Solarcity's (SCTY) business plan is to spend now in order to reap the benefits later, much later. Its primary market is to homeowners. It offers homeowners solar systems with no money down and monthly payments which it sells by persuading those homeowners that their monthly bills will be less than they would have to pay to the utility. One of its products does, in fact, achieve this goal and the others may or may not.
SolarCity is losing money under GAAP accounting, a lot of it, and running a substantial negative cash flow. Its business plan is to grow its customer base this way and capitalize on that customer base later, maybe much later, if and when the customer renews the customer's commitment and continues buying power from SolarCity.
This article is an effort to analyze this business plan and see if it is likely to work and to value SolarCity in the process. If it works, it might work in a number of different ways with different prospects for SolarCity, all good to one or another degree. If it works, SolarCity may or may not be a good investment depending upon its current price's relation to its presumed value under those scenarios.
This article is intended to be a joint project that will help us all understand SolarCity and its future potential and risks, and the residential rooftop solar industry in general. As is customary for me, the article is intended to solicit criticism and comments which result in all of us getting a better understanding of SolarCity and the residential rooftop solar industry. It is a "joint" project because the article together with the commentary is the message, and we all are writing that.
I started the research for this article because I was looking for an investment in the solar industry and because I am always on the lookout for overvalued stocks which might have a catalyst for collapsing. I haven't found either yet but the comments may give me one.
The analysis is rather large so I am breaking it up into three parts.
This is the first of three parts and focuses on an analysis of SolarCity's various offerings and the effect of selling each one on the controversial metric "Retained Value".
Later, we will build on what we learn here and in the comments to value SolarCity stock.
In exploring various scenarios, I'm going to make assumptions in the middle. I usually make assumptions on the optimistic side because I want to see what might happen if things go right. This is ultimately a risk/reward ratio assessment, so I usually want to look at the better side first. If that better side doesn't produce a result that I consider good enough, I save myself a lot of work since I don't have to look any further. In this case, however, the best case scenario and the worst case scenario ultimately arrive at obvious opposite results. We'll mention them after we talk about what I think is a mid case scenario.
The assumptions that I am making are all stated in the spreadsheet on the input worksheet. As usual, you can download the full spreadsheet and change any assumption and the numbers will update across the whole spreadsheet to reflect the new assumption you made. Also as usual, I'm looking forward to hearing about any logic or calculation mistakes I made. I'm sure I made some. I always do. And lastly, also as usual, I'm looking forward to your feedback in telling me what you think I got wrong and what, if anything, you think I got right.
This article uses a 32.25 kW rooftop solar system in Las Vegas, Nevada as its example. All the projections are based on that system. A kWh means kilowatt hour which is a unit of energy equal to 1,000 watt-hours, or 3.6 megajoules. If the energy is being transmitted or used at a constant rate (power) over a period of time, the total energy in kilowatt-hours is the product of the power in kilowatts and the time in hours. The kilowatt-hour is commonly used as a billing unit for energy delivered to consumers by electric utilities. A 32.25 kW system is enough to handle all the electric needs of a fairly large house.
As part of my research for this article, I spent several months researching the various options which were available to me. I obtained two sets of price quotes from two different SolarCity salesmen for a lease, a power purchase agreement, a prepaid lease, and an outright purchase. I negotiated a quote for a power purchase agreement from a local competitor of SolarCity's. I interviewed in person or by telephone four local installation companies and one California installation company. I negotiated two quotes for an outright purchase of a system from two different installers. I obtained a quote from a non-local supplier who will ship the entire installation materials for me to arrange installation myself. None of the quotes are at the lowest price I could have gotten since I stopped negotiating at a point when there was still room to chisel. Two of the purchase quotes I negotiated have to be adjusted since they are for better systems with lower capacities. They are not apple-to-apple comparable to SolarCity's quotes. One of the quotes is apple-to-apple comparable.
So let's get into the substance.
SolarCity is a company engaged in the business of delivering solar energy solutions to residential and commercial customers to service their electrical energy needs. For residential systems, SolarCity has by far the largest market share, accounting for about 29% of the installed systems in the US during the first quarter of 2014. SolarCity markets its products by offering homeowners two deals with little or no upfront costs and supposedly with guaranteed rates below the utility's charges. What happens later depends on the deal. We'll look at what happens later in this article comparing SolarCity's offerings with a real outright purchase from a local installer in Las Vegas where I live.
