MEMC Electronic Materials Initiation of Coverage - $70 Target

MEMC Electronic
in association with
Initiation of coverage - $70 - BUY
TM

George A. Kotzias Putting the “tech” in cleantech
george.kotzias@us.calyon.com
We are initiating coverage of MEMC Electronic Materials (WFR) with a BUY
(212) 408-5627
rating and a $70 price target. WFR is a leading polysilicon producer for the
semiconductor and solar industries. The company boasts a strong financial
Zachary F. Sadow
position and at 12x forward earnings, it is attractively valued relative to its 5-
zachary.sadow@us.calyon.com
year average forward P/E of 17.5x. We are confident in management’s
(212) 261-3485
ability to ramp its polysilicon capacity successfully along with capacity for
high margin 300mm wafers. We also expect the company to bring solar
wafering in house by 2009 either organically or via an asset acquisition,
enabling the company to apply its expertise in semi wafers to solar wafers.
Slicing a better wafer
19 August 2008 MEMC has been a leader in the semi wafer business since 1959, but has emerged
rapidly as a major supplier of solar wafers which we estimate accounts for more
USA than 14% of sales. Direct polysilicon sales to customers (mostly solar companies)
Solar are also a significant percentage of revenue at over 20%, but we estimate semi
sales still represent two-thirds of revenues. We believe that combined sales of
NYSE WFR solar wafers and poly to solar will continue to be a high growth area for MEMC.

Priced on 18 August 2008
Cash sweet cash
WFR’s $1.4bn in cash and equivalents in 2Q08, along with estimated FCF/share
of $2.94 in 2009 is a testament to the company’s ability to benefit from the
12M hi/lo $96.08/41.58
demand for polysilicon from the high growth solar sector, but mostly from the
12M price target $70 company’s dominance in the high margin semi industry. Our $70 price target is
Current price $48.51 based on a P/E multiple of 15x 2009e earnings, which is lower than the 17.5x
±% potential 44%
Target set on 18 August 2008 historical five-year P/E but in line with its peers. Our DCF value of $68 supports
our target and sensitivity analysis suggests a range between $58 and $85/share.
Shares in issue 225.9M
Free float (est.) 225.0M Spending it wisely
Market cap $11.0bn
There may be considerable upside to WFR’s valuation depending on
management’s use of free cash flow. Although MEMC has been proactive in
buying back shares and returning value to shareholders, we would applaud some
5.0m average daily volume
cash being returned to shareholders in the form of a dividend, which the board is
considering. A value creating acquisition such as a solar wafer maker would also
Major shareholders improve our outlook as the company could apply its years of semi wafer
AllianceBernstein – 4.9% technology to improve the quality and therefore margins on solar wafers.
Barclay’s Global Inv - 3.8%
State Street – 3.4% China rising
Vanguard – 3.0% There have been great expectations for the ramp up of new polysilicon, but
American Century – 3.0%
supply from more than 30 eager Chinese poly producers has yet to materialize.
The production which was expected by 2009, has been slow, as new entrants
have found it technically challenging to enter the market. As a result, spot poly is
Stock performance (%) still over $400 per kilogram. The meteoric rise of thin-film solar technology
1M 3M 12M should also help ease demand for the semiconducting material along with the
Absolute (9.8) (30.6) (10.7) advancement of lower purity UMG-Si that is also on the radar.
100

Financials
80
2007A 2008E 2009E 2010E
60
Revenue ($bn) 1.9 2.3 2.7 3.4
40 Revenue growth (YoY %) 24.7 17.4 20.5 24.1
Net income ($bn) 0.8 0.9 1.2 1.3
20
Non-GAAP EPS ($) 3.30 4.05 4.92 5.32
0 EPS growth (YoY %) 105.6 22.6 21.5 8.0
Aug-07 Nov-07 Feb-08 May-08 Aug-08
Price/earnings (x) 15.1 12.0 10.1 9.4
Price/sales (x) 5.7 4.9 4.1 3.3
Source: Reuters Source: Company reports and Calyon Securities (USA) Inc.

Calyon Securities (USA) Inc. FOR IMPORTANT DISCLOSURE INFORMATION PLEASE REFER TO PAGE 33

WFR - BUY

Contents
Slicing a better wafer .............................................................................. 3

Cash sweet cash ...................................................................................... 6

Spending it wisely ................................................................................. 12

China rising ........................................................................................... 20

Appendices............................................................................................ 24

All prices quoted herein are as at close of business 18 August 2008, unless otherwise stated.
FOR IMPORTANT DISCLOSURE INFORMATION, PLEASE REFER TO PAGE 33

More research for your alternative-energy portfolio

2 george.kotzias@us.calyon.com 19 August 2008

Section 1: Slicing a better wafer WFR - BUY

Slicing a better wafer
MEMC has been a leader in the semi wafer business since 1959, but has emerged
rapidly as a major supplier of solar wafers which we estimate accounts for more
than 14% of sales. Direct polysilicon sales to customers (mostly solar companies)
is also a significant percentage of revenue at over 20%, but we estimate IC sales
still represent two-thirds of revenues. We believe that combined sales of solar
wafers and poly to solar will continue to be a high growth area for MEMC.

As an experienced tier 1 polysilicon producer, WFR has been able to increase
market share due to economies of scale, industry know-how and top talent. The
company has been at the helm of technological innovation and has led capacity
expansion for four decades. We believe WFR is well positioned to capitalize on the
extremely tight polysilicon market that should last through 2009.

Premium poly player
WFR benefits from WFR has benefited from being an experienced tier-1 polysilicon producer during
experience and increased the early growth stage of the solar industry. As one in a small group of
market share of
established polysilicon producers, WFR has been able to build out its solar
polysilicon to 14% in
2007 capabilities while capturing market share and positioning itself at the helm of
technological innovation. In 2007 WFR had 14% market share of the polysilicon
market, up from 12% and 13% in 2005 and 2006, respectively. Economies of
scale and technological know-how have led WFR to this incumbent position.

