SolarCity Playing in a House of Cards

 | Mar 21, 2014 | 4:00 PM EDT  | Comments
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If you own SolarCity (SCTY), this might be a good time to exit. While it is an interesting story, their fundamentals appear weak. When the others figure it out, there could be a rush to the bottom. Let me explain.

In the solar power industry, there are two basic strategies. One is to build utility-grade solar farms and feed power into the utility's distribution system. The other is to build small units on customer's property, feed power to the customer and sell any surplus to the utility. The first strategy is called, in-front-of-the-meter, or utility-grade. The second strategy is called, behind-the-meter, or distributed energy.

While the differences may appear minor, they are not. Utility-grade facilities take advantage of scale. They optimize costs, size and orientation. They maximize production. They sell power to the grid at wholesale. Unless they secure power purchase agreements, their revenues are correlated to wholesale power prices. Their operations are streamlined.

Distributed energy installations rarely achieve scale. Power production is frequently weak. Return on assets can be low. Customer management can be costly. Revenues are tied to retail rates. In comparison to utility-grade, their operations are costly and labor intensive.

For reasons of costs and simplicity, most developers avoided small energy installations. If they sought behind-the-meter deals, it would be for large box top stores, campuses or shopping malls. With larger installations, they interact with sophisticated owners and they can attempt to reach scale.

Meanwhile, serious investments are concentrated on utility-grade solar farms. NextEra Energy (NEE), Duke Energy (DUK), Consolidated Edison (ED), WGL Group (WGL), Berkshire Hathaway (BRK.A), Apple (AAPL), Google (GOOG) and others invested in scaled projects, which were easy to operate and produced predictable returns.

SolarCity arrived then. It came out of nowhere. Incredibly, they sought industry's least attractive customer. They marketed the residential and small commercial end of the market.

Many might say the results were predictable. Arithmetic conspires against companies focusing on small consumers. Not only is power production suboptimal; customer acquisition, transaction and operation costs become overwhelming.

SolarCity's recent 10-K confirms their challenges. Like previous years, the company has not been able to achieve margin. There is red ink at operations, at earnings before interest, taxes, depreciation and amortization and at bottom-line earnings.

SolarCity's 10-K appears vague in critical areas. They do not define critical terms. They do not provide enough numbers. However, they do provide a troubling picture:

Revenues

SolarCity's revenues are anemic. Their energy sales appear to be $290,000 per installed megawatt, and this is a generously high estimate. It is based on their 2013 revenues and 2012 assets. Their top line revenues were $83 million (10-K, p. 61). Their assets were 287 megawatts of installed capacity (p. 46). In contrast, nuclear power plants produce a minimum of $350,000 per megawatt and utility-scale solar farms are expected to produce $400,000 per megawatt.

Customer Acquisition Costs

SolarCity's customer acquisition costs are unsustainable. In 2013, they spent $97 million (p.61) to acquire $37 million of new business. Approximately half of that new business was one-time sales of equipment, which had nothing to do with ongoing power production. In contrast, utility-scale solar farms' customer acquisition costs are zero.

Expenses

In 2013, SolarCity spent $91 million in general and administrative expenses. This figure does not include marketing or customer acquisition. Their back office is costing them 56 cents to manage each dollar of revenue. In contrast, utility-scale solar farms' G&A expenses are in the range of 5 to 10 cents.

Losses

In 2012, SolarCity's net losses were $114 million and $99 million were allocated to shareholders. In 2013, losses were higher at $152 million and $97 million were allocated to others, presumably as tax equity. Year-over-year operating and net losses are growing. In contrast, utility-scale solar farms losses decline each year.

Cash Flows

SolarCity booked operating losses in excess of $55 million (p.68), yet they somehow produced $60 million in positive cash flows from operating activities. They did it by booking $234 million in deferred revenue (p.86). Without deferred revenue, the company's net cash would have been almost $60 million. In contrast, utility-scale solar farms' cash flows are positive from day one without deferred revenue.

Common Equity

In the face of huge losses, there is some good news and bad news. The good news is stockholders equity is $600 million (p.76) and the company has a market capitalization over $6 billion. The bad news is there is a long line in front of stockholders (p.79).

From the perspective of fundamentals, SolarCity appears to be a house of cards. Investors are buying a story. Like other house of cards, it could collapse overnight. Then again, they could pull a rabbit out of the hat.

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