Since SolarCity's (
) IPO back on December 13, 2012, its stock price has quadrupled
from $8.00 a share to $35.20 as of this article's publication. I
believe there are three main reasons for this dramatic rise in
One, investors are in love with SolarCity's business model. The
company offers the option to lease solar panels to customers which
allows them to pay little upfront cost while paying off the loan
throughout the life of the solar panel. So the idea is, the more
and more residential and commercial installations SolarCity signs
up the more recurring customer payments it will receive which
provides steady cash flows for many years to come. These steady
cash flows will provide a steady stream to continue reinvesting in
its core business and allow it to leverage its business further
with more debt if it so chooses to do similar to traditional
utility companies to fuel expansion.
The second reason it has taken off is because of the Elon Musk
effect. Elon Musk founded SpaceX, co-founded PayPal, and co-founded
the current talk of Wall Street and Main Street, Telsa Motors (
). There is not much debate among investors that Elon is a genius
and he excels at not only creating an innovative idea but
implementing it into an economically viable business model.
Thirdly, the solar industry's supply and demand curves are
finally coming back to normal. After a few turmoil years of falling
solar panel prices due to an oversupply in the industry, supply and
demand have finally begun to stabilize. The highly leveraged and
weak solar companies exited, and demand, due to the falling prices,
Also, looking at the longer term, I think there is a place for
Energy Information Administration
estimates that solar energy will lead the renewable capacity growth
by expanding a total of 46 gigawatts from 2011 to 2040 which
translates to about a 1000% growth from its current level. However,
as it stands now, solar power is not competitive less subsidies but
with prices continuing to drop, grid parity is starting to look
like an inevitability.
So given all this great news for SolarCity, what's not to like?
Well unfortunately there are many headwinds ahead for SolarCity.
Below I highlight some of the major risks of investing in this
The current tax credit of 30% is set to decrease to 10% at the
beginning of 2017 in the United States. I would not expect any type
of extension if not possibly decreasing it even further. The U.S.
is already $16 trillion in debt on top of a continually rising Fed
balance sheet due to the spending of billions of dollars through
quantitative easing programs to boost the economy. These tax
credits are crucial not only to SolarCity but the entire solar
industry. If you completely wipe out all subsidies, solar power is
simply not competitive with traditional power like coal, nuclear,
and natural gas at the present time. A decrease this significant
will essentially raise the cost of capital and translates to higher
prices charged to SolarCity's customers which will decrease demand
and possibly squeeze margins.
Unique business model?
I question how unique this business model is. The idea of
billions of dollars of steady cash flow every year is nice to think
about, but when you really boil it down, its unique factor is
leasing solar panels. Something many solar companies already offer.
Specifically, Real Goods Solar (
) has been doing it for decades and trades at 0.7 times sales
compared to SolarCity's pricey 13.4 price per sales despite similar
revenue (although their growth rate in revenue and market share is
less than SolarCity's). And any company not currently incorporating
leases in their business model could make the switch very easily.
In other words, this competitive advantage has very low barriers to
The one plus the company has going for it is Elon Musk's amazing
business and marketing skills. But I question how involved he is in
SolarCity when he is trying to change the world and disrupt the
United States' big three automakers (General Motors, Ford, and
Chrysler) century reign with his electric car maker company Telsa
Motors. Remember, he is CEO of Telsa running the day to day
operations and major strategic decisions while he is only the
chairman of the board of SolarCity only taking part in the major
decisions. Much more of his time is spent with Telsa and not
I think a lot investors agree that there is a lot of growth
potential in the solar industry; however, looking for the next big
thing is a tough task in this industry. SolarCity is trading at a
valuation that would indicate it will become the king of the solar
industry as I detail below. But this industry has become very
fragmented and commoditized. In other words, there are a lot of
companies selling similar products in similar ways. SolarCity's
best chance at pulling ahead of the competition is building a very
strong, trusted brand. To its credit it currently controls the most
market share of leasing solar panels at 17% in the United States. I
think it's possible that it could continue to grow a strong brand
to become the dominant choice among its competitors if absolutely
everything falls into place perfectly, but given the numerous risks
I foresee in the future, I do not see this happening.
No love for shareholders
For starters, the directors, executive officers, and insiders
(stockholders who own over 5% of SCTY's common stock outstanding)
own about 78% of the common stock. In other words, retail investors
have essentially no say in important matters of the company.
Secondly, over the last several years, SolarCity has relied upon
a lot of third party equity financing. A lot of these third parties
have senior claims above that of shareholders. This exposes common
shareholders to even more risks if the company were to go bankrupt
which will decrease the chances of getting even a fraction of their
Possible accounting shenanigans
I would like to put a little disclaimer before I begin this
section. I am not directly accusing SolarCity of cooking the books.
I am merely bringing to the attention to investors a couple of red
flags that I believe should be closely monitored. Unfortunately,
many companies in recent years have engaged in accounting fraud
which has forced keen investors to look out for potential
points out in its recent article on SolarCity, the company has
consistently reported higher fair value of its solar panels than
its peers. Why does this matter? It matters because it is a crucial
source of cash that is determined by the federal government based
off the fair value of its solar panels. In other words, the higher
the fair value the bigger the tax credit. Glancing at the first
chart below, courtesy of Barron's, a noticeable trend of reporting
higher fair value then its peers has emerged. To be fair,
SolarCity's rebuttal is that developing leases cost more than
selling the systems outright. However, this can only help explain
the last couple of years because leasing solar panels were not part
of SolarCity's core strategy when it began operations in 2006
(Shown in second chart below. Numbers in thousands of dollars).
(click to enlarge)
(click to enlarge)
To put this into perspective, if SolarCity is forced to make
just a 5% downward adjustment of about $400 million of grants it
has submitted to the Treasury as of December 31, 2012, it would be
forced to repay about $20 million to fund investors. This is a big
hit for an unprofitable company making a bit over a $100 million
per year while keeping in mind this is a conservative estimate.
Also, I would like to point out that SolarCity is deemed an
"emerging growth company" by the Securities Act so it does not have
to disclose certain accounting data. As the company states in its
10-k, "…our stockholders may not have access to certain information
they may deem important." The less information an investor has, the
more risk that is added on to the investment.
SolarCity is being priced as a three billion dollar company
while making about $130 million per year in revenue as of 2012. For
comparison's sake, First Solar (
) trades at about a four billion dollar market capitalization while
making over three
dollars in revenue. SolarCity is trading at a 14.7 price to book
multiple and a 12.8 price to sales multiple compared to First
Solar's 0.9 and 1.1 price to book and price to sales multiple,
respectively. Not to mention the industry averages 1.7 and 1.0 for
price to book and price to sales multiples, respectively. At these
valuations, investors are clearly pricing this company as if it
will be the dominant force in the solar industry. The next Apple of
technology, Wal-Mart and Amazon of retail, McDonald's of fast food,
and so on. For the reasons I list in this article, I do not believe
SolarCity will achieve this status. I believe it can be a
successful company in a growing industry, but I cannot justify
these current valuations.
SolarCity is being priced as if it has a clear, paved, yellow
brick road to dominance of the solar industry. However, I believe
the market is not fully pricing in the decreased subsidies to come,
the overrated uniqueness of its business model, the intensely
competitive nature of the solar industry, the poor support for
shareholders, and the potential for accounting mischief.
Regardless, I think SolarCity has the potential to be a solid
company but not a great investment at its current lofty
I 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. I have no business relationship with
any company whose stock is mentioned in this article.
This article is for informational and educational purposes only and
shall not be construed to constitute investment advice. Nothing
contained herein shall constitute a solicitation, recommendation or
endorsement to buