At the time of writing SolarCity's (SCTY) stock just hit $15, up 87.5% from its IPO price.
Sure, part of this jump is related with the markets new-year fillip caused by the avoidance of the US fiscal cliff.
And we think there will be problems for SolarCity's stock price consolidation in the short and medium term. The pending IRS audits on two of the company's investment funds will be pressing this stock until there is more visibility about its consequences. Also, we believe that SolarCity is burning too much cash in SG&A and marketing. We typically like business models that turn cash positive more quickly; SolarCity has been around since 2006.
Still, our long run view on SolarCity stock is positive. We believe they are poised to lead a very attractive new market segment.
In this first article we explain what we are for us the major flaws in all recently posted "great short" analysis. In a second article, we will introduce what we believe are more comparable business models for SolarCity. Lyndon Rive, SolarCity's CEO recently stated that "There is no comparable company. Distributed energy generation is new." We think he is basically right. But some comparable business models give us good clues about the potential long term evolution of this stock
But first, let's start with some myth-busting! Basically, we think negative views miss the point by looking into 2017 with current market assumptions.
Myth 1: The "potential market is only 15% of total electricity sold in the US."
SolarCity's value proposition is to allow customers to buy electricity for less than traditional electricity. The company's current average rate is about $0.15 per kilowatt-hour. Shorts point to the fact that only 15% of the electricity sold in the United States costs more than $0.15 per kWh, implying this is "only" a $58 billion addressable market.
The cost of solar technology was reduced in more than 300% in the last 5 years. Credible sources (like McKinsey) predict that PV costs will continue to decrease in the upcoming years - even if at a slower pace. Experts indicate that there is still room for cost reduction in the solar panels, while expecting most of the future cost improvement in the balance-of-system components. As the solar installation prices continue to go down, the potential market of solar panels will continue to increase significantly. By 2017 SolarCity may be able to offer a price bellow grid parity almost everywhere in the US! This even not considering significant power price increases in the next years. Also, with this continued cost reduction, net metering policies will increasingly be less significant for SolarCity's offer.
And there are more sunny places in the world outside the US - SolarCity's management says they want gradually to play global. Overall, we believe the total addressable market can be in 2017 10X the current one (a $580 billion opportunity).
Myth 2: the "tax credit reduction impact"
Currently, the federal government offers a 30% tax credit for solar investments. The credit is currently critical for investors providing capital to SolarCity. Come January 1, 2017, the credit will be reduced to 10%. Shorts say this is a major problem: it could dry financing for SolarCity.
But again we should consider that most experts predict that solar installation prices will continue to decrease in the next years. This means that an investment tax credit of 10% in 2017 may end up being better for SolarCity and supporting investors than the current tax credit of 30%. With the current rate of cost reduction, even a 0% tax bracket may end up being fine in 2017!
Myth 3: the "overall industry sucks"
Let's face it: solar-panel makers like First Solar or SunTech are definitely not in a good shape… there is right now a big capacity glut in this industry. FT indicates that SunTech, the world's biggest panel manufacturer, carries $1.6bn in net debt and is lossmaking. Shorts argue that SolarCity is basically part of a "sick industry" and when compared with solar-panel makers, its valuation multiples do not make any sense.
This is like arguing that Best Buy (BBY) will never make money selling LCDs because of the persistent supply glut in the LCD TV sets industry. If an analyst compared Best Buy to a loss making division of LCD TV sets, what would the reader think?
Myth 4: "no barriers to entering the residential and commercial solar systems business"
Shorts say that the residential and commercial solar systems installation businesses have very low barriers to entry, and this segment is highly fragmented, being this the reason that big solar installation/systems developers like MEMC (WFR)'s SunEdison, First Solar (FSLR), and Sunpower (SPWR) are mainly concentrated in the utility solar segment.
This argument starts with a valid point: residential and commercial solar systems installation businesses indeed have low barriers to entry. But this is NOT the business segment of SolarCity. Lyndon Rive points that they are in the Distributed Energy Generation business. We think he is right:
- Solar systems installers typically don't have direct relationships with solar panel manufacturers. They buy panels trough local distribution channels, being less competitive in their procurement efforts.
- Solar systems installers typically don't take care of paperwork for their clients. Firms that do that need to invest in centralized software and specialized HR. Distribution Energy Generation providers do it - and this extra service and cost is a clear barrier to new entrants.
- Solar systems installers typically don't offer zero-upfront packages. And even when they do it, they need to price the monthly lease payments higher than SolarCity. They don't benefit from SolarCity economics of scale so they have worst cost of money terms from funding providers and have to reflect these higher finance costs in their final pricing.
- Finally, solar systems installers are solar system installers, period. They typically don't offer online performance monitoring of installations. And they also don't cater to other related ESCO services. When they get their money upfront, they don't benefit from a 20 year long relationship with customers! Do you remember what services Verizon (VZ) or Vodafone (VOD) sold customers earlier in the days? (we will come back to this comparison in the next article)
So we think that short arguments are not well supported. We believe that solar technology is still far away from cost stabilization. PV prices will likely be cut in half again in the next years. We also believe that Distributed Energy Generation is indeed a different business from solar panel installation, facing different KSFs and long term competitors.
In our next article we will bring some historical comps from industries we like to consider when thinking about the potential long term potential of SolarCity.