Last week there was an interesting development for Hoku Scientific, Inc. (Nasdaq: HOKU). The company issued a press release noting a "$678 Million Polysilicon Supply Contract" with Suntech Power Holdings (NYSE: STP).
When you see a contract of this size and magnitude for a small company like Hoku Scientific, it makes you think that either the company hit the mother lode or that it is a multi-year contract with many stipulations. This contract is a bit of both.
The Industry Shortage
If you have been following anything related to alternative energy and solar power, you're probably are aware that there is a land grab going on for the raw materials needed to make the panels. There have even been discussions that semiconductor companies have been able to use their waste and the silicon from defective chips for these materials.
Applied Materials Inc (Nasdaq: AMAT) has been making a new push into the sector, and MEMC Electronic Materials (NYSE: WFR) has seen some wild blips.
Hoku Scientific has signed a "future contract" where Hoku will sell and deliver polysilicon to Suntech Power for 10-years in an agreement staring in mid-2009. This value is a total of $678 million and is subject to many milestones.
The most important of which is the completion of the actual plant producing 2,000 metric tons of polysilicon per year in Pocatello, Idaho. Hoku's public estimate of the cost to build this factory may require total construction costs of $260 million and the company intends to seek approximately $150 million in debt capital to finance the construction.
Hoku is to receive initial deposits of $2 million and additional payments of $45 million in contract prepayments. The prepayment amount is backed by a letter of credit issued to Hoku by the Bank of Communications. Further, the contract can be canceled in years eight through 10 if either HOKU or STP cancels prior to the end of the fourth year. This is 2013 according to the current schedule.
The agreement states that the initial $2 million deposit will be returned to Suntech, and the letter of credit may be canceled, if:
1-Hoku is ultimately not successful in building the polysilicon plant
2-Hoku does not meet certain quality and productivity milestones
3-Hoku doesn't deliver of minimum quantities of polysilicon in a timely fashion
Hoku signed a similar seven-year pact with SANYO Electric Co Ltd, with a life-value of approximately $370 million. The company maintains it is on track for this 2009 delivery time frame.
The Long-Term Implications
This contract can be thought of as a long-term call option owned STP, rather than a steadfast and assured contract, with a premium of $2 million, and a total strike price of up to $678 million.
It is hard finding people who do not believe that the growth in solar will remain for years and years. However, in this case, it is subject to an entire plant being constructed, which is contingent upon Hoku being able to secure financing. The financing should be much easier to obtain with these two contracts in hand, but it is obvious that there are no assurances the financing will be secured.
Hoku Scientific saw its shares rise 75% at one point last week, and when you see huge gaps like this, it is almost always better to let the dust settle before you make a move. The company's market capitalization is a mere $113 million. With a company as small as Hoku, you know there are no assurances.
Hoku is also barely producing revenues and is not close to being profitable. Its last balance sheet showed a tangible net value of only $27.4 million, so this is a company still deep in its development stage.
The Big 'IF'
Now the company has to go and secure its debt financing for its new plant. This one has major upside from here if the company gets all the ducks in a row and can start full-scale production.
Just keep mind that the "IF" in this case is a much larger "IF" than other contingent contracts. That's why this one should be thought of as a leveraged long-term call option, rather than a finalized pact operation with a high degree of predictability.
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