Figure 1

Polysilicon Market Share - 2007

Other
12% Hemlock
25%
Mitsubishi
7%

MEMC
14%
Wacker
15%

Tokuyama
13% REC
14%

Source: Company reports and Calyon Securities (USA) Inc. estimates

Sources of revenue
WFR manufactures a MEMC is a large-scale manufacturer and designer of a variety of polysilicon
variety of polysilicon products intended for the semi and solar industries. The company sells three
products on a large scale categories of polysilicon wafers; Prime Wafers, Epitaxial Wafers and Test/ Monitor
for solar and semi
industries
Wafers, that range from 100mm to 300mm. By year end 2008 WFR’s polysilicon
capacity will have grown to 8,000MT and will have extended its global reach to
encompass 2 poly and 7 wafer facilities in 6 different countries.

19 August 2008 george.kotzias@us.calyon.com 3


Figure 2 Figure 3

Revenue by region – 2007 Revenue by segment - 2007

Polysilicon
Europe 22%
15%

U.S.
Solar
24%
Asia Pacific W afer
Semi
61% 14%
Wafer
64%

Source: Company reports

MEMC - silicon since 1959
Silicon since 1959 Since its founding in 1959, Missouri based MEMC Electronic has enjoyed a long
and prosperous 50 year history partaking in the design, development and sale of
its silicon wafers to the integrated circuit market and solar industry, encountering
few impediments along the way. The well positioned silicon and wafer
heavyweight finds itself strategically straddling the saturated $1 trillion
integrated circuit market and the blooming $18 billion solar industry providing
each with the necessary poly. Although the company has seen mostly success
over the decades, along with the rest of the electronic/integrated circuit and
semiconductor industries, MEMC faced major setbacks just before the turn of the
century due to overcapacity and steep drop off in demand. Subsequent to
surviving the turmoil, today they face a new challenge of meeting increasing
demand for poly from solar.

Brief history
Defining industry MEMC established itself as a technological leader not long after its inception with
standards much of its fundamental research coming about during the 1960’s. The research
was so landmark that much of the work done at the time still remains an industry
standard today such as the chemical-mechanical polishing process (CMP),
epitaxial (Epi) deposition, and the discovery and use of zero dislocation silicon
crystals.

MEMC made a name for These technological innovations allowed the company to grow swiftly alongside
itself during the semi the booming semiconductor industry in the 1970’s and 1980’s as MEMC met
boom in the 70’s and 80’s soaring demand for smaller and faster integrated circuits with further
technological advancement including the development of the 125mm, 150mm,
and 200mm diameter wafers. The growth required an increase in capacity which
was made possible through the unveiling of new manufacturing facilities in Kuala
Lumpur, Malaysia and Utsonomiya, Japan.

1995 IPO raised over The 1990’s marked a period of momentous growth for MEMC as the company
$440 million, just before raised over $440 million in capital during its IPO in 1995. During that same year,
the overcapacity in 1998 MEMC decided to purchase the granular polysilicon manufacturing facility that
they had been using from Abermarle Corporation and renamed the plant
Pasadena. Despite its good times, MEMC suffered a crippling setback in 1998 and
1999 as global overcapacity and demand drop off hurt it financially.

With a new outlook and goal to reclaim industry leadership following these tough
times, the company appointed Nabeel Gareeb as President and CEO of MEMC and
looked to him to reinvent its business strategy and increase market share. Prior
to joining MEMC, Mr. Gareeb held the title of COO at International Rectifier
Corporation, a leading power semiconductor company, for over 10 years.



Products and technology
MEMC certainly fits the description of a pioneer as it boasts a rich portfolio
comprised of over 600 patents globally with an additional 300 on file for
application. Customers can take comfort in the consistent supply of fresh
innovation as MEMC was the first merchant manufacturer of silicon wafers, the
first to commercially produce 100mm, 125mm, 150mm and 200mm diameter
wafers, and the first to create a patented defect-free wafer, among many other
industry firsts.

MEMC meets customers’ MEMC meets its customers’ strict specifications and offers vast flexibility since
specifications and offers the application of the wafer is unique to each customer. In 1990, the company
flexibility filled orders for 1,200 different wafer specifications. This figure has stretched to
2,200 in 2006 as integrated circuit and electronics manufacturer needs continue
to advance. For this reason, the company makes three different types of wafers
available for purchase: prime polished, epitaxial, and test grade. Choice only
begins there as the customer must then decide on the composition, level of
purity, crystal and electrical properties of the wafer. MEMC continues to strive
toward increased wafer yield while simultaneously reducing the thickness of the
wafers to benefit electronics manufacturers. MEMC’s primary product offering is
the polished wafer. After growing their pure crystalline silicon wafer from granular
polysilicon, it undergoes their CMP process to eliminate all surface defects which
results in a smooth, mirror-like wafer.

Company has begun to Silicon wafers make up the foundation of most solar cells which is why MEMC has
produce 156mm wafers devoted more of its focus to the solar industry. The company has begun to
for solar application produce solar grade, 156mm wafers as it seeks to facilitate the solar industry’s
road to grid parity. Production of the wafer is only the first step that the company
has taken in what promises to be a strong relationship in the future between
MEMC and the solar industry as they expect to extend their knowledge of
polysilicon and wafer production to the solar industry to spur innovation
throughout, beginning with MEMC solar grade wafers.

SOI allows for more Much of the company’s research is devoted toward forward progress in the
complex surface designs research and development of new materials. Silicon-On-Insulator (SOI) is a novel
base material for the fabrication of chips that increases the functionality without
requiring large amounts of money for changes in fab equipment. This tri-layer
wafer allows for more complex circuit design and ultimately leads to faster
operation at lower voltages.

