SolarCity Is a Lightning Rod

 | May 30, 2014 | 12:30 PM EDT
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SolarCity (SCTY) has always been a controversial stock. Critics seem to follow it the way they follow Elon Musk and Tesla (TSLA). What's interesting is that Musk is also a major backer and the chairman of SolarCity.

Critics of SolarCity center on GAAP losses that continue to pile up. It's a consumer-focused solar-panel business, the biggest in the U.S. It focuses on getting mainstream Americans walking through their local Home Depot (HD) and Best Buy (BBY) to want solar panels on their rooftops. Why? The main pitch from SolarCity is that it will cost less than what they pay for energy from their local utility.

And that pitch is compelling. People are signing up more and more with each year. SolarCity installs the panels and then starts charging customers for the energy created.

How does SolarCity do this? Through leasing the equipment on a 20-year contract. SolarCity is not only a giant utility of sorts but it has these ongoing payment streams that it can go out to the market and collateralize.

Even though it is incurring losses on a GAAP basis, SolarCity points to the "retained value" of its contracts under management and the cash coming in the door every quarter. The critics are hung up on the financing part of the business, and some of the assumptions that SolarCity makes. For example, will people really pay their bills for 20 years? What happens if they move? How many will walk away from these contracts and what does that do to SolarCity's future expected earnings? SolarCity assumes people will re-up their contracts at the end of the 20-year term for another 30-year term. Is that realistic? What if the solar panels are outdated in five years? Will SolarCity switch the all out? What will that cost the company?

The short interest in the stock has risen in the last month to about 25% of the float. That's very high. Tesla also had a high short interest in the months leading up to its first-quarter earnings call in 2013, when the stock literally took off and quadrupled in about two months. Its short interest was about 44% before the earnings came out. That's a lot of pain for the shorts.

A big similarity between the two companies is that about half the stock in the company is held closely by insiders. This means that when a little bit of good news comes out, the stock can be juiced further by all the shorts scrambling to cover short positions.

SolarCity has had a great run from its late 2012 initial public offering. It went up about 9x to its all-time highs. It's declined considerably since then, though, and now is only 5x above its IPO price.

Nevertheless, with the continued rapid pace of customer sign-ups expected over the next couple of years, I would be reluctant to short this stock. It has all the makings of a Tesla-like explosion in price upwards once it's able to show some bigger-than-expected growth.

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