Here Comes The Sun: It's The Business Model, Stupid

| About: SolarCity Corp. (SCTY)


Utility scale solar at 40 cents/watt, and $1.50/watt installed, makes more sense than rooftop solar at $3/watt installed.

Utilities and energy companies buy and sell electricity.

Homeowners buy heating, cooling and hot water, and demand is fungible except for 25-30% actual electrical demand.

In corporate and government bureaucracies, the standard method for making a presentation is to talk about a list of points organized onto slides projected up on the wall. For many years, overhead projectors lit up transparencies, and slide projectors showed high-resolution 35mm slides. Now "slideware" computer programs for presentations are nearly everywhere. Early in the 21st century, several hundred million copies of Microsoft PowerPoint were turning out trillions of slides each year.

Alas, slideware often reduces the analytical quality of presentations. In particular, the popular PowerPoint templates (ready-made designs) usually weaken verbal and spatial reasoning, and almost always corrupt statistical analysis. What is the problem with PowerPoint? And how can we improve our presentations?

(Description of Edward Tufte: The Cognitive Style of Powerpoint: Pitching out Corrupts within.)

Edward Tufte is the undisputed master of graphical presentation of quantitative information. I think the same risk he has identified attaches to the overuse of spreadsheets. It becomes so easy to project beautiful cash flows, and it is much harder to get the analytical details right, in terms of the major assumptions and uncertainties. Ask anyone who had to adjust their models from $100 oil to $30 oil. As usual GIGO applies - garbage in, garbage out.

Recently, the analytical debates that have been raging on this site and elsewhere about the validity of the rooftop solar model, and the yieldco model are being tested in interesting ways. Appaloosa is in court with TerraForm Power (NASDAQ:TERP) to block the acquisition of the Vivint Solar (NYSE:VSLR) portfolio, pursuant to the acquisition of Vivint Solar by SunEdison (NYSE:SUNE). In that case both issues are being tested, for the argument is about both the independence of the TerraForm board, or lack thereof, and the analytical distinctions between consumer solar and utility scale solar assets - all solar are not alike. Separately, flotations of most recent SolarCity (NASDAQ:SCTY) ABS portfolio as well as its first solar loan portfolio clearly demonstrated that the management assumptions of 6% discount rates for valuing these portfolios require pink colored glasses and some rich imagination to be believed.

Rooftop Solar Business Model Questions

Besides all the many ways in which shoddy assumptions exaggerated companies' self-assessments of "retained value," which has been aired out here repeatedly, there remains the fundamental issue of the business model, and the sales proposition, which rests on marketing misrepresentations of the benefits.

The rooftop solar companies use a very deceptive sales model that compares the monthly payments on their 30-year loans and leases to the monthly electrical bills consumers pay, and then bamboozle the customer into thinking that they are ''saving" money if the payments are lower. This is an apples-to-oranges comparison, which de facto treats borrowed capital as if it is not at risk capital, and obfuscates the very real liability consumers are assuming. People find out the hard way if they have to sell their property before the 20 year lease, or the 30 year loan is up.

If the financial decision for rooftop solar is looked at properly, it is a capital decision, which makes sense only if it produces a superior NPV compared to the alternatives. Based on my experience, this is rarely the case in the residential space. Usually there are plenty of more rewarding projects on hand, mostly because residential energy demand is not necessarily specific to electricity, and the major demand is thermal (heat, cooling, hot water).

Why the utility solar model makes sense

At the utility level, you are actually selling power to customers who are buying power. Moreover they are sophisticated buyers, whose profession is buying and selling of power, and that fact alone makes for easier risk assessment and management. The plants produce power wholesale and they sell their production to the energy companies who sell retail to the end consumers, be it their utilities in regulated states or energy service companies in the de-regulated states. In this market, there is a relatively simple competition between the fuels and directionally solar is increasingly very competitive, and growth expectations reflect it, as discussed by StreetInsider, here. The only limitation to solar in the end is that it is peaking power, not base load, but there are ways around that too, as the Ivanpah plant of NRG proved, because its use of solar thermal extends the hours of solar heat it can capture, and the natural gas backup makes its production dispatchable, so that it functions as base load power, the trade-off being that it's not totally 'green,' as has been widely discussed in the press, such as here. Nevertheless, hybrid solutions of one form or another will be with us a long time.

Why the rooftop solar model needs help

At the residential level, the energy demand is typically only 30% electrical, and 70% thermal, though that is starting to change for several reasons, including heat pumps and electrical vehicles (EV). For the seventy percent of energy demand that is thermal, 50-90% is best (i.e. most economically) solved by a variety of passive and energy harvesting solutions, including insulation. For retrofits, the economics would be in the lower end of that range, but for new construction, we now know that a passive house can be heated with a hairdryer, as much as the central station of Stockholm, Sweden can be heated by the body heat of the passengers, and still be an exporter of energy to an adjacent office building.

In other words, to maximize the value of your home, it makes sense to first address the 70% of energy demand which is thermal, and don't assume that the fuels you are using today are the best energy sources for HVAC and DHW (Domestic Hot Water). Granted, with lower oil and gas prices the renewable case is becoming harder, but switching might still be smarter in the long run even if it's a close call, but people just have to analyze the economics right.

