There's a quote you will hear once in a while around racing tracks that goes “to finish first, first you have to finish”. Given the nasty cyclical decline in semiconductor and flat panel manufacturing, and the near-death spiral of solar power, that seems like a relevant starting point for a discussion of Advanced Energy Industries (Nasdaq:AEIS). While conditions look pretty uninspiring today, AEIS has maintained solid market share through this downturn, has a liquid balance sheet, and should be poised to benefit when its core markets ultimately turn around.

SEE: Spotlight On The Solar Industry

Treading Water For Now
It's not that easy to get excited about AEIS's financial performance right now. For the April quarter, the company reported 6% year-on-year revenue growth, but a slight (1%) sequential decline as its key markets – semiconductors, flat panels, and commercial/utility PV – are remain in the doldrums. Revenue from the thin films business (which primarily serves semiconductor and flat panel companies) rose 2% from the year-ago period and 16% sequentially (and was 55% of the total), while the solar business saw a 10% annual improvement and a 16% sequential drop.

Margins have held up pretty well despite the shaky revenue situation. Gross margin improved almost a point from last year, while operating income was up about 184% on an adjusted basis. Adjusted operating income also improved about 17% sequentially. This is a good testament to the cost savings that the company has managed to achieve through more efficient manufacturing and distribution, and management believes it has identified even more potential savings – to the tune of up to $20 million in annual savings.

SEE: A Look At Corporate Profit Margins

Will Solar Start Chipping In?
I think one noteworthy detail from the first quarter results is that the solar business was basically breakeven – suggesting a roughly 15% operating margin for the thin film business. For a business still in a cyclical low (semiconductor revenue was up sequentially, but still down 15% year over year), that's pretty good, and I believe it testifies to the company's strong market share – rival MKS Instruments (Nasdaq:MKSI) had low single-digit operating margin for its first quarter.

By the same token, that focuses attention on the question of just when the solar business will carry its own weight. Certainly these are still bad times in the solar business. Funding for commercial projects is very hard to come by, and that has pushed multiple panel suppliers into bankruptcy. It's also made life tough for the component companies as well – one of AEIS's large rivals, SatCon (OTC:SATCQ), declared bankruptcy in the fall of 2012.

Longer term, I believe this business has potential. While a lot has been made of the bad news in solar, the good news has gone relatively under-reported – parity to conventional electricity generation has gotten closer, and it’s not inconceivable that solar will stand on its own merits in multiple European countries within three years. If and when that happens, that should be a very positive development for companies in the inverter space like AEIS, SMA Solar Tech (OTC:SMTGF), and Power-One (Nasdaq:PWER), and AEIS could be looking at double-digit operating margins from this business in a few years. Moreover, companies like Siemens (NYSE:SI), Schneider (OTC:SBGSF), or General Electric (NYSE:GE) may come to see this as a good business to consider for the synergies to their existing power businesses.

In the near-term, though, the company is still looking to build this business. AEIS spent about $75 million on German string inverter company REFUsol (not including earn-outs worth about $13 million). REFUsol was third in Europe in terms of market share for string inverters, and this acquisition not only gives AEIS the company's 3-phase string technology (which is useful in lower-end commercial applications) for the U.S., but also could expand AEIS's European business. The downside to this deal is that it not only represents more investment in a cyclically down business (which investors often hate), but also more dilution over the next few quarters (which investors always hate).

SEE: Green Energy: Why We’re Still Not Using It

The Bottom Line
I don't believe that it's coincidence or random luck that led AEIS to build a strong market share in the power conversion systems that semiconductor and flat panel companies use to convert grid electricity. Likewise, I don't believe the company's solid share in photovoltaic inverters is something to ignore. What we have, then, is a company with #1 or #2 market positions in most of its markets, with those markets in severe downturns. As chip companies migrate to the next, smaller, generation of technology and solar cost efficiency continues to improve, I believe both markets will recover over the coming years.

I model a nearly 10% long-term revenue growth rate for AEIS, as well as solid free cash flow (FCF) growth as the company's restructuring efforts and maturing solar business lead to better margins. That said, I don't believe this is a company that will ever have smooth growth curves – there's too much cyclicality in the underlying markets for that. Nevertheless, I believe fair value today is in the low-to-mid $20s, and I believe investors should consider these shares before the improvements in the semiconductor and solar industries become apparent.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.