At $1 Billion, Solar City Valuation Is Too High Relative To Peers

| About: Tesla, Inc. (TSLA)
This article is now exclusive for PRO subscribers.

Solar City's (SCTY) looming IPO has garnered a lot of press coverage recently, as interest grows to see how the public market will value this company. According to their 11/27/12 regulatory filing, Solar City will offer about 10 million shares, priced between $13 to $15, which could raise up to $151 million. This would value Solar City at about $1 billion, with 71.7 million total shares outstanding, assuming the offering prices at $14/share, the midpoint of the range.

Solar City Will Offer A Point Of Comparison

Downstream solar companies are involved in the financing, development and installation of solar systems. Generally downstream companies specialize in a specific market, like residential, commercial, government or utility scale. Solar City is unique in that they do it all: the financing, development and installation function; and they sell their energy contracts (lease and power purchase agreements) to a mix of residential, commercial, and government customers in 14 states. This will make it difficult to compare Solar City versus a downstream company that has a different mix of functions; for example a financing company that only serves residential customers.

With $124.1 million in ttm revenues, and assuming a $1 billion valuation, Solar City would have a price-to-sales multiple of roughly 8. This would be an order of magnitude higher than any other publicly traded solar company, upstream or downstream. It is reasonable that Solar City get a valuation premium because of their growth trajectory, which by any measure has been spectacular. Their IPO filing states that the "aggregate contractual cash payments that our customer are obligated to pay over the term of our long-term customer agreements have grown at a compounded annual rate of 117% since 2009." Although it is not clear what rate of return Solar City makes over the 20-year lifetime of those energy contract agreements after their fund investors are paid off.

At $1 Billion, Solar City Valuation Too High Relative To Peers

Solar City's price-to-sales ratio of 8 (and price-to-EV ratio of 8.5) is 10 times higher than the comparable companies listed below. Even considering their growth trajectory and the fact that they may be more of a financial engineering company than a solar company, this large of a premium is not sustainable. Either the comparable stocks listed below will go up, Solar City will go down, or some combination of the two.

Stock Price Market Cap Enterprise Value (NYSE:EV) Revenues ttm Price to Sales Price to EV Net Income ttm
Solar City (SCTY) $14.00 $1,003.9 $1,061.0 $124.1 8.09 8.55 ($94.9)
Real Goods Solar (RSOL) $0.44 $11.7 $19.9 $106.4 0.11 0.19 ($43.3)
MEMC Electronic Materials (WFR $2.93 $676.7 $2,390.0 $2,650.0 0.26 0.90 ($1,620.0)
SunPower (NASDAQ:SPWR) $4.63 $551.2 $996.7 $2,300.0 0.24 0.43 ($290.3)
First Solar (NASDAQ:FSLR) $27.50 $2,390.0 $2,160.0 $2,950.0 0.81 0.73 ($663.6)
* assuming SCTY prices at $14/share
* RSOL, WFR, SPWR, FSLR using 12/3/12 closing prices
* all numbers taken from Yahoo Finance

Real Goods Solar

Real Goods Solar (RSOL) may be the only pure-play, publicly traded downstream solar company. Similar to Solar City, Real Goods is a full-service developer and installer selling to residential, commercial and government customers in multiple states. The most notable difference is that Real Goods does not have in-house financing and the recurring revenue streams that come with that. At $0.44/share, Real Goods currently has an $11.7 million market cap, which would be 1/85th the value of Solar City at $1 billion. For the first three quarters of this year Solar City had 56% higher revenues, reporting $103.4 million versus $66.1 million for Real Goods.

Real Goods stock is down over 95% since 2008 and is currently trading near its all-time low. On 11/5/12 Real Goods reported abysmal 3rd quarter earnings, reporting $39 million in net loss for the quarter. The company took a combined $36.5 million in non-cash write-downs, which included a $22 million write down in goodwill and other asset impairments, and a $14.5 million charge for a valuation allowance to offset the company's net deferred taxes assets.

Real Goods should go up if Solar City can maintain a market value anywhere near $1 billion. Also having just taken large write-downs this stock may finally be able to put in a bottom.

Other Comparables To Watch

SunEdison, a subsidiary of MEMC Electronic Materials (WFR), is a reputable development and financing company, which sells to commercial, government, and recently residential clients. WFR has a $677 million market cap, on $2.65 billion of revenues, for a price-to-sales ratio of 0.26. Their semiconductor materials business makes up a large part of these numbers. WFR did report a net profit in their last quarter.

Sunpower (SPWR) is generally considered an upstream company because they manufacture panels, but they also sell to the residential and commercial market through a dealer network, and do turnkey EPC through their Utility and Power Plants division. At $4.63/share, SPWR has a $551 million market cap, on $2.3 billion of revenues, for a price-to-sales ratio of just 0.24.

First Solar (FSLR) is generally considered an upstream company because they manufacture panels, but they also have an integrated downstream EPC and financing business focusing on large solar power plants. At $27.50/share, FSLR has a $2.39 billion market cap, on $2.95 billion of revenues, for a price-to-sales ratio of 0.81. FSLR reported a net profit in their last quarter.

If Solar City goes through with their IPO and can maintain a price anywhere near the $13 to $15/share opening range, these other names in the sector are poised to go higher. And apparently December is historically a good month for solar stocks.

Disclosure: I am long RSOL, WFR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: RSOL is illiquid and may be delisted by NASDAQ