SolarCity's financial foibles

As I pointed out in the earlier articles, the more scary thought is that as CEO Lyndon Rive actually might believe that SolarCity is saving their customers money in line with the sales pitch the company proffers, for it implies that he thinks borrowed capital is not at risk capital, much like consumers think plastic is not real money. One look at the company's balance sheet ratios would reconfirm the worst fears of SolarCity shareholders. Meanwhile, the latest ABS syndication established that the discount rates used in the company's fanciful projections of "retained earnings," are more likely 10% or higher, rather than the 6% management were using. And the recent "success" with the placement of their first solar loan portfolio points in the same direction.

The upshot is that with net margins of -18.69%, ROE of -8.62%, and ROIC of -2.44%, and a debt/equity ratio of 2.67, evidently borrowed money does count in the eyes of the market, even if the CEO thinks otherwise, and is trying to teach his customers and investors to come over to his new world view, which is merely the oldest mistake in the financial playbook, and not any different if the asset is solar power or anything else. The fact that he's related to Chairman Elon Musk, who apparently worships at the same altar, and recently increased his stake in the company (November 13th) still does not alter the financial math any - and three days later COO Tanguy Serra sold off 20% of his stock. There is a reason short interest is stubbornly high (circa 40% of the float recently), even though some shorts may have covered because of the ITC-bounce, and the high cost of borrowing shares.

The whole rooftop solar model is mostly the product of the transaction oriented banking world, where caveat emptor is the name of the game. Clearly this whole framework, now called WHEEL (WareHouse for Energy Efficiency Loans) in NY, is designed to create transaction fees, the interest of the buyer be damned - rooftop solar remains a negative NPV decision for many if not most buyers. But the assumptions are becoming increasingly iffy.

A good investment project is one with a large positive NPV, and that is robust enough that it will survive if a few assumptions get blown out of the water. The rooftop solar model is a house of cards of assumptions upon assumptions, some more far-fetched than others, but it can crumble quite easily, and it's all predicated on harvesting as many incentives as you can, and transaction fees everywhere, which is why the banks love it. A recent piece by fellow author Enertuition about the California Netmetering decisions highlights the weaknesses. SolarCity does not have a future unless it learns to create value for the customers, but it is questionable if they can afford to make the change, for fear of self-incrimination. The company remains on a slippery slope, and is likely to continue sliding in value as a result. Over-priced module manufacturing is not likely to help matters much.

The options for SunEdison

For SunEdison it is painfully difficult to navigate between the Scylla and Charybdis of one large shareholder (David Einhorn), and a large shareholder in one of " its" yieldcos (David Tepper) demanding transparency and accountability, which is in the process also exposing the issue of the fanciful valuation of the installed base of Vivint Solar. Even if the Vivint deal was brought to the table by TerraForm Power, that does not automatically mean that TerraForm had done due diligence on it, or the deal was not ultimately driven by SunEdison at the expense of TerraForm.

It remains very possible that Tepper will prevail, for his demand of adequate independence of the TerraForm board is pure motherhood and apple-pie. What remains then is the question if SunEdison should sell itself entirely to survive, or simply sell off Vivint Solar immediately, or sell off merely the old portfolio of Vivint Solar's existing installed base. An attempt at valuation of that portfolio was just published on SA, here, but it ostensibly does not deal with the implications of the initial reversal of the Nevada PUC, where the installed base was not grandfathered in under the new netmetering regime. Regardless if that particular decision is changed or not, the issue of fairness to all rate payers is squarely on the table now, and puts another question mark behind these valuations. The outcome will be an interesting lesson in transparency, and clarity in business plans.

The practical meaning of the utility model

In a situation like Nevada's where solar is becoming the prerogative of the energy companies, this should ideally lead to optimal decisions for all consumers, because building utility scale solar at $0.40/Watt and $1.50 per installed Watt makes more sense than installing it on rooftops at $3 per installed Watt, supported only by subsidies from the other tax payers (via tax incentives), and the other rate payers (via rate incentives, primarily net metering). So the direction set by the Nevada PUC is not negative to solar, but more socially equitable, and it points in the direction of more utility scale projects, and de-emphasizing rooftop solar.


The rooftop solar business has been beset by a high degree of exceptionalism in conceptualizing their sales proposition and their business plans, and presently, reality is catching up to it. On the one hand, newly low oil and gas prices that will likely persist for a while, make it all the more urgent that energy retrofits be properly designed with a pareto optimal outcome that maximizes property values, while minimizing green house gas emissions. There is going to be precious little room for the consumer deception of lowering monthly payments and obfuscating a very real twenty year liability behind month-to-month 'savings.'

The very public debate on valuation of portfolios of these consumer financings is increasingly exposing the fanciful "retained value," of the rooftop solar industry, which is based on unsound economics and finance. Greater independence of the boards of the so-called yieldcos is the only way forward from a point of view of transparency and accountability in public companies. Any company with public shareholders cannot be treated as the private playground of one large shareholders, even if it is a majority shareholder.

Underneath it all, it is good to realize that homeowners are not professional energy buyers, but in principle have a large degree of fungibility of energy demand in their favor, and the best retrofits (i.e. the ones that have high positive NPVs) typically involve a large measure of passive measures and fuel switching. Rooftop solar's marketing pitch of starting with the solution, and re-defining the problem for the sake of the sale amounts to building the house from the roof down instead of from the foundation up makes no sense, and compromises the options of the homeowner.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.