Saturday, September 17, 2011

Lessons From Solyndra's Debt Debacle

Q- What often happens when private sector debt is created with government "stimulus" monies?

A- In the Solyndra example, we observe poor business judgment by both the government lender and the private borrower, which resulted in heavy losses for taxpayers (private investors, too).

Lesson- The Solyndra stimulus enabled debt debacle arose from a combination of easily available cheap credit, ignorance, arrogance, and greed. It was an accident waiting to happen, and there will be more such accidents to come.

Lesson- The Solyndra stimulus story is neither remarkable nor unusual. The saga played out about as could be expected, given a set of similar circumstances. {In that regard, I doubt that anything illegal was done. Probably not anything all that unusual either.}

Lesson- My guess is that Solyndra is a simple matter of financially ignorant government bureaucrats "investing" taxpayer stimulus monies in the businesses chosen to be favored by the government. In this case, the color green was in vogue, so the government story was written to fit the desired outcome.

Lesson- In addition to not being objective with respect to which companies receive government loans, financially ignorant and biased bureaucrats spending OPM invariably do a poor job compared to knowledgeable MOM investors.

Lesson- One problem with government spending programs is making lots of OPM available to government officials which, of course, is the very nature of government "stimulus." And that's precisely where Solyndra got its $535 million.

Lesson- Another less obvious problem is often the lack of sound business judgment by the borrower. The Solyndra "stimulus" money was used to expand the company's capacity, even though more than sufficient capacity was already installed. Moreover, the company was unprofitable due to both its high costs and high prices, accompanied by low demand. Thus, its competitive situation should have restricted all concerned from digging the company's hole even deeper.

Lesson- Since the company was losing money and not fully utilizing its then existing capacity, the obvious question is why the company wanted to expand and build another factory. Well, the short answer is that the company's management wasn't spending/investing its own money.

Lesson- In an apparent greedy and get rich quick effort, the CEO and his management planned to cash out later by selling the company to public shareholders. The government partnership and $535 million of expanded capacity would provide a story they could "sell" and make appealing to public investors.

At least that's my guess about management's motivation to secure the unneeded and speculatively dangerous government loan. If there was a more straightforward reason, it's not apparent in light of the company's operating performance.

Lesson- The market is indifferent to who owns what, who does what and why they do what they do. Customers simply want value, or to buy the best product possible for the least money spent. That's the simple and unvarying nature of competition and markets. And in the Solyndra sphere of competition, the Chinese were in the game and playing to win as a low cost provider.

Loan Was Solyndra's Undoing tells the simple story of an inappropriately granted and sought-for loan extended by the government to a greedy business management. Although the loan made no business sense for either party, billions of dollars for economic "stimulus" were there for the taking. Both the project and money were green, President Obama had a story to tell, and he proceeded to tell it. I wonder what he'd say now.

The management exercised very poor judgment in seeking the government loan, but the government officials approved it. Whether the loan was granted out of abject ignorance or for other reasons, we'll never know. Still, our government shouldn't have "invested" taxpayer money that way. In any event, they did just that, even though the deal was an obvious loser from the get-go. In the end we the people will pay the bill.

The combination of government bureaucrats and taxpayer money generally causes bad things to happen, so we shouldn't be surprised when the obvious occurs. That said, we could stop it if we chose to do so, since this is America.

Let's look a little closer at the Solyndra matter and a few excerpts from the referenced article.

With respect to the appropriateness of the $535 million loan: "The new factory built with Department of Energy funds foisted fixed costs on a company already struggling through an industry shake-out, they say. What's more, the debt paradoxically made raising more money difficult. Once the government demanded priority in the event of failure, private investors were less likely to prop up the company."

One Solyndra investor said that, in retrospect, "the worst thing that happened to Solyndra was the loan."

With respect to the extremely poor judgment exercised by company officials: "Behind the political firestorm lies a company with a business case that never quite added up, owing to a fundamental cost problem that quickly got worse after the infusion of taxpayers' money that began in 2009, according to investors, analysts and people familiar with the company."

With respect to the Solyndra investors: "The company, founded in 2005, was blessed early on with influential backers. They would ultimately pump nearly $1 billion into the company.

Solyndra's largest backer was the family foundation of George Kaiser, a billionaire whose family had made a fortune from natural gas. Other venture-capital luminaries piled in, attracted with the help of Goldman Sachs Group Inc., Solyndra's financial adviser. Investors included Madrone Capital Partners, which manages money for the Walton family of Wal-Mart Stores Inc. and the Virgin Green Fund, which includes investments from Richard Branson."

Thus, the company, had it had a solid business case, would have been able to secure additional funds for investment from private market investors. That means they probably perceived the government loan terms as a "sweetheart deal." Another example of "be careful what you wish for."

In the end, everybody lost money, including us ignorant taxpayers, even though our interests were supposedly being represented by our government.

With respect to Solyndra's competitiveness: "Solyndra's costs stayed relatively high because of the tricky manufacturing process. In late 2009, Solyndra's tubes cost $4 for every watt of power output to produce, according to company securities filings. The problem was the company could sell them for only $3.24 per watt. One reason for the losses: the company often had to throw out defective or test panels, according to one former production executive.

As it was losing money, competition was getting worse. China's solar panels were dropping in price. U.S. rival First Solar Inc., was making panels at less than a quarter of Solyndra's cost then and today produces panels at about 75 cents per watt. In 2009, Solyndra lost $172.5 million on revenue of $100.5 million."

In other words, the handwriting was on the wall, but that didn't stop the government goodie "stimulus" giveaway.

With respect to the business judgment and motivations of the various players: "In mid-2009, Solyndra had a choice: It could hunker down with its existing factory and try to slash costs to meet competition, drawing on additional private capital as needed, according to the people familiar with the company. Or, with a loan from Uncle Sam, it could gamble and build a brand-new, bigger factory in a bid to gain economies of scale and dominate the market.

The Obama administration was eager to help. The loan-guarantee program dated to the George W. Bush administration—it was created in a 2005 energy law—and now was swimming in funds from the economic-stimulus package.

Solyndra's founder and chief executive at the time, Chris Gronet, decided to go for the gamble."

Summing up

Of course, that decision to gamble by the CEO sealed the company's fate. But what's the lesson for us? Well, my takeaway is that the money loaned by our government to back the CEO's long shot gamble was the taxpayers' money. It belonged to we the people.

We should not trust our government with taxpayer money to "stimulate" the economy. They will want to help their own political agenda, and this will almost never coincide with what MOM would want-- that they would make solid business investments in solid projects. Besides, they don't have the necessary competence to do so.

At the same time, when monies are there for the taking, private actors will try to access it. They will want to take an all expenses paid for ride underwritten by the taxpayers.

Thanks. Bob.

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