SolarCity offers the residential homeowner two things which are greatly to be desired:
1. Little or no upfront cost.
2. Guaranteed maintenance for the life of the system's agreement.
It also markets based on its guaranteed lower pricing for power, compared to the utility. This is often, however, an overstatement. Although this is true at the beginning of one of the agreements, it may or may not remain true for the life of the agreement. It is not true at the beginning of another agreement but quickly gets true and stays true.
Local and national installers have had difficulty competing with SolarCity because of the substantial upfront costs necessary in installing a residential solar system. There are the equipment costs, including the costs of the panels, the microinverters, the meter, the cabling, etc. There are the soft costs, including the labor and fees involved in applying for, and securing, an installation permit, in obtaining a sign-off from the local regulatory body after an inspection of the system, etc. There are the labor costs involved in installing the system. All of these can add up to a substantial investment for a typical homeowner. The local installer usually does not have the financial ability to front these costs and until recently, bank financing wasn't available.
This upfront cost issue is now solvable with more and more banks offering zero down financing for residential solar system installations. Even better, localities are forming home improvement districts where you pay for your solar system with a multi-year but temporary increase in your property taxes. That has the advantage of making all the payments tax deductible. I am not familiar with these special assessment real property tax arrangements, "PACE programs", so I will generally ignore them in this article. Perhaps someone who knows more about them can comment on them for us.
First, let's look at SolarCity's offerings because it offers just about every kind of deal a homeowner might want in order to put a solar system on his or her rooftop. I got these quotes directly from SolarCity when it first came into the Las Vegas market a few months ago and confirmed that the pricing is the same as of August 5. They are for a 32.25 kW DC system with panels of unspecified capacity and efficiency from an unspecified supplier. To give you an idea of the size of that system, it would be enough to replace an estimated utility bill (SolarCity's estimate) of $534 a month at 12.4 cents/kWh. My own calculations come out close to SolarCity's. Let's use theirs. That comes out to 4,306 kWhs monthly. NVEnergy's actual rate is $.1234. Let's use that.
My sources for the data in this article are, as always, documents SolarCity filed with the Securities and Exchange Commission taken from the SEC's archives. The SolarCity contracts I refer to are the contracts provided to me by the SolarCity salesmen for signature which are the same, without pricing, as the ones filed with the SEC.
1. The solar system Power Purchase Agreement ("PPA").
This is SolarCity's primary product. There are two variations.
1.(NYSE:A) Variable Rate Agreement.
SolarCity will handle everything for you.
It will get the permits, install the system, make the arrangements with your local utility for net metering, turn the system on, maintain the system, and deliver the power to your home for 20 years. You agree to buy all the power the system produces for the next 20 years.
The price: In Southern Nevada the price is at a fixed rate to start of 9.21 cents/kWh increasing at 2.9% per year for the 20 year term. You have to pay all the taxes and governmental charges imposed on your own generation to NVEnergy, even though it is your own.
You have some other obligations like provide an internet connection within 80 feet of the system; keep trees from shading the panels; don't use it to heat your pool, and other stuff. None of it would be a problem for most homeowners except for the internet connection within 80 feet of the system. I have a big house. My internet connection is 170 feet from the system and running a hard connection to within 80 feet would cost from a few hundred to a few thousand dollars depending upon how nicely I would want the cable hidden and the walls restored. Let's assume you have a small house or your router is right there near the system. As for the rest, if you have a favorite palm tree you don't want to cut I doubt that SolarCity is going to check the aerial photos and complain. They do not do that as far as I can find out. You do have to pay the utility's fixed charges and the taxes on all of the power generated, including your own generation though. I looked at my bills. There is a fixed tax of 5% and a bunch of other little taxes and charges which look to me like a total of about 10%. Let's use that for this comparison. If you don't have the cash or the credit, this is a pretty good deal. Let's look at the 20 year rates and compare them to the price of the local utility for the same power. NVEnergy's rates have gone up a total of 6.45% or an average of 1.07% a year, from January 2008 through January 2014, so let's use that as an estimate for NVEnergy rate increases going forward. I have uploaded the full spreadsheet with a configurable rate of increase so that you can make your own assumptions and check out how it comes out. There are still amounts you will have to pay to the utility for fixed charges, taxes, etc. I think those charges will be $15.01 per month fixed plus variable taxes of about another 10% on the generated power. I will use $15 a month for this comparison but this amount can be configured by you in the spreadsheet to suit your own local situation. For those of you who haven't seen one of my configurable spreadsheets before, you just change the number that is configurable and all the numbers in the spreadsheet automatically change to reflect your new input.