Chemical-mechanical MEMC’s innovation is not only limited to the end product. In 1962, MEMC the
polishing process pioneered chemical-mechanical polishing process, which is still an industry
developed in 1962 is still standard today. The process is a combined effort between a chemical corrosive
industry standard today
used to weaken the silicon and a mechanical polishing pad to remove any surface
defects, leaving a flat, smooth, mirror-like surface.

Through the years, silicon manufacturers have spent much time and money
ensuring that the wafers are not only functional, but that they enhance the user’s
yield. Most wafer manufacturers use a conventional method of internal gettering
(the process of moving impurities to the bulk) which requires long heating and
cooling periods followed by a third, growth step which leads to variation in wafers
due to high sensitivity to oxygen concentration. MEMC developed and patented a
breakthrough Rapid Thermal Process (RTP) named Magic Denuded Zone (MDZ),
which allows them to bypass the long heating period and control oxygen related
complications by heating the wafer to over 1200°C in a matter of seconds,
followed by a slightly lengthier, more controlled cooling period. MDZ gives
manufacturers a newfound freedom in working with the silicon while also
reducing processing cost to the manufacturer.


Section 2: Cash sweet cash WFR - BUY

Cash sweet cash
Cash heavy balance sheet WFR’s $1.4bn in cash and equivalents in 2Q08, along with estimated FCF/share
reveals ability to benefit of $2.94 in 2009 is a testament to the company’s ability to benefit from the
from solar and semi
demand for polysilicon from the high growth solar sector, but mostly from the
demand for polysilicon
company’s dominance in the high margin semi industry. Our $70 price target is
based on a P/E multiple of 15x 2009 earnings, which is lower than the 17.5x
historical five-year P/E but inline with its peers. Our DCF analysis supports our
target within a range between $58 and $93/share.

Discounted Cash Flow…yes it really means something
DCF analysis forecasts Using what we believe are realistic assumptions, we forecast WFR’s DCF-based
WFR’s fair value to be $68 fair value is $68 per share. The table below lists our assumptions including a
per share
WACC of 11.1% and a 4% terminal growth rate (nominal rate based on 2.5%
inflation and implies a real terminal growth rate of 1.5%).

Figure 4

DCF assumptions
WACC (%) 11.1
Cost of debt (%) 7.00
Tax rate (%) 25.0
Value of equity 11.7
Value of debt 0.0
Debt plus equity 11.7
CAPM
Risk free rate (%) 2.00
Market return (%) 8.50
Beta 1.40
Cost of equity (%) 11.1
Source: Calyon Securities (USA) Inc. estimates

Figure 5

Discounted cash flow analysis ($m)
2007A 2008E 2009E 2010E 2011E 2012E
Pre-tax income 829.6 556.9 992.2 1,101.2 1,050.2 831.7
Less: Taxes & Int 20.3 443.5 125.4 123.4 93.2 242.9
EBIT 849.9 1,000.4 1,117.6 1,224.5 1,143.4 1,074.6
Add: D&A 80.7 52.2 102.8 165.6 229.2 294.6
Less: Cap Ex 276.4 420.0 407.9 506.0 512.0 526.8
Less: Change in WC (173.2) 170.2 46.2 52.6 55.4 89.9
Free cash flow 827.4 462.3 766.3 831.5 805.2 752.5

Figure 6

Discounted cash flow analysis - equity value ($m except per share data)
PV of terminal value 12,367.8
PV of free cash flows 2,617.4
Total NPV 14,985.2
Net debt (1,105.2)
Equity value 16,090.4
Shares outstanding 237.7
Equity value per share 67.69



Figure 7

Stock price sensitivity to change in growth rate and cost of capital ($/share)
Nominal growth rate (%)
Cost of capital (%) 4.5 5.0 5.5
12.1 57.11 60.06 63.45
11.1 63.74 67.69 72.35
10.1 72.65 78.23 85.02
Source: Calyon Securities (USA) Inc. estimates.

Execution misfires present opportunity
Lingering concern of Incidents that have occurred recently include a fire and an equipment failure in
stolen talent may point to Merano, a tropical storm, and a chemical buildup in Pasadena. These are some of
cause of execution
the events that have occurred over the course of the last year or so that have
problems
assisted WFR’s shares in gaining membership to the 52-week low club. Are these
execution missteps purely bad luck? Or are they symptoms of something more
chronic? Likely the answer is a little of both. There is concern that the solar wafer
industry may be stealing talent from some of the established polysilicon and
wafer makers, especially in Asia where there are over 30 new polysilicon
production projects underway. MEMC has been a casualty of this migration east.

