With the announcement a couple of weeks ago that SolarCity (NASDAQ:SCTY) was buying a manufacturer of solar modules, the market sent the stock soaring for questionable reasons. The biggest issue with any vertical integration is that the company is now somewhat trapped into a technology instead of pursuing the most economical solution available on the market. Secondarily, the solar module market has never lacked from investments, nor is the manufacturers historically overly profitable.
The only reason to enter the space in scale is to lock in supply or to accelerate an asset previously not obtaining adequate investment. Otherwise, SolarCity has now risked the installation services and solar power generation business for the high-risk module business.
SolarCity agreed to purchase the solar technology and manufacturer of modules that are claimed to achieve a combination of high energy output and low cost. Silevo cost SolarCity up to $350 million when including earn-outs. Considering the company used mostly cheap SolarCity stock, the deal is mostly immaterial to the company prior to any major capital investment for a manufacturing plant.
According to the blog post "Solar At Scale," the company plans to build a 1 gigawatt factory in New York within a couple of years. The long-term plans are to build significantly larger plants in the subsequent years to meet the anticipated soaring demand for solar power that would need to reach 400 gigawatts of annual capacity to reach electricity generation of 40% by 2040. A number that appears very aggressive, but maybe anything is possible with Elon Musk involved.
High Efficiency Modules
The presentation about the deal spends a lot of time pretending that the market is not aware that higher efficiency panels reduces space and costs of installation. It's the holy grail of the industry to have the highest efficient panels to squeeze more electricity out of the same panels. It's the very reason that FirstSolar (NASDAQ:FSLR) bought TetraSun in 2013. At the time, TetraSun claimed a new architecture capable of hitting 21% efficiency at a low cost.
Silevo claims a target of reaching 24% cell efficiency compared to standard panel efficiency of 17 to 18%.
The real issue with some of the presentation is that it misrepresents the difference between the target of Silevo and the industry targets. Plenty of Chinese manufacturers are heading towards over 20% efficiency meaning that by the time the new company has a facility producing scale it won't have the stated lead projected in the presentation. In fact, JA Solar (NASDAQ:JASO) recently announced achieving 20.4% efficiency on cells that started production on June 20. The solar manufacturer expects to reach a capacity of 350 MW of the PERCIUM solar cells by next year.
In addition, within the five years or so that SolarCity projects building the mega module plant, the industry could move in a different direction leaving the company tied to an inferior technology.
Solar Module Graveyard
One of the benefits of being an installer in a competitive module market is that SolarCity benefited from the manufacturers slugging it out for scraps providing the company with lower costing panels. The results of the past seven years have been brutal for the solar industry with large losses from the likes of SunPower (NASDAQ:SPWR), JA Solar Holdings , Trina Solar (NYSE:TSL), and Yingli Green Energy (NYSE:YGE) along with Suntech Power going bankrupt.
Even worse, vertical integration hasn't recently produced a significant valuation advantage for other domestic providers including SunPower, FirstSolar, and SunEdison (SUNE). Ironically, all of these stocks have market valuations in the $6 - $7 billion range and trade at multiples of below 3x revenue. In essence, the best in the industry with billions worth of panel sales and utility-scale installations are only worth the same price as SolarCity now.
The biggest issue that will hit SolarCity is that the relatively low margins of the solar panel business will hit a stock currently trading based on long-term cash flow estimates from the recurring revenue stream of selling solar power. Probably even more concerning is that the company provided the industry with its game plan for the next five years allowing competitors to prepare accordingly. Elon Musk and the SolarCity team might quickly find out that providing a road map in the electrical vehicle market against sluggish car manufacturing giants isn't the same as in the aggressive solar panel market.
The stock of SolarCity might get a big boost from the ability to grow revenue by adding a manufacturer planning to add large scale, but the industry history and competitors' valuations continue to suggest the stock is already maxed out based on years of growth ahead.
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