The premise of value investing is to buy securities whose shares appear underpriced by some form of analysis. Warren Buffett is the strategy’s greatest adherent and also its greatest success story.
In the past six weeks, Buffett’s MidAmerican Energy Holdings Company has been on a renewable-energy investment spree, buying up the $2 billion Topaz Solar Farm, in Southern California; a 49 percent interest in the $1.8 billion Agua Caliente solar project, in Arizona; and, last week, another wind project acquisition in Illinois, which brings the company’s wind power portfolio to $6 billion.
The solar acquisitions, in particular, are new, and they make you wonder, Did the Buffett investment machine see some seriously undervalued assets, even as most investors viewed solar as a train wreck?
The awful year that 2011 was for solar has been reported and analyzed here and elsewhere: Supplies ramped up as polysilicon prices dropped and demand plummeted on subsidy rollbacks. Viewed from a macro level, the Bloomberg Large Solar Index, which tracks the biggest global solar companies, had fallen almost 60 percent by last November. On a micro level, the treacherous environment for solar meant First Solar couldn’t secure a DOE loan guarantee for its Topaz Solar project, and without new financing the project’s prospects didn’t look good.
So what exactly did MidAmerican see that others haven’t?
Analysts have argued that it is simply a matter of subsidies. The production tax credit (PTC), which subsidizes renewable energy generation, expires at the end of this year for wind power but runs until 2015 for solar. While it is true that the 2.2 cent per kilowatt-hour subsidy makes solar more attractive, that is not the whole story. And there may be tremendous variance in the levelized cost of electricity comparison, but that averages around 8 cents for a coal-fired power plant versus 15 cents for a solar project. Put simply, the subsidy helps, but it isn’t enough for grid parity.
Rather, the opportunity lies in the falling price of solar power and the reality that MidAmerican could do these deals at a time when the solar industry was in distress. First Solar, in particular, made the critical announcement in December that it was exiting subsidy markets and that it now has a road map to get to grid parity in electricity pricing in three to four years — a major accomplishment. It is likely that MidAmerican foresees solar’s continuing to decline in price, which in turn would offer even more value to the utility. With 73 percent of its power coming from coal, natural gas and oil, solar projects also reduce the overall risk for the utility, because solar contains long-term visibility on pricing (the price of the sun doesn’t fluctuate).
It was also auspicious that MidAmerican’s deal to buy First Solar’s Topaz Solar Farm was announced just weeks before First Solar disclosed its new business strategy. MidAmerican must have sensed First Solar’s goal to further reduce the cost of its solar power projects, making them even more attractive in the long term. Buffett, after all, has made a living in seeing value where others haven’t. And the distress of the solar industry allowed MidAmerican to find well-priced energy generation assets.
All of this raises a final question. Did MidAmerican and Buffett get the best deal by buying now, or would the price of solar projects have dropped further? Despite reports of improvements in demand in parts of Europe, I still believe that, in the subsidy-dependent markets of the U.S. and Western Europe, at least, solar prices have a strong chance of coming down even further (I am far more optimistic about pricing in India and China, where government-mandated solar goals combined with increasing urbanization are making new power generation critical). That means some of the projects MidAmerican bought might have gotten even cheaper as panel prices continued to fall. But the risk, of course, is that there may not have been any sizable solar projects left to buy, because the companies developing them are struggling to survive themselves.
Even if MidAmerican left a bit of money on the table, a major investment by a private utility into the solar game shows a lot of courage, particular since MidAmerican is under less pressure to make renewable deals than, for example, a California utility like PG&E, where there are renewable mandates. A private utility’s acting on it own is a sign of a belief that there is still a lot of growth ahead for the solar industry, along with a reasonable amount of profit to be made. Combine that point of view with the upheaval in the solar industry, and the famous saying from 18th-century investor Baron Rothschild starts to make a lot of sense: “The time to buy is when there’s blood on the streets.”