Figure 8

MEMC incident report since 2005
Date Incident
8/05/08 The company reported that it has taken safety precautions in preparation for heavy weather associated with
Tropical Storm Edouard at its Pasadena, Texas facility. As part of these precautions, the company has
moderated operations in various areas of the facility, which is currently anticipated to have approximately a
two day effect on polysilicon production.
4/03/08 MEMC reported it experienced accelerated buildup of chemical deposits inside the new expansion unit
("Unit 3") at its Pasadena, Texas facility. These buildups occurred multiple times, and each instance required
downtime of several days for premature maintenance to clean and re-stabilize the unit. The company also
delayed the remaining maintenance (from the prior quarter) on the existing units ("Unit 1" and "Unit 2")
waiting for Unit 3 to stabilize, but eventually had to perform the maintenance on Unit 2.
4/29/08 Pasadena, Texas -- a transfer line from a transport vehicle developed a leak and caused a release of STF, a
raw material gas used in the manufacturing process. The leak was quickly contained by the on-site
emergency response team and the flow of material was stopped.
7/23/08 The company said it suffered a "premature failure of a relatively new heat exchanger" at its Merano, Italy
facility, while a loose pipe fitting caused a fire at its Pasadena, Texas facility during the quarter.
9/04/07 A construction incident caused by one of its electrical subcontractors working on the Pasadena, Texas,
polysilicon facility expansion resulted in a power outage to the entire site. Although the power was
eventually restored later the same day, the unplanned and abrupt shutdown of high temperature and pressure
chemical operations caused considerable complications. The facility is now in the late stages of recovery, but
the abrupt nature of this incident, combined with the rain and thunderstorms in Pasadena, Texas over the last
few days, has hampered the facility's ability to recover operations expeditiously. This disruption has also
caused the on-going polysilicon expansion project at the site to be additionally delayed.
9/26/05 Pasadena, Texas -- The company reported that its employees in the Pasadena area are safe and that business
resumption activities had begun on Sunday. The facility itself sustained no major damage from hurricane
Rita. Prior to the hurricane, MEMC had safely evacuated employees from this facility.
Source: Company report, Calyon Securities (USA) Inc.

Market is pricing in a lack The bad news for the stock is that the market generally fears the unknown, and
of talent and any the unknown in this case is how much was due to lack of talent in key positions
improvements will boost
and how much was due to uncontrollable events that are inevitable in the
value of the stock
business of manufacturing polysilicon. The good news for investors is that the
market is pricing in a lack of talent. Placing the right talent in key positions is a
problem that senior management can address and correct (and in some cases
WFR has already made key personnel changes). We are confident that execution,
and therefore the value of the stock, will improve at MEMC.

Last 2 quarters of misses In WFR’s last two quarters, the company missed Street EPS estimates by 9% in
tarnish a long history of 2Q and 1% in 1Q. Previously, the company had beat earnings estimates for 9
beating expectations
consecutive quarters dating back to its last earnings miss in 3Q05.



Trading at rock bottom
Trading at relatively low We believe WFR’s shares are attractively valued relative to historical trading
multiple of 11x forward ranges. As can be seen in the figure below, at 11x its forward P/E, WFR is trading
P/E suggests bottom of
at near its 5-year low of 9x and substantially below its 5-year high of 29x and 5-
the cycle has been
reached year average of 17.5x. The relatively low multiple suggests that we are at the
bottom of the cycle in the highly cyclical semiconductor industry. While all of the
evidence points to a bottom, the important question is will demand recover soon?
Or will we stay at the bottom for a prolonged period of time…

Figure 9

Historical forward P/E

35.0
(P/E)
Forward P/E 5 yr avg P/E
30.0

25.0

20.0

15.0

10.0

5.0

0.0
5/23/03 5/23/04 5/23/05 5/23/06 5/23/07 5/23/08
Source: Factset, Calyon Securities (USA) Inc.

Signs of a semi rebound?
Multiple expansion would We believe that semi demand may be showing signs of life, as recent reports
be justified if we see the indicate an increase in wafer sales. Applied Materials (AMAT – NR) recently
semi cycle reverse
posted strong Q2 results and indicated a 30% increase in equipment orders from
foundries and DRAM. This indicates some hope (but not proof) that a recovery
may come sooner rather than later. As MEMC increases its capacity to produce
polysilicon and 300mm wafers, we need to see a return to capital spending by
the chip makers, DRAM makers and foundries. A confirmed increase in demand
would justify multiple expansion from our 15x number.

Anecdotal evidence of Besides AMAT’s favorable comments on demand, we have heard other
semi recovery incrementally positive comments from our channel checks and from industry
associations. SEMI reported this month that global silicon wafer shipments were
2,303 million square inches (MSI) in 2Q08. This is up 4.6% Y/Y from 2,201 MSI
in 2Q07, and up 6.5% Q/Q from 2,163 MSI in 1Q08. According to Kazuyo Heinink
who is the chairwoman of SEMI and also, more importantly for investors, Vice
President for New Product Marketing at MEMC, “this growth was mainly attributed
to 300mm” where MEMC is growing to over 700k wafers per month in 2010 from
under 400k per month by year end 2008.

Setting the bar too low to miss
MEMC reduced FY08 MEMC lowered its full year 2008 guidance for both top and bottom line by $150
guidance to compensate to $175 million and $0.30 to $0.50 per share respectively to compensate for a
for execution problems
mix of its execution problems as well as weakness in semi demand. Original
and weak semi demand
guidance was for earnings of $4.50 to $4.60/share on annual revenues of $2.4 to
$2.5 billion. Revised guidance for the year is $2.25 to 2.35 billion in revenues
and EPS of $4.00 to $4.30/share. In tandem with its lower guidance, the
company scheduled a mid-quarter progress update for September 2nd. We



believe that the progress update will be positive and act as a positive catalyst for
the stock leading into 3Q results.

Growing Capacity and Revenue
Growth in market share WFR’s growth in market share has been reflected by its growth in polysilicon
reflected by growth in capacity and revenue. The compnany has undergone an aggressive capacity
polysilicon capacity and
buildout over the past few years and we expect it to reach 15,000 MT of
revenue
polysilicon by 2010, translating into approximately $3.2 billion in total revenue in
2010, a Cagr of approximately 36% and 18% since 2004 for capacity and
revenue, respectively.

Figure 10

WFR polysilicon capacity and revenue growth: 2004 - 2010E

16,000 (MT) ($M) $4,000

14,000 $3,500

12,000 Polysilicon capacity $3,000
Total revenue
10,000 $2,500

8,000 $2,000

6,000 $1,500

4,000 $1,000

2,000 $500

0 $0
2004A 2005A 2006A 2007A 2008E 2009E 2010E


Margins will remain WFR has been able to increase margins in tandem with volume. Favorable pricing
attractive in the near for wafers and polysilicon coupled with an improved mix of 156mm solar wafers,
term
300mm wafers and polysilicon sales. We expect margins to remain attractive in
the near term as the semi industry’s transition to 400mm wafers remains distant
and the poly shortage continues through 2009.

