SolarCity (SCTY) is the first solar company to IPO in the U.S. markets in a long time (the previous IPOs were by Chinese solar companies). In between, a number of U.S. solar companies have tried to list their stocks, but a lack of investor interest made most of them cancel their listings (Enphase (ENPH) was the exception). While Solyndra is bankrupt now, solar thermal startup Brightsource Energy is surviving on P/E and investor money to fund its large California CSP plants. SolarCity initially came up with a $13-$15 range for its shares, but was forced to cut the price by almost 45% to $8. Since then the stock since has bounced up to the $12 area, which is very near to the bottom end of its initial IPO price band.
We think that the current market valuation of SolarCity is totally absurd given the business it operates in and the comparable valuation of other solar energy companies.
What to Do Now After the IPO Dust Has Settled
The crucial question as the IPO dust settles is what you should do with the stock. For a lot of retail investors, SolarCity presents an opportunity to play the massive growth in U.S. solar installations (projected to rise ~3.5 GW in 2012 from ~2 GW in 2011). However, as the aircraft industry has taught us, volume growth does not necessarily translate into investor profits. We will briefly examine what the company does and go on to list what we don't like about the stock (particularly the lack of profits and the high valuation).
SolarCity is mainly in the business of solar systems installation, which it sells or leases it to customers. The company has tied up with a number of big investors like Google, Bank of America, etc. to fund residential solar systems. The investors benefit as they get the tax subsidies associated with solar systems. SolarCity in recent times has branched out into the energy efficiency retrofit, energy storage, and EV charging segments as well. The company's investors include Draper Fisher, DBL Investors, and Generation Investment Management. Tesla Motors (TSLA) CEO Elon Musk is the biggest investor and also its chairman.
What We Like About SolarCity
1. Growth in a Tough Business
SolarCity has grown rapidly, leaving behind many competitors that have been in this business for a longer time. Pure play solar installers/integrators like Real Goods Solar (RSOL) and Westinghouse Solar (WEST.OB) have never managed to grow at SolarCity's pace.
2. Expansion Into Energy Efficiency Retrofits
SolarCity has very intelligently expanded into the related energy efficiency retrofit segment. Solar energy panel owners would be more receptive to environment friendly measures, and SolarCity has used this fact to sell these products/services to a large portion of its solar customers
What We Don't Like About SolarCity
1. Low Barriers to Entry
The residential and commercial solar systems installation business has very low barriers to entry, and this segment is high fragmented. The big solar installation/systems developers like MEMC (WFR), SunEdison, First Solar (FSLR), and Sunpower (SPWR) are mainly concentrated in the utility solar segment. There are almost no barriers to entering the residential and commercial solar systems business.
It was easy for companies to take advantage of the fast growth in U.S. solar panel installations in recent years. But as people become savvier and get used to the solar business, getting customers will be harder. There are already a large number of solar installers competing for customers, and the biggest cost for these companies is customer acquisition.
3. Low-Margin Business
The solar systems business has historically been a low-margin business because there are few competitive advantages. Switching vendors has almost no cost for customers, which means that solar installers don't have a lot of pricing power in the market. Lack of differentiation means that customers will gravitate to the lowest-priced supplier.
4. Financials (Can SolarCity Make Money?)
The company has not made a profit in its entire six-year history. Though revenues have grown from $32 million in 2008 to $60 million in 2011, losses have grown even faster from $26 million to $73 million. While quarterly revenues are growing strongly ($102 million YTD), the losses are not slowing down (~$60 million YTD). (Source for all data is from Google Finance.)
5. Valuation Makes No Sense
The biggest reason why we don't like SolarCity is its valuation. The company has a market cap of more than $900 million at the current stock price. Compare that to the world's biggest module supplier Yingli Solar Energy (YGE) at ~$350 million. I know the businesses are different, but the price difference does not make sense to me. The company makes no profits and the P/S at $900 million and $60 million revs implies a trailing P/S of 15x . First Solar, which is the most valued module maker and systems installer, trades at roughly 1x trailing P/S. Real Goods Solar, which is a U.S.-based solar installer, has a market capitalization of ~$26 million, which gives it a trailing P/S of 0.25x.
6. Litigation Risks
The U.S, Treasury Department has been investigating solar companies for artificially raising solar systems prices to get a higher solar tax credit. SolarCity has also been sued by Sunpower for stealing its intellectual property. While these litigation problems don't present existential risks, they have the potential to tarnish the reputation of the company.
We are at a complete loss to explain why SolarCity is being valued at such a price. The only reason we can think of is that the market does not understand the solar installation business and has been taken over by the Elon Musk hype. We think that SolarCity is going to decline sharply in the coming days regardless of what happens to the rest of the solar sector. While SolarCity will hopefully not meet the trajectory of A123 Systems after its IPO, it is certainly going further below its IPO price.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.