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Share price soars despite doubling of deficit -- Investors wooed by Vestas' full order books and strong revenue growth

A massive belief in Vestas' ability to turn a deficit of EUR 116 million in 2005 to a profit this year of EUR 144-EUR 266 million raised the company's share price by 16% after publication of Vestas' annual report on March 29. On the same day it took just a few hours for Vestas to sell 10,292,930 new shares to a closed circle of institutional investors for EUR 191 million, a 5.88% capital increase.

The background for the rare mix of what company head Ditlev Engel described as an "entirely unsatisfactory financial performance" with delighted shareholder reaction lies in a 52% increase in Vestas' revenues for 2005 coupled with a series of outlook projections which proved convincing to investors. Vestas' 2005 result might have been 7% down on the sum budgeted a year ago, but investors apparently believe that company management not only has its problems under control, but that no further problems are likely to turn up.

Vestas' plans for 2006 are a strengthening of its capital base, done almost before the ink on the emission document sent to the Copenhagen Stock Exchange was dry, and initiatives aimed at improving customer satisfaction, production efficiency and product quality. Revenues of EUR 3.6-EUR 3.8 billion are projected, more than 60% of that already secured in "firm and unconditional orders." To what extent the target is reached will be made public in quarterly financial reports, not seen before at Vestas. An earnings margin before interest and tax (EBIT) for 2006 is predicted in a range of 4-7%, while the 2008 targets of an EBIT of 10% and market share back up to 35% are unchanged. Market share fell to 28% in 2005.

The order flow last year was surprisingly large and for this reason revenues were EUR 200 million more than expected as recently as November. But completion of eight "low margin" projects in North America proved unexpectedly demanding on company resources, further weakening their profitability. In addition, deliveries of other more profitable projects were delayed. Management has since "significantly improved prices and terms in Vestas' contracts in all markets." Had the margins on the American projects been the same as for other markets, revenues would have been EUR 135 million higher, improving EBIT by four percentage points, says Vestas.

Warranties

After an "extraordinary review of warranty provisions" in the autumn and identification of "lack of reliability in several of Vestas' products," the company has increased the set aside for wind turbine repairs to EUR 221 million -- described as an "obscene" amount by Engel. The sum is a "significant part of the explanation for Vestas' operating loss in 2005."

The company distinguishes between "one-off" product faults and "type" faults. For one-off faults, the set-aside is EUR 38 million for "unscheduled service" and component failures. It is based on a fixed amount per turbine. For type faults, defined as "serial faults in large groups of turbines" the allocation is EUR 183 million, for distribution on a case-by-case basis.

In the wind industry, publicly acknowledging the risk of series failure -- and setting a price on it -- is unusual. But as the 124-page annual report makes clear, Vestas' management has experience of the significant costs of dealing with a "type" fault. Dependent on the fault's complexity, how many turbines are affected and the availability of components, "the actual costs of remedying faults may thus be higher or lower than the amount provided," warns the company.

Vestas has gathered a group of 80 engineers within the company to identify and deal with serial faults. Of the 30,700 turbines sold by Vestas, 7900 were under warranty at the end of 2005. Warranties are for two to five years. "The settlement of the many unresolved warranty claims will be crucial for the group's financial performance in the years ahead," warns Vestas.

Over the years Vestas' customers have become increasingly dissatisfied, reveals the company's latest customer survey. From a customer satisfaction level of 96% in 2000, just 60% were "satisfied" or "very satisfied" when Engel arrived last year. "To me, these were strongly flashing lights providing an unpleasant confirmation of the spate of challenges we face at Vestas. A dramatic change of behaviour was called for and in several areas a whole new approach. Above all there was a need to listen to the customers and, literally, allow them to speak up," says Engel. After meetings with customers the world over, Engel sums up their attitude: "We like Vestas, but pull yourselves together!"

In response, Vestas now has a Customer Advisory Board. Under the heading "Dialogue for development" it is reviving the tradition which 20 years ago was the wind industry's strength: a close co-operation and continuous exchange of experience between wind turbine owners and the turbine manufacturer. Improvement of quality and reliability is a precondition for customer satisfaction, acknowledges Vestas.

Whistle blowing

In the hope of uncovering problems early on, Vestas has introduced a whistle-blowing policy. "The decision to set up this function highlights the fact that Vestas is an organisation where all employees and other stakeholders can be sure that no attempt will be made to conceal or suppress significant information of any kind," says Vestas.

Under the policy employees who speak up about "criticisable conditions or actions" are granted safe conduct, says Engel. "The employees will typically be the first to detect irregularities or fraudulent behaviour in a work place. However, it often turns out that most people are reluctant to pass on their suspicions. While this may be understandable, it is often for the wrong reasons," he says.

Engel's new policy of transparency at Vestas does not extend to one area. To date the company has given detailed information on plans for new wind turbine models and timetables for their development and market introduction. In future, Vestas will keep its plans quiet if it decides that publication of them will damage its competitive position. The company does state, however, that the launch of its V120 model is postponed to 2009 in order to channel resources to other projects "with significantly higher earnings potential in both the long and short term."

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