Figure 11

Gross margin and operating margin: 2004 – 2008E

60.0
(%) Gross margin Operating margin

50.0

40.0

30.0

20.0

10.0

0.0
2004 2005 2006 2007E 2008E




A strong financial position We believe WFR is well positioned to weather the solar shake-out that we see
will protect WFR from looming due to its strong cash generating capabilities and its robust balance
looming solar shake-out
sheet. We believe WFR’s strong financial position will act as a protective shield
during difficult operating environments as well as enable the company to make
strategic investments and acquisitions while others may be sidelined or
susceptible to takeovers themselves as the result of a lack of cash.

Figure 12

Net debt to net debt plus equity

20

0

-20

-40

-60

-80

-100
(%)
-120

-140
2004 2005 2006 2007 2008E 2009E 2010E


Possibility for earnings Strong revenue growth, resulting from increased volume, coupled with continued
upside and margin cost improvements should lead to widening margins in the near-term. Following
expansion could come
this fruitful near-term period we believe growth and expansion will level off due
from a strategic
acquisition to the aforementioned threats to polysilicon producers and transitions taking
place in the industry. We believe margins and growth will be sustained at
attractive, albeit lower, levels during this period; however, we believe WFR will be
uniquely positioned in the solar industry at this point due to its strong financial
position. We see the possibility for earnings upside and continued margin
expansion resulting from a strategic acquisition made before WFR reaches this
phase of slowing growth.

Figure 13

Revenue and EBITDA estimates ($m)

4000 ($M) ($M) 1600

3500 1400

3000 Net sales 1200
EBITDA
2500 1000

2000 800

1500 600

1000 400

500 200

0 0
2004 2005 2006 2007 2008E 2009E 2010E




WFR will continue to Steadily increasing free cash flow has led to a sharp reduction in total debt as a
deliver strong FCF per percentage of total capital. We believe WFR will continue to deliver strong free
share to shareholders
cash flow per share to shareholders into the foreseeable future with growth
levelling off from its 2007 high.

Figure 14

Free cash flow per share: 2004 – 2012E

$3.50

$3.00

$2.50

$2.00

$1.50

$1.00

$0.50

$0.00
2004A 2005A 2006A 2007A 2008E 2009E 2010E


WFR will likely continue We expect debt as a percentage of total capital to have trailed off to
to maintain low level debt approximately 1% at the end of this year from approximately 21% during 2004.
relative to capitalization
We believe WFR will continue to maintain a low level of debt relative
capitalization.

Figure 15

Debt as percentage of Total debt to total capital
total capital to trail off to
~1% at year end 25.0
(%)

20.0

15.0

10.0

5.0

0.0
2004 2005 2006 2007 2008E


Section 3: Spending it wisely WFR - BUY

Spending it wisely
There may be considerable upside to WFR’s valuation pending management’s use
of the company’s substantial free cash flow. Although the company has been
proactive in buying back shares and returning value to shareholders, we would
applaud some cash being returned to shareholders in the form of a dividend,
which the board has been considering. A value creating acquisition such as a
solar wafer maker would also improve our outlook as the company could apply its
years of semi wafer technology to improve the quality and therefore margins on
solar wafers.

What to do with all that cash
WFR is sitting on a pile of cash, with $1.1 billion in cash and equivalents alone at
the end of 2Q08. Why aren’t they giving out that cash right now? Well most of
the current board members are survivors of the late 90’s and early 00’s when
cash was tight due to the tech implosion. In our model we forecast the company
reaching in excess of $2.4 billion in 2012 (assuming no dividends).

Still plenty of buyback to The company already has a share buyback program in place with a board
be done authorized amount of $1 billion which was approved in 2Q. This is twice the
amount of the $500 million which was initially approved in May 2007. As of June
30, 2008 the company had already bought back 4.04 million shares for a total of
$270 million.

Share buyback program is The possibility of a dividend has also been discussed at MEMC’s board meetings,
preferred method of however it seems that the preferred way of paying back shareholders is through
rewarding shareholders
the buyback program. A dividend policy, if implemented, would be a token
over dividend policy
amount, but could act as a catalyst as the company would be exposed to an
additional class of investor that is either required or compelled to own dividend
paying stocks.

Competition heating up in solar, cooling in semi
New entrants in poly face high barriers to entry as high capital requirements,
technical barriers, equipment procurement and long lead times make it difficult
to gain a foothold. MEMC’s competitors include Hemlock, SUMCO, Soitek, Wacker,
LDK, Shin-etsu, Covalent, LG Siltron and REC.

Vertical integration in solar
MEMC may be shopping MEMC is already integrated from poly to wafer on the semiconductor side of its
for a cheap wafer maker business, however on the solar side of the house the company outsources its
wafering to 3rd parties. In 2009 the company plans to bring its solar wafering in-
house, retaining more margin power in the process. More importantly, the
company’s R&D shop is chomping at the bit to apply years of extensive research
in semiconductor wafer enhancement technology to solar. Management is
confident that they can improve margins on solar wafers by improving the watts
per wafer, the basis of their pricing on solar wafer sales contracts.

The decision to bring solar wafering in-house has launched what we believe is a
global search for a wafer maker. Most wafer makers are located in Asia and
include companies like LDK (LDK US), M. Setek, Renesola (SOL US), and Sino-
American Silicon. We also would not rule out the eventual possibility of forward
integration into the cell manufacturing segment if they develop a process
whereby cell architecture is designed around a proprietary MEMC wafer.

