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September 19, 2011 4:29 pm

Sinovel legal action casts shadow over potential export opportunities in China’s wind power industry

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This article is provided to FT.com readers by mergermarket—a news service focused on providing actionable, origination intelligence to M&A professionals. www.mergermarket.com
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Wind energy and technology companies eager to capitalize on the vast export opportunities in the Chinese market may have been taken aback by US-based American Superconductor’s allegation that China’s Sinovel Wind Group Co. stole intellectual property related to operating wind turbines.

But there is a great demand for technologies and services to help upgrade a still rapidly expanding market for wind energy in China, industry sources in China and equity analysts in the US told mergermarket. And as many US-based companies focus their attention at exporting to foreign markets as their salvation to stagnating growth and demand at home, the issues arising from the potentially drawn-out legal battle are something to consider.

American Superconductor (AMSC), the Devens, Massachusetts-based power infrastructure technology concern, this week initaited a series of legal challenges against its single largest customer, China’s Sinovel. The Chinese wind turbine manufacturer has historically represented two-thirds to three-fourths of AMSC’s total revenues and in May 2010, the company signed a USD 445m contract with Sinovel to provide components for wind turbines through 2013, according to regulatory documents.

AMSC filed a claim for arbitration in Beijing with the aim of forcing Sinovel to pay for past shipments and to accept existing contracted shipments. In March this year, Sinovel refused to pay for products already shipped by AMSC as well as future shipments for components used in 1.5MW and 3MW wind turbines.

The company also filed civil complaints in China against Sinovel and its partly-owned venture Dalian Guotong Electric Co. AMSC claims Sinovel paid an employee of Windtec, a wholly-owned subsidiary of AMSC based in Austria, to give them source code for software needed to operate wind turbine systems. AMSC believes that Sinovel worked with the Windetc employee to remove encryption on the software so that it could be used for components from other suppliers in the turbines.

Sinovel denies the allegations made by AMSC and will respond actively, a company spokesperson told this news service. The Chinese company said it refused to pay for existing shipments from AMSC and future contracted shipments because AMSC’s products do not meet the requirements of the contract, fail the standards of the Chinese power grid, have a high failure rate and provide poor after-sale service, the spokesperson said. AMSC also failed to provide upgrade solutions for the low voltage ride through systems required by Chinese regulatory agencies, the spokesperson continued.

In any case, the legal battle is sure to be long and drawn out. Anecdotally, there are very few instances where a US company challenged and won an IP dispute with companies in China, said equity analysts. However, AMSC CEO Daniel McGahn, during a conference call to discuss the allegations, cited Cisco’s patent dispute with Huawei Technologies as a precedent for US companies winning these types of legal battles.

“Cisco was able to prevail and they were able to win a settlement with the company that had stolen the intellectual property. So I believe there is precedence,” McGahn said in the call yesterday.

Dire need for upgrades

The dispute between Sinovel and AMSC is in large part due to the massive push from the Chinese government to upgrade the country’s power transmission infrastructure, said industry sources and equity analysts. Reports estimate roughly 30% of the country’s wind farms are not connected to the power grid. Last month, China’s State Electricity Regulatory Commission (SERC) conducted nationwide inspections in response to the widespread disconnection of power from the grid taking place throughout the country, according to a report from China Daily. The inspections followed power failures in the Jiuquan, Gansu province, a major wind power base, where nearly 3,000 turbines were disconnected from the grid, according to the report.

Operation rates of new wind farms in China fell to 0% in the second quarter of this year, a Chinese government source told this news service. Lower demand for new turbines affected most Chinese wind turbine makers and caused problems in converting inventory levels into sales, said the government source.

At the same time, wind turbine makers across China are in need of massive capital investments to upgrade the power transmission systems to prevent further power outages around the country.

China’s National Energy Bureau issued 18 new industry standards in August, which tightened the inspection of wind farm safety management, operations, grid connections and the wind turbine quality, industry sources said.

The issue concerns the lack of low voltage ride through (LVRT) systems in the country’s power grid. LVRT systems help keep wind turbines in operation whenever there are large drops in voltage, like when the wind dies down for example. Without these systems, wind turbines will just disconnect from the power grid. To pass the SERC inspections, existing wind farms were required to upgrade these LVRT systems, said industry sources in China.

The root problem is, as usually is the case, one of costs. It costs between CNY 10,000 and CNY 500,000 to upgrade a single turbine and most of China’s 34,000 turbines are without a LVRT system, according to the China Daily report.

But the need for upgrades in China was, and remains, a major opportunity for green energy companies in the US and abroad, analysts say. Industrial giants such as GE and Siemens have been developing LVRT systems for years and newer clean-tech companies such as A123 Systems have been involved in supplying components for such system upgrades in China.

In fact, AMSC has been pushing to capitalize on that opportunity as well with its recent acquisition of Finland-based The Switch Engineering, which specializes in converters made for wind power systems.

Sinovel, too, has been trying to find its own internal solutions for the upgrades, turning to suppliers in China that can provide components for up to 20% cheaper than AMSC, said industry sources in China. Sinovel partly owns Dalian Guotong Electric, which has been named in AMSC’s allegations, and has also been sourcing components from China-based Shenzhen Hopewind Electric, another maker of wind energy converters, said industry sources in China.

The allegations against Sinovel relate to these changes in the country’s power grid. AMSC claims that the software that Sinovel stole would “potentially enable Sinovel to deploy, independent of the Company, wind turbine control software, including a low voltage ride through (LVRT) solution, on all of its 1.5MW wind turbines in the field.” The stolen software would also allow Sinovel to use components from other suppliers for its LVRT systems, the company said in the news release.

A strain on cash flow

Whether or not Sinovel executives were trying to cut corners to upgrade their systems, the fact is that the company was facing financial pressures, said equity analysts in the US.

Cash flow has been a high priority in the past couple of years as overcapacity in the wind sector has made competition cruel, said industry sources in China. Wind turbine prices have also recently fallen below EUR 1m per megawatt for the first time since 2005, the industry sources said.

In this environment, Sinovel has been ramping up production, with power capacity climbing to 4,386MW in 2010 from 3,150MW in 2009, ascending it to China’s number one spot and the world’s number two, according to a Sinovel release in March. The company also raised roughly CNY 9.5bn in January in its initial public offering on the Shanghai Stock Exchange. It has been doubling its total revenue every year since 2007 and posted CNY 20.3bn in revenues in 2010, according to data from Bloomberg Businessweek.

But the company has been able to beat its competition on market share by stocking a massive inventory of products and boasting a fast delivery time, said the equity analysts in the US. For a rough comparison, Sinovel’s inventory was 55.2% of total revenue in 2010 compared to industry leader Vestas, which sported a 39.5% inventory to revenue ratio. Sinovel also increased its inventory level in 2010 compared to the previous year while Vestas decreased inventory over the same period.

Delivery time may have helped company but having all that capital tied up in inventory may have put added pressure on cash flow for the first half of the year, the analysts said.

American Superconductor did not respond to calls for this article.

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