Don't Follow the Insiders to SolarCity

 | Dec 21, 2012 | 2:00 PM EST
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SolarCity (SCTY) went public earlier this month, and already a pair of insiders are using the opportunity to buy additional shares in the company. Elon Musk, who became a billionaire as the co-founder of PayPal and who currently sits on the board of directors, bought nearly 2 million shares of SolarCity at the IPO price of $8, and fellow board member Nancy Pfund bought 300,000 shares. The company had originally planned a price of $13 to $15 per share, so these two insiders seem to have taken advantage of the sudden discount in the value of the equity (it currently trades at $10.65, still well below the planned IPO price).

SolarCity installs rooftop solar panels for homeowners for free, and then leases the system. It also serves government and business customers. Its products enable pollution-conscious energy users to use solar energy, and the system can result in savings on utility bills (though we'd imagine that much of its customer base doesn't require solar to be lower cost in order to buy). The company's current market capitalization is only $120 million, but over half a million shares have been traded each day that it has been a public company, so it should offer over $1 million in average daily dollar volume.

The company's filings with the Securities and Exchange Commission disclose that in the first nine months of 2012 it earned $103 million in revenue, compared with $39 million in the first nine months of 2011 and $60 million for the full year. Looking at the first nine months of 2012 and 2011, sales of solar energy systems, which had previously been the slower-growing segment of the business, more than tripled while operating leases (a smaller portion of the business) more than doubled.

Cost of revenue was up strongly, but by less than 100%, and operating expenses showed a similar story. As a result, operating losses of $45 million were about even from those of a year earlier, reflecting an improvement in SolarCity's margins. However, the company is of course still unprofitable, and it had higher interest expenses and other expenses this year as well. SolarCity does struggle with cash flow; cash flow from operations was slightly negative in the first nine months of 2012 (though it was positive in the fourth quarter of 2011 and on a trailing basis).

The company's margins improve with revenue growth, and there is likely to be continued improvement on the top line. This suggests that SolarCity has at least some chance of becoming profitable. Solar, of course, is one of the frostiest investment theses right now, and this likely explains why the company was forced to reduce its IPO price.

First Solar (FSLR), for example, is down 75% in the last two years. Though First Solar still has a market capitalization of $2.8 billion, more than half of the outstanding shares are held short, as the market actually believes the stock is not done going down, and it was JPMorgan's pick for the No. 1 stock to avoid in 2013 -- in fact, it was the only stock on its list of stocks to avoid. First Solar isn't precisely comparable. As it is a manufacturer of solar modules, lower prices hurt FirstSolar but help SolarCity. Still, we believe the collapse of First Solar's stock illustrates the market's sentiment toward solar power.

We really can't think of SolarCity in value terms, as it isn't even generating operating income, so comparisons with other companies are difficult. SolarCity's market cap is about even with its revenue; if we use enterprise value instead, we get an EV/R ratio of 3. This is considerably lower than that of "world changing" companies such as Facebook (FB) or fellow Musk investment Tesla Motors (TSLA), but much higher than that of First Solar or SunPower (SPWR), a company that provides solar systems for both utilities and homeowners.

Certainly a number of investors aren't interested in solar at all, and as we've noted, value investors should be avoiding SolarCity for now, as it's not clear when it would even become profitable. However, the revenue growth rates are impressive, and the lease model should provide recurring revenue while sales move on to other customers. It may be worth watching for future developments.



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