We believe that WFR is well positioned to capitalize on the opportunity that the
demand for solar energy presents. The need for alternative sources of energy has
never been greater. The EIA estimates that world marketed energy consumption



will grow by 110% over the 2000 to 2050 period. This onslaught of growth is
mainly attributable to strong growth in energy demand among non-OECD
nations.

Figure 16

World electric power generation

35,000
30,000
OECD Non-OECD
25,000
20,000
15,000
10,000
5,000
0
2000

2002

2004

2006

2008

2010

2012

2014

2016

2018

2020

2022

2024

2026

2028

2030
Source: EIA

Need for energy A need for alternative fuel sources brought on by this growth in energy demand
alternative exacerbated has been exacerbated by the steady rise in carbon dioxide emissions as well as in
by rise in CO2 emissions
the rapid rise in the price of fuel and electricity. We believe solar energy is one of
the foremost candidates to help meet global energy demand, curb energy prices
and abate carbon emissions.

Figure 17 Figure 18

Crude oil & natural gas prices: 1986 - Present World carbon dioxide emissions: 2005 – 2030E

$/BBL $/Mcf 45
WTI Oil (L-Axis) Natural Gas (R-Axis) $16 OECD Non-OECD
40
$140 (Billion metric tons)
$14 35
$120
$12 30
$100
$10 25
$80 $8 20
$60 $6 15
$40 $4 10
$20 $2 5
$0 $0 0
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008

2005 2010 2015 2020 2025 2030
Source: Bloomberg and EIA

Technical innovator
Through its progressive in-house R&D program and a series of acquisitions, WFR
has been able to maintain its edge as a technological innovator in the ever
changing and performance demanding polysilicon industry. Fundamental research
conducted in the 1960’s led to the zero-dislocation silicon crystals that allowed
WFR to grow in-line with the booming semiconductor industry in the 1970’s and
1980’s.



Since WFR’s entrace into the solar industry in 2006 the company has focused on
offering higher grade polished wafers.

The company offers three WFR offers three general categories of wafers that include prime wafers, epitaxial
different types of wafers wafers and test / monitor wafers. Prime wafers are polished, highly refined pure
including prime, epitaxial,
wafers with an ultraflat and ultraclean surface. WFR’s premium brand prime
and test grade
wafer is called the OPTIA wafer. The OPTIA wafer is a defect-free crystalline
structure that incorporates patented technologies and processes, such as the
Magic Denuded Zone, which increases yield by drawing impurities away from the
wafer surface.

Figure 19

Wafer category offerings
Type Characteristics Premium brand name
Prime wafers Polished, highly refined, ultraflat & clean surface OPTIA
Epitaxial wafers Superior isolation between circuit elements AEGIS
Source: Company reports

Epitaxial wafers have a thin silicon layer grown on the polished surface of the
wafer and provide superior isolation between circuit elements versus a polished
wafer. WFR’s proprietary epitaxial wafer, AEGIS, also incorporates Magic Denuded
Zone and has a thin eqitaxial layer grown on a standard starting wafer that
elimates harmful defects on the wafer surface.

WFR also offers test / monitor wafers for the testing of semiconductor fabrication
lines and processes. These wafers are produced from the portion of silicon ingot
that does not meet certain specifications but are similar to prime wafers in
regard to cleanliness and flatness, in some cases.

Increasing GOI yield The company sells higher grade polished wafers under their trademark Advanta.
The wafer offers customers a cost effective product that includes a higher yield
and better performance for integrated circuits. Advanta is aimed at next
generation integrated circuits and has low levels of crystal originated pits (COPs)
on the surface while also boosting performance with higher gate oxide integrity
(GOI) of 81.8. For even better performance, the company’s trademark Optia
wafer is entirely COP free and has a superior GOI of 98.6 which makes it an ideal
long term solution for advanced integrated circuits.

Figure 20

GOI yield by MEMC wafer

100
(%)

95

90

85

80

75

70
Advanta Optia Aegis

Source: Company Reports



MEMC wafers increase Manufacturers of advanced semiconductor devices demand greater functionality
functionality through more complex circuits. As the size of the circuit is reduced, insufficient
electrical isolation between the elements becomes a problem. MEMC offers its
epitaxial wafers as the solution. Epitaxial wafers were created to increase the
reliability of the semiconductor device and provide higher efficiency by growing a
thin, single crystal silicon layer above the polished surface having different
electrical and compositional properties. Their trademark epitaxial wafer, Aegis, is
a cost effective alternative to the prime polished wafer with the difference lying
in the COP free zone which only exists in the epi layer of the wafer rather than
the entire bulk.

Weaker semi demand increases solar appeal
There is excess memory and processor capacity at the enterprise level due to the
emergence of virtualization and improved software efficiency. Some estimates
suggest that 65% or more of existing capacity is idle, as software efficiency has
reduced the strain on memory and processor capacity. The internet has allowed
companies to manage their global server network much more efficiently, as over-
utilized servers can communicate with underutilized or idle servers and share the
computing load.

The in-house advantage
WFR produces granular MEMC puts itself at a huge advantage against its competitors by making its own
polysilicon in-house granular polysilicon to use as the raw material for wafer manufacture. Granular
polysilicon processing is a far more efficient process that supports higher growth
yield. The continuous throughput is an improvement to the Siemens process. In
the more common and lower barrier to entry Siemens process, a high purity
silicon rod receives exposure to trichlorosilane gas at high temperatures
exceeding 1100°C. The chemical reaction causes additional silicon from the gas
to be deposited onto the rod. MEMC uses the more efficient fluidized bed reactor
(FBR) process to produce its granular polysilicon which has helped lower material
costs in its wafer production. The FBR process makes this possible by consuming
80% - 90% less energy while allowing for greater yield, productivity and product
purity.

