First Solar, Inc. (FSLR), Canadian Solar Inc. (CSIQ): Bankruptcies Are a Healthy Sign for the Solar Industry

First Solar (FSLR)

Suntech Power Holdings Co., Ltd. (ADR)(NYSE:STP) is officially in bankruptcy, and once again, one of the flagship companies in the industry is now deciding how to pay back as much as it can to creditors. If we look back, there are some very notable bankruptcies in solar. Energy Conversion Devices, Inc. (PINK:ENERQ) was once a hot technology, Q.Cells was once the largest solar manufacturer in the world, and of course we all remember Solyndra, Inc. But this doesn’t mean the solar industry is in trouble. In fact, the opposite is true.

In a normal business cycle, bankruptcies are a healthy sign of a maturing industry. In the case of solar, companies with poor cost structures or weak technology will fall by the wayside, leaving their market share to healthier companies with better technology. Since the solar market has around 70 GW of supply and only about 30 GW of demand right now, companies will have to go bankrupt to bring the industry into balance.

More companies will fall
If there’s more than double the capacity the world currently demands for solar modules, then more companies will fall. In China, the balance sheet is a huge differentiator, which is why I think Yingli Green Energy Hold. Co. Ltd. (ADR) (NYSE:YGE) and LDK Solar Co., Ltd (ADR)(NYSE:LDK) are next on the chopping block.

We may also see consolidation of some suppliers, making one larger, more powerful company. Now that China has let Suntech go bankrupt, I think it’s more likely that companies see this as a warning sign and make preemptive moves to stay alive. In the end, fewer companies will be left in the solar industry, which is a good thing in a maturing industry.

Costs drive companies out
A lot of focus in solar over the past two years has been about cost differentiation. This is the first thing that will get a company in trouble, as Q.Cells, Solyndra, and Energy Conversion Devices found out. Canadian Solar Inc. (NASDAQ:CSIQ) , now the third largest module maker in the world, said earlier this week that its manufacturing costs have fallen from $1.31 per watt in Q2 2011 to $0.51 per watt in Q2 2012. Companies that can’t keep up with that rapid reduction in costs will find themselves with falling margins and growing losses.

That’s why First Solar, Inc. (NASDAQ:FSLR)‘s module business is in trouble right now. It makes modules that are less efficient than Chinese modules, such as Canadian Solar Inc. (NASDAQ:CSIQ)’s, and now has higher costs. Costs aren’t the only thing that will sink a company in solar, but they’re still key.

Differentiation is the new key
What we’re seeing with recent bankruptcies is that product differentiation has to be combined with low costs to survive. Suntech’s cost structure wasn’t terribly different from that of any other Chinese solar manufacturer, but they’re also making the same product as these competitors. So when the company ran into a fraud  at an investment it made, the company couldn’t fall back on a superior product to keep customers from fleeing.