Here is a summary of the spreadsheet:
As you can see from the calculations, you start out ahead with SolarCity but, in year 10, NVEnergy becomes less expensive. You are now paying more to SolarCity than you would be paying to NVEnergy if you had stuck with them. It isn't until year 17 though that the rates themselves, without counting the surcharge and taxes, reverse, and you are paying more per kWh to SolarCity. The reason for this is that, on our assumptions based on historical data, NVEnergy's rate grows more slowly than SolarCity's. You start out saving money but by year 11 you are paying more to SolarCity than you would be to NVEnergy. By the end of the 20th year, you reach the point at which SolarCity's previous 19 years of savings have been all used up and you have now spent more money with SolarCity than you would have if you had stayed with NVEnergy.
So what happens at the end of the 20 years? As an aside, when I asked the SolarCity salesmen what happens after 20 years, one told me that I just owned the system and the other said that I could renew for 6.4 cents/kWh.
But what really happens if you extend the contract for one or two more five-year periods?
I extended the calculations another 10 years at the same increasing cost for NVEnergy electricity and 90% of the 20th year cost for SolarCity, again assuming the 2.9% annual increase. Note that the homeowner does not have the right to extend the contract. The homeowner has the right to extend the contract for two 5-year periods at whatever price SolarCity decides to charge. That is nothing more than the right to enter into a new contract at an agreed-upon price, which we all always have.
But let's see what happens on the assumptions SolarCity uses for calculating Retained Value. SolarCity assumes, and puts the results in its Retained Value balance sheet asset, that every customer will renew for an additional ten years at 90% of the rate he was paying in the 20th year. Retained Value includes amounts for customers and not-quite-yet customers in SolarCity's backlog. Retained Value represents the discounted present value of that maybe stream of future income. It is a primary metric used to value SolarCity as an investment. SolarCity has no earnings and has a negative cash flow which it funds by borrowing against the income stream from these contracts.
Let's say that you renew for an additional period of 5 or 10 years. Since the rates have already crossed over, though, you will be paying more for your electricity than you would if you were buying it from the utility, from the very beginning, although it's not as bad as it was in the 20th year. Under those circumstances, it is in the homeowner's interest to tell SolarCity to remove its system and go back to the utility.
I doubt many homeowners will renew. Some will. They won't know what the relative prices are. No doubt the salesman will explain to them that it's really only 6.4 cents a kWh; or why it really isn't more than NVEnergy charges; or that it's better to pay more and have SolarCity rather than NVEnergy as your electricity supplier, or that your roof just looks better with those pretty panels on it. So some renew but certainly not 100% of everybody as SolarCity projects.
It isn't going to be easy for a homeowner to figure out how much he would have to pay to NVEnergy. The salesman can tell him anything. Based on my experience, he will. Try deciphering one of NVEnergy's bills. They are written in legalese and accountantese, with the numbers all in the wrong places, just in case you speak both languages. Fortunately I do speak both languages and I enjoy jigsaw puzzles.
Now what? You have a solar system on your roof that you don't own and you have to do something. Many homeowners, maybe even most of them, will renew the agreement without knowing that they did so. If you do nothing, the agreement automatically renews for one year at a time. The rate under this "default" renewal is interesting. The rate is 10% less than the current average rate being charged by the local utility! A good deal.
What does this do to the homeowner's supposed option to renew on "Retained Value" renewal assumptions? It depends on how much the local utility has been increasing its prices for the last 20 years. SolarCity assumes that the local utility's rates will go up by at least 2.9% a year for each year of the 20 years. That has not been the case in Nevada but you would never know that talking to solar system salespeople. As part of their sales pitch, every sales person I spoke with told me that NVEnergy's rates have been going up 5%, or 8%, or some percentage increase greater than 5%. They also told me that the system would last with no maintenance for 25 years, or 35 years, or even 40 years. When I asked the 35 year guy to show me one that is 35 years old he smiled and said "Well, what can I say, I'm a salesman."
You don't own the system so you either have to buy it, renew your PPA again, or tell SolarCity to take it off your roof. They commit to take it off the roof and restore the roof to its original condition, less ordinary wear and tear but not counting color variation. This is also true at the 20 and 25 year mileposts.
