regions of the world," Lehman convertibles analysts Venu Krishna and Brendan Lynch wrote in the report.

They added that the market for solar photovoltaic applications is set to grow to $40 billion in 2010 from $13 billion in 2006, with 6.5 gigawatts expected to ship in 2010 versus 1.7GW in 2006.

According to the report, there are three companies producing solar panels and photovoltaic cells with outstanding convertibles, with a total face amount of $1.015 billion. Of those three companies - SunPower Corp., Suntech Power Holdings and Evergreen Solar Inc. - SunPower's convertibles appear to be the best bet, the analysts wrote.

SunPower currently has two outstanding convertibles, $225 million in 0.75% convertible senior notes due Aug. 1, 2027 and $200 million in 1.25% convertible senior notes due Feb. 15, 2027. Suntech has $500 million in 0.25% convertible senior notes due Feb. 15, 2012. And Evergreen currently has an issue of $90 million in 4.375% convertible subordinated notes due July 1, 2012 outstanding.

Less than 0.5% of global electricity is produced using solar energy, which Lehman Brothers says allows for significant growth in the industry. Germany, Japan and the United States are the largest producers of solar energy, with Germany and Japan planning to triple their solar output by 2010. The United States, Spain and Italy are also expected to significantly increase their solar energy production. Increased government incentives in many countries are also helping solar power's growth.

The production costs of photovoltaic cells are going down, the analysts point out, and the supply of raw materials is on the rise.

Lehman expects to see strong third quarter earnings and positive outlooks for the fourth quarter and 2008 from all three solar energy companies with outstanding convertibles.

"While we are constructive on the macro environment and growth potential for the solar industry, solar stocks have risen significantly in recent weeks and year to date, such that three of the outstanding four convertible issues are highly equity sensitive," Krishna and Lynch wrote. "As such, we suggest investors look to establish a more balanced risk/reward profile."

Both outright and hedged investors should look to the SunPower 0.75% convertible senior notes due 2027 because it only has 2.8 years to go before reaching a put or call, its 80% delta and "more balanced" risk/reward profile. The analysts give it an 82% upside and a 55% downside, tops among the group.

The analysts counsel investors to swap out of SunPower stock (Nasdaq: SPWR) and into the company's 1.25% convertible senior notes due 2027. With an equity-like delta of 91%, 71 basis points of income advantage, call protection of 4.3 years, seniority and a 95% upside versus a 77% downside, the convertibles provide a stronger alternative to the stock.

Krishna and Lynch say investors should reduce their exposure to the Suntech Power 0.25% convertible senior notes due 2012, or swap into the SunPower 0.75% convertibles. Suntech Power common stock (NYSE: STP) closed Monday at $47.26, so the analysts say the convertibles have a limited upside compared to their $51 per share price target. The convertibles also have an "unattractive" risk/reward profile and the poorest carry of the group.

Finally, the analysts recommend outright investors to think seriously about synthetic alternatives in "high quality names" SunPower, MEMC Electronic Materials Inc. and First Solar, Inc., saying that they provide "significantly improved risk/reward profiles over what the current outstanding convertibles can offer."

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