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Summary

  • Shares jump more than 30% on the back of a deal and announced intentions to build a new plant.
  • Estimating the value of SolarCity is very complicated: unsuitability of GAAP accounting, changing dynamics and rapid growth make it a daunting task.
  • Long-term investors can allocate a small portion of their portfolio, knowing that they are betting on Elon Musk and have true long-term vision.

Investors in SolarCity (SCTY) enjoyed a good news show on Tuesday, marking a +30% rally in just a week's time. The announcement to acquire Silevo and the announcement of its intention to set up a huge manufacturing site in the state of New York drive enthusiasm.

The rapid growth, changing industry dynamics and unsuitability of GAAP accounting for its business model make it hard to make up viable assumptions to value the business. Therefore an investment remains very much a bet on long-term solar industry success and Elon Musk as a long-term visionary.

Silevo Acquisition

In a blog post, SolarCity's Chairman Elon Musk announced that the company has signed an agreement to acquire Silevo, a solar panel technology and manufacturing company.

With the $200 million stock deal, SolarCity aims to combine what it believes is the fundamentally best photovoltaic technology with economies of scale, making a big improvement in the cost of solar power. Depending on whether certain milestones will be reached, the company might pay another $150 million to shareholders of Silevo.

The deal is set to close in the third quarter of this year.

Small Deal With Large Implications

Perhaps even more exciting is the news that SolarCity is holding discussions with the state of New York to build a huge manufacturing plant. These discussions are already led by the Silevo team.

A potential facility would have a capacity of more than 1 GW to be completed in two years' time. This would make it the largest solar panel production plant in the world. The company aims to open even larger plants in the future.

Musk furthermore notes that there is excess supplier capacity, driven by too many suppliers producing low efficiency solar cells at too high costs. SolarCity, he stresses, aims to accelerate mass adoption of sustainable energy.

Size Of The Deal

The planned 1 GW facility is very substantial and is roughly equivalent to its annual installation target of a gigawatt for 2015. In comparison, the total installed capacity in the U.S. was little less than 2 GW in 2013.

The company so far relies heavily on Chinese solar cells to provide installations to its 110,000 consumers, but it wishes to control the supply chain better. As such, it aims for more efficient and reliant supply chain operations at lower costs.

First Quarter Review

Back in May, SolarCity reported its first quarter results. The company deployed 82 MW, which was more than double the amount in the comparable period the year before. Bookings of 136 MW resulted in a book-to-bill ratio of 1.66.

Revenues came in at $63.5 million on which the company posted an operating loss of $67.0 million. Due to non-controlling interests, reported losses were just $24.1 million. The usability of these measures is limited given the recognition of all the up-front costs, but not the present value of lucrative long-term contracts.

For 2014, SolarCity increased the guidance to deploy 500 to 550 MW. Deployment is expected to increase between 900 and 1,000 MW next year. Based on a simple extrapolation of the megawatt numbers, revenues are seen around $400 million for this year, while the company will post a large operating loss.

SolarCity has access to $520 million in cash and equivalents. The company operates with various kinds of debts, including convertible notes, seen around $570 million.

At $67 per share, SolarCity's equity is valued around $6.2 billion, which would peg the valuation at more than 15 times anticipated revenues for this year.

SolarCity's Long-Term Goals

It is officially SolarCity's mission to be the most compelling energy company in the 21st century, offering clear and affordable power.

The company offers consumers value by not requiring upfront costs of installation, but instead offers energy which is billed on a monthly basis at attractive rates.

The company incurs all the upfront costs, but stands to benefit from 20 years of predictable cash flows, with the option of contract extensions. Lower cost of capital, higher rates and lower costs of panels and installation improve the economics from all sides to SolarCity.

In the presentation, SolarCity notes that 12% of new generation capacity in the U.S. was solar in 2013, with nearly 2,000 MW being installed that year. By 2018, SolarCity sees potential of 1 million customers, resulting in a cumulative 6,000 MW being deployed.

In comparison, SolarCity is targeting 500 MW to 550 MW to be deployed this year, giving it an estimated 32% market share. This amazing growth has been driven by partnerships across the economic spectrum. This includes builders like Pulte Homes (NYSE:PHM) and Taylor Morrison (NYSE:TMHC), home improvement retailer Home Depot (NYSE:HD) and of course Tesla Motors (NASDAQ:TSLA).

Takeaway For (Potential) Investors

Shares of SolarCity have seen huge momentum following its public offering in December of 2012. Shares started off trading in their low-teens but rose hand-in-hand with Musk's other venture, Tesla.

After the huge run in 2013, shares peaked at $88 in February of this year. Ever since, shares have seen a nearly 50% correction to levels in the high forties in May.

After the deal, and market recovery for momentum stocks, shares have jumped back towards $67 per share at the moment of writing. Investors simply have a great deal of faith in Musk, the improved economics of solar power, the announced deal and ambitions of the mega factory.

The implications and accounting of the business model are hard to foresee, with the value of projects relying heavily on future rates, maintenance assumptions as well as anticipated efficiency improvements.

The usage of GAAP accounting makes it even more difficult, and creates huge losses for SolarCity, with depreciation terms being far shorter than lease terms. The huge upfront investments result in huge financing requirements during today's growth phase as well.

As such, SolarCity comes up with alternative metrics including the "estimated nominal contract payments remaining." This is equivalent to anticipated cash flows of $2.50 billion at the moment, resulting in a "retained value" of an anticipated $1.29 billion.

Important to notice, these values are far below the current valuation, as investors anticipate further growth. Note that these are assumptions and rely heavily on key inputs in their calculation models.

For me, SolarCity remains a bet on the long-term emergence of solar power and the disruptive impact of Elon Musk. Perhaps allocating a very small portion of your portfolio in the company makes sense if you believe in the story and are a truly long-term investor. Otherwise, shun the shares.

Source: SolarCity - Attaching A Valuation Is A Daunting Task, An Investment Is A Bet On Musk