You can buy it at fair market value, as conclusively determined by SolarCity in its infinite wisdom. I don't see any difference between that and they'll sell it to you if they feel like at whatever price they set. But hey, that's how business is done. Most sellers don't say that their price is the fair market value as conclusively determined by them. They just say "The price is $4,212.14."
Or, and this is better, you can buy it at fair market value, as determined by a third party independent appraiser. This is exactly what the agreement says. There is no definition of "third party independent appraiser" or of "fair market value". Problems with this definition, for example, arise because "third party independent appraiser" is a term which is very carefully defined in SolarCity's loan agreements with investors seeking the tax credits and an income stream. The definition there would result in an appraiser being selected who is not independent as between the homeowner and SolarCity, but I suspect that is the appraiser SolarCity intends to use. A more significant problem is what the heck does "fair market value" mean. "Fair market value" essentially means what a willing buyer would pay a willing seller. There is no market for used solar systems and probably will never be. They get obsolete quick and cost a lot to uninstall, repair the roof, move, and re-install. So does the term in the contract mean fair market value on my roof? I would argue that is going to be zero. On someone's roof who bought it? What about the cost of getting it there? I see class actions looming on the horizon.
Or, if you don't want to buy it, you can renew the PPA at a renewal rate agreed to by SolarCity. Again, that is not a right at all. It's just signing a new contract at a rate SolarCity picks.
Or you can just get rid of it and go back to NVEnergy or make a new deal with someone, maybe even SolarCity. Or, you can wait a year and renew at 90% of what your utility is charging.
SolarCity is fortunate they do not have me as a customer. If it were me, I'd ask them how much they wanted to pay me in order for me to let them out of their obligation to remove it and restore my roof, and save themselves the cost of recycling what they get in an environmentally legal way. The SolarCity fans will say that they'll take it and sell it to someone else. I don't think so. Who is going to buy 20 year old technology for more than the cost of removing it, restoring the roof, moving the system, and re-installing it.? I think it's like asking who wants to buy a 1994 PC? It still works too.
They might try to give it away to a church or a homeless shelter. Maybe the expense of removing it and getting permits, etc. and re-installing it will be less than the tax benefit. Even with SolarCity's past practice of substantially increasing the market value of some systems when applying for federal Investment Tax Credits, I still think it's doubtful.
Another possible issue is what happens if you decide you want to sell your house before the PPA agreement is over? A bloomberg.com news article from June 24, 2014 indicates that you may have a problem. Although a solar system that you own adds value to your house, one that you don't own is a liability. You need to get a prospective buyer to read the agreement; understand it; and agree to assume it. Many do not want to bother reading it; don't understand it; or just don't want the obligation of assuming it. They won't know the economics and those may not be favorable near the end of the agreement. In addition, SolarCity has to approve their credit and they may not qualify. Realtors are pretty universal in saying "Don't lease solar" since it makes their job harder. The solar leasing companies disagree.
It's not as bad as the Bloomberg article makes it sound. You do have certain rights when you sell your house. If the buyer of your house qualifies for SolarCity credit, they can assume it. But that is problematical as indicated above. You can prepay it through the end of the twenty years and see what you can get out of the buyer of your home for it in the selling price of your home. Or you can move it to your new house, if SolarCity determines that it is feasible to do so. They charge $499 for looking to see and another $499 to move it if it's feasible. My guess is that if it's too large or you're moving cross country or it's at all difficult for any reason, SolarCity will find it not to be feasible. I think that term is badly used in this agreement. "Feasible" just means logically possible, attainable. I see more class actions over the horizon. It is not the same as "economically feasible" or practical from a cost point of view.
What about other alternatives from SolarCity at the start? There is another no down payment option.
1.(NYSE:B) Fixed Rate Agreement.
This similar to the Variable Rate Agreement discussed above in all respects except that the rate you pay SolarCity for the power produced by the system is fixed for twenty years. In Southern Nevada the price is at a fixed rate of 11.5 cents/kWh for the whole 20 year term. You have to pay all the taxes and governmental charges imposed on your own generation to NVEnergy, even though it is your own.
Let's project that out for 20 years and then for another 30 years at a rate for the additional ten years of 90% of the 20th year rate. That is also on the spreadsheet configurable the same way as above.
