SolarCity (SCTY) has a byzantine loan product called MyPower that we have written about none too fondly when it was introduced in 2014.
This awful product, whose main intention was to overcome the flaws in the company's older product, was even more flawed than the products it was intended to replace/augment.
Fast forward to 2016, and the problem for SolarCity is that this product is not at all working out on many levels. Some deep problems, in no particular order of importance, are:
- A fatal flaw with the MyPower product is the interest rate being extended to customers for these loans. As readers can see in the linked article, these were set at 4.5%. We believe there is some variation geographically and some of the loans were subsequently set at slightly higher levels (ex: CA @ 5%). However, these loans were built on an assumption of ongoing low cost of capital to SolarCity. We have been forecasting that these cost of capital assumptions will come shattering down over time. As we discussed in our article on January 15th (SolarCity Inevitable Downward Spiral Has Begun), the first ABS of MyPower loans was disastrous with blended yields coming in at about 5.9%. In other words, the company has negative value generation of about 140 basis points on this product, excluding any origination and overhead costs. In other words, SolarCity is literally selling these products for pennies on a dollar right off the bat without even considering the impact of payment risks down the road.
- One of the intricacies of MyPower is that, the company depends on the customer to apply for and get a federal tax credit per ITC. SolarCity then expects the customer to pay the company when they get a federal tax refund in the year after the system is installed. If the customer does not send the tax refund to SolarCity, the customer will end up paying a higher per KWH charge for energy (in some jurisdictions, SolarCity could potentially force default for nonpayment but that is an entirely fascinating discussion all by itself). SolarCity can use the cash from ITC, based on overpriced valuation, to get a significant part of its investment back and can use this money to further drive its development engine. Unfortunately, "0" down customers are not the ideal demographic for surrendering cash. Some of the customers may not have enough tax burden to get the full credit. And, some of the customers are likely to use the tax refund for other purposes and take a hit on energy prices in the form of increased per KWH costs. The downside to SolarCity is that it will not get early ROI and the much needed cash flow to continue feeding the development beast. We do not know the size of the problem and percent of customers who are not applying the refund to decrease their rates, but we expect this contingent to be substantial.
- When customers keep the refund, they have almost no skin in the game and can even walk away in the future with potentially positive consequences. This dynamic raises the default rate profile for this product. (As a perverse example, a customer could sign up for MyPower, happily collect $10K or so tax credits from uncle Sam, and default on the payments)
- The other big problem with the MyPower product is the duration of the contracts. The last few months of wranglings with regulators should have made it abundantly clear to investors that SolarCity does not think its products will be economical without retail Net Metering. While the company has won some rare policy victories, such as the grandfathering piece in California, even in this most favorable solar state, Net Metering was grandfathered only for 20 years and not the full 30 years of the MyPower term. In effect, even assuming every policy decision for the next 20 years is favorable to SolarCity, and there are no adverse developments on technology front that disrupt system economics, these MyPower assets are likely worthless after year 20 when grand fathering on the systems expires. So, not only does SolarCity sell this product at an initial loss but has very low chance of collecting much on the back third of the payment schedule.
- If one puts all these factors together, the company will have a solidly negative ROI on this product line.
To make bad things worse, MyPower has messed up product pricing for SolarCity. Pricing energy out over a ridiculous 30-year term with MyPower, instead of the already bad 20-year term with earlier lease/PPA products, has caused SolarCity to offer cheaper per KWH terms and set an expectation of lower price per KWH in customers' minds. Salespeople, on the strength of these low prices, have been selling this product hard and have seen much success. While we have no visibility into the company's current sales or backlog breakdown, we suspect that MyPower constitutes at least 25% of the company's current sales and backlog.
With debt markets starting to tighten, and equity markets being less forgiving, these realities are hitting the company hard today. The latest MyPower ABS costs and the regulatory trends, in particular, make sustaining this product a cash flow and ROI nightmare. Unfortunately for SolarCity investors, MyPower is a proven value destroyer and must be discontinued sooner than later - this is a bullet the company must bite.
To kill the product, the company will argue that it does not need the MyPower product line because of the ITC extension, and with the ability to get tax equity and take accelerated depreciation, its other products are superior. While technically true, killing this product line could have a chilling effect on sales and raise some very uncomfortable questions on the company's retained value and backlog.
Going into Q4 earnings on 2/9, the question for investors is going to be if and when the company will kill this product, and what impact such a move will have on the growth, guidance, cash flows, business model, etc.
When coupled with the adverse impacts of the utility rulings, including Hawaii, Nevada, and California, we expect the company to be seriously growth challenged in 2016. California rate change impacts, in specific, are likely to attract considerable amount of discussion which would not be consistent with the company's past narratives.
We believe that investors expecting a 40% growth, or may be even hoping for an accelerated growth forecast due to ITC renewal, will be in for a surprise.
On the subject of just completed Q4, we believe the company is likely to perform poorly against the 280-300MW guidance mainly due to regulatory dislocations in Hawaii and Nevada. It is possible that the company can meet its guidance if it successfully closed on a large commercial (or a small utility scale) project.
The disruptions in Nevada and Hawaii also mean that a significant part of the company's backlog is impaired, and the company may show a material book to bill decline for Q1.
The company has yet another problem with regards to capital needs as its Nevada assets have become unmarketable since the PUC decision. Traditionally, the company has resorted to ABSs to raise capital, but that is not currently an option with these assets. To raise capital, it has been rumored that the company was attempting to sell some of its residential assets. To the extent that topic is discussed in the earnings call, we expect that any disclosures on the discount rates under discussion could also materially destroy the fantasy of 6% discount rate the company has been using in its investor communications.
As such, we see mostly bad news going into this earnings call. The company could potentially have positive PR on some of the non-core aspects of the business to soften the blow, but that is likely to be a distraction than anything substantive.
The situation with MyPower has become very acute. With the current economics, the company is producing solidly negative ROI even with the most favorable regulatory outcomes in the future.
We expect the upcoming Q4 earnings call to be potentially ugly for SolarCity. We believe it is likely that the Q4 performance, Q1 guidance, 2016 guidance, and the basic assumptions of the business model could all unravel in the conference call. If so, the bottom will likely fall out for this stock.
Our View of SCTY: Sell Short
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.