Figure 21

MEMC manufacturing and R&D plants
MEMC Year
Name Location Ownership Products Completed
100mm, 125mm, 150mm, 200mm and
St. Peters, 300mm single-crystal CZ silicon; 100mm,
St. Peters 100% 1959
Missouri 125mm,150mm, 200mm Polished and
Epitaxial CZ silicon wafers
Sherman, 200mm single-crystal CZ silicon; 200mm
Southwest 100% 1997
Texas Polished and Epitaxial CZ wafers
Semiconductor-grade Granular Polysilicon,
Pasadena,
Pasadena 100% Monosilane and SiF4 Gases, 1995
Texas
Semiconductor-grade silicon powder
Utsunomiya- 125mm, 150mm, 200mm and 300mm
Utsunomiya city, Tochigi, 100% polished CZ silicon wafers; 200mm and 1986
Japan 300mm epitaxial CZ silicon wafers
Hsinchu,
Hsinchu 100% Polished and Epitaxial Wafers 1996
Taiwan
Petaling
Kuala
Jaya, 100% Polished 1970
Lumpur
Malaysia
Chonan,
Korea 80% Polished Wafers 1993
Korea
Novara Novara, Italy 100% Polished and Epitaxial Wafers 1976
Merano Merano, Italy 100% Single Crystal and Polysilicon 1976
Source: Company Reports



Growth: From semiconductors to solar
Experience during Over the past three decades WFR has enjoyed strong growth in the
semiconductor boom will semiconductor industry. We believe WFR will be able to leverage off the technical
translate into rapidly
experience it received during the seminconductor boom as well as benefit from
growing solar industry
the trials it experienced operating in a rapid growth industry, which it faces once
again.

Rapid growth in semi As highlighted by figure 22, the semiconductor industry has achieved robust and
industry is marked by a rapid growth underlined by strong demand in the early 1990’s and 2000’s.
67 fold increase from
According to the Semiconductor Industry Association, global semiconductor
1977
billings for the semiconductor industry have grown to approximately $255 million
from approximately $4 million in 1977, a 67-fold increase.

Figure 22

Semiconductor global billings: 1977 - 2007

300
($ MM)
250

200

150

100

50

-
1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007
Source: Semiconductor Industry Association

Emergence of growth WFR has been able to use its semiconductor segment as a cash cow since the
prospects in solar has semiconductor industry has reached a stage of maturity. However, the
caused WFR to shift focus
emergence of the solar industry has prompted WFR to shift its focus from the
away from semi industry
semiconductor industry to the growth prospects presented by the solar industry,
as reflected in figure 23.

Figure 23

Semi wafer revenue & semi wafer revenue as a % of total sales

2,000 Semi wafer revenue % of sales 100%

1,600 80%

1,200 60%

800 40%

400 20%

0 0%
2008E

2009E

2010E

2011E

2012E
2004A

2005A

2006A

2007A




Growth prospects by We estimate that the growth prospects presented by the c-Si solar industry will
polysilicon for solar will reach almost $70 billion by 2015, growing at a CAGR of approximately 30% over
be ~$70bn by 2015
that period from current levels.

Figure 24

C-Si market value: 2006 – 2015E

100,000
90,000 ($m)
80,000
70,000
60,000
50,000
40,000
30,000
20,000
10,000
0
2007A 2008E 2009E 2010E 2011E


Tight polysilicon market This rapid growth places a demanding and stressful supply scenario on polysilicon
will persist through 2010 producers. We believe the tight polysilcion market will persist through 2010 with
as demand outstrips
demand outstripping supply. These favourable market conditions for incumbent
supply
polysilicon producers could exceed our estimates as new entrants struggle to
bring additional supplies to the market.

Figure 25

Polysilicon supply/demand balance

5,000
(MW)
4,000

3,000

2,000

1,000

0
(1,000)

(2,000)

(3,000)

(4,000)
2006A 2007A 2008E 2009E 2010E 2011E 2012E 2013E 2014E 2015E


Talent drain in industry The experience, economies of scale and talent that WFR possesses are the exact
will leave inexperienced factors contributing to the delay in excess polysilicon available for the market. A
entrants with large delays
wave of Chinese polysilicon is set to enter the market; however, it is set to come
on-line much slower-than-expected due to the underestimation by these new-
comers of the complexities of the technology, design, trial and production
process. A talent drain in the industry, which WFR has acknowledged, will more-
than-likely leave the inexperienced Chinese new entrants the most susceptible to
delays.



Polysilicon market will Figure 26 illustrates the expected output in Chinese polysilicon production this
remain tight in year as reported by China Reality Research (CRR). CRR has been tracking the
foreseeable future
progress of 22 Chinese polysilicon producers through various plant visits and has
reinforced our belief that the polysilicon market will remain tight for the
foreseeable future due to slower-than-expected Chinese production.

Figure 26

Estimated Chinese polysilicon output in 2008

4,000 (MT)
3,500

3,000

2,500

2,000

1,500

1,000

500

-
C RR estimate of actual output With upside

Source: China reality research – CLSA Asia Pacific Markets

Eventual flood of poly is Globally, we attribute approximately 40% of a discount to this factor and
to come currently predict that only 162,000 MT of poly will be available for the solar
market by 2012 versus the 265,000 MT that has been announced. While we
believe a large amount of this poly should be discounted due to an expected
delay, we also remain wary of this eventual and unavoidable flood of poly that is
not a matter of if it will come, but when it will come.