Here is a summary of it:
This is a much better deal. SolarCity does not break out what amount of PPAs are at a variable price and what amount are at a fixed price. Neither of my salesmen offered me the fixed price option to start. I only got it when I declined the variable price PPA and, in one case, asked for it. Both called it a custom plan and one told me it was a special deal for me because I have such a big house. Based on that, I am going to guess that most of SolarCity's PPAs are of the variable rate variety.
Secondly, I am going to guess that SolarCity will not be offering the fixed price PPA at 90% of the 20 year rate, as assumed in this summary. I think that SolarCity will determine that the fair market value of the system is higher based on the fact that it is producing higher priced energy. They will charge you 90% of what NVEnergy is charging you at that time to renew it. That spreadsheet looks like this:
This is still a good deal, for the entire first 30 years.
How does this reconcile with SolarCity's Retained Value asset?
The short answer is that it does not.
Very few homeowners will renew the variable rate agreement at 90% of what they were paying. That would be locking themselves into a higher rate with no benefits. None should but some will for any of the wrong reasons stated above. These represent the bulk of the money in Retained Value simply because they are the largest product SolarCity places.
Most of the homeowners who have a fixed price agreement will renew. SolarCity's power is still cheaper and why pay more if you don't have to. Some will pass though because of one bad experience or another with SolarCity.
Most of those who do not actively renew, will renew by default. Who keeps calendar entry reminders that "SolarCity lease expires next Monday"?
Another things. How does SolarCity do in the customer service arena?
Let's check some SolarCity's recommendations in Yelp.
Los Angeles. SolarCity gets two and a half stars, tied with Verengo Solar and the 31st worst out of 34 reviewed. Even allowing for the biases built into this kind of an open recommendation scenario, that's terrible. Read some of the reviews. There are some real horror stories and the usual. Most complain about "Smooth talking salesman lied through his teeth." Several claim that the salesman took their signature for an "application" and only later did they find out that it was a binding contract. A few complained that Yelp doesn't have negative stars, so one will have to do.
Ventura also gives SolarCity two and a half stars, third from the bottom.
Interestingly, the one five star recommendation for SolarCity that I have looked at, complete with pictures, appears in every local Yelp served location and is always listed first. I guess that homeowner has five homes and liked SolarCity so much he put their panels on all his roofs. I have carefully compared the five pictures that homeowner posted of his roof, the meters on his garage wall, and his salesman. They are all identical. What do you know about that? Duh!
OK, there are two more SolarCity deals to look at.
2. Prepaid Power Purchase Agreement.
The prepaid power purchase agreement is a PPA in which you pay all the 20 years worth of charges upfront. It doesn't have the advantage of little or no upfront costs and has all the disadvantages of the PPA except that it's a little easier to resell your house since it isn't necessary to get the buyer to assume the lease.
Does it make sense to prepay? I don't see how unless it is stopping you from selling your house.
3. A Full Purchase.
SolarCity will sell you the system, just like other local installers will. Except SolarCity's price for this system is $150,829, $32,000 higher than what the local installers, on average, charge for the same system.
There is one other point to make about SolarCity's Retained Value. It includes the assumption that every potential customer, that is a customer in SolarCity's "backlog", whatever that means, will become an actual customer; stay for 20 years; and renew for another 10 years. SolarCity counts sales that it hasn't made yet for 30 years of power that it hasn't delivered yet, in its Retained Value. This Retained Value metric is what SolarCity uses in financing its systems, so it is more important to SolarCity than as an investment valuation metric.
I seem to recall quite a few businessmen going to prison for borrowing money from banks against future sales which hadn't happened yet as though they had already been made. But hey, those were in ancient times, before SolarCity figured out how to do it.
So, in my view, SolarCity's Retained Value metric is grossly overstated. That does not necessarily make SolarCity a bad investment. We'll get to that later.
OK, that does it for now on SolarCity's Retained Value and products. In the next part, we will attempt to answer the question as to why SolarCity would use absurd assumptions to artificially inflate the Retained Value metric. In order to do that, we have to take a somewhat detailed look at SolarCity's financing mechanisms and partners. We will also look at how SolarCity's best deals compare with a purchased system, both paid for in cash and financed with available terms, with a lien on your house (better terms) and without a lien on your house.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I intend to initiate a position in SolarCity, either long or short, or in options, after I learn what I can from the comments to these articles.