Figure 27 Figure 28

Expected poly capacity versus announced poly capacity Announced capacity – new entrant breakdown

300,000 300,000
(MT) (MT)

250,000 250,000
Wildcards
Discounted capacity 200,000
New producers-traditional process
200,000 New producers-emerging processes
Expected capacity Established producers
150,000 150,000

100,000 100,000

50,000 50,000

- 0
2007 2008 2009 2010 2011 2012 2006 2007E 2008E 2009E 2010E 2011E 2012E


Serving wafers worldwide
MEMC’s wafers are used by some of the best known names in tech and solar
globally. In 2007, only two of MEMC’s customers, Samsung and Yingli Green
Energy (YGE US) represented more than 10% of sales. In addition to Yingli in the
solar segment, the company has signed long term wafer supply contracts with
Suntech (STP US), Gintech (3514 TT), Conergy (CGY GR), and Tainergy. MEMC’s



solar contracts typically require significant deposits and in some cases MEMC
acquires rights (as in the case of warrants on STP’s shares) to the company’s
equity. In tech, wafers can be found just about everywhere. The end users of
semi wafers include many well known names like IBM, Apple, HP, Cisco, Nokia
and Dell among others.

Figure 29

MEMC has secured over MEMC's announced long-term solar wafer supply contracts
$15bn in long-term solar Company Term Size
wafer contracts
Suntech 10 year $5-6 billion
Gintech 10 year $3-4 billion
Conergy 10 year $4 billion*
Tainergy 10 year $3-3.5 billion
Total 10 year $15-17.5 billion
Source: Company reports. Note: Conergy contract reduced from $7-8bn

Potential Q2/Q3 catalyst Upcoming catalysts
! 23rd European Photovoltaic Energy Conference and Exhibition in Valencia,
Spain on September 1-5, 2008
! MEMC mid-quarter status call on September 2nd to update investors on the
poly production ramp
! Increased evidence of strength in semi equipment orders would increase
confidence in semi wafer demand which is one of the key reasons for the
stock poor performance as of late
! Passage of solar ITC in the U.S. which could happen some time in the fall
upon Congress returning to session from summer holiday
! Solar Power International Conference in San Diego, USA on October 13-16,
2008


Section 4: China rising WFR - BUY

China rising
Uncertainties include up There have been great expectations for the ramp up of new polysilicon, but
and coming Chinese poly supply from more than 30 eager Chinese poly producers has yet to materialize.
producers, thin-film and
The production which was expected by 2009, has been slow, as new entrants
UMG-Si
have find it technically challenging to enter the market. As a result, spot poly is
still over $400 per kilogram. The meteoric rise of thin-film solar technology
should also help ease demand for the semiconducting material along with the
advancement of lower purity UMG-Si that is also on the radar. We feel confident
that management will address and be able to stay in front of the ever-changing
solar landscape.

Thin-film: Poly enemy #1
Thin-film poses a threat The unexpected success of thin-film poises a major threat to c-Si producers.
to WFR Assumptions made just a few years ago that thin-film technologies would not be
able to compete with the efficiency-superior c-Si technologies have since been
retracted as thin-film continues to lead the industry in terms of yeild and growth.

Figure 30

c-Si and thin-film demand

30,000
(MW)
25,000

20,000 Thin-film
c-Si
15,000

10,000

5,000

0
2007A 2008E 2009E 2010E 2011E 2012E

Source: Photon international and Calyon Securities (USA) Inc. estimates

Thin-film may capture Thin-film companies, such as FSLR and ENER, have capitalized on the tight
20% of market share in polysilicon supply market by increasing market share. We believe thin-film may
2008
capture 20% of market share in 2008, up from 12% in 2007 and 7% in 2006.

Figure 31

Share of competing PV technologies

Ribbon c-Si a-Si
4% 7% C dTe
5%

Mono c-Si
39%
Multi c-Si
45%



Section 4: China rising WFR - BUY

Aside from acting as an alternative for c-Si, thin-film has the advantage of
versatility and adaptability. Thin-film solar cells are flexible, making them
c-Si can lose efficiency in
versatile and able to be integrated into various structures, such as buildings.
high temperature Building integrated photovoltaic (BIPV) panels are still in a relatively early
environments commercial stage; however, we believe the technology has strong potential.
Thin-film cells are also able to withstand hot weather much better than c-Si,
which can lose efficiency in high temperature environments. This adaptability to
extreme climate conditions sets c-Si back in the bid to win some of the most
promising emerging markets that have yet to garner much attention, such as the
Middle East and Africa.

Figure 32

Many untapped solar markets are also the hottest

Source: NASA

Thin-film is likely to be Most importantly, thin-film leads the sector in pricing and is likely to be the first
first technology to technology to achieve grid parity. While we recognize the importance of cell
achieve grid parity
efficiency and the effect that reducing wafer size has on pricing, we also believe
that in the end these increases in efficiency need to translate into a steep
reduction in price per watt. In our recent report, Survey of U.S. Solar
Integrators, we found that the majority of customers are more interested in price
per watt than power density.

Figure 33 Figure 34

Module ASP forecast for c-Si and thin-film Importance of cell efficiency to solar integrators

10.0
($/Wp 45.0
9.0 (%)
40.0
8.0
35.0
7.0
30.0
6.0 25.0
5.0 20.0
4.0 15.0
c-Si ASP
3.0 10.0
Thin film ASP
2.0 5.0
1.0 0.0
0.0 Not important Somewhat Important Very Most
important important important
2006A 2008E 2010E 2012E 2014E

Source: Calyon Securities (USA) Inc. estimates Source: Calyon Securities (USA) Inc. – Survey of U.S. Solar Integrators


MEMC Electronic Materials Initiation of Coverage - $70 Target

MEMC Electronic Materials Initiation of Coverage - $70 Target

Recommended

Recommended

More Related Content

What's hot

What's hot (17)

Similar to MEMC Electronic Materials Initiation of Coverage - $70 Target

Similar to MEMC Electronic Materials Initiation of Coverage - $70 Target (20)

Recently uploaded

Recently uploaded (20)

MEMC Electronic Materials Initiation of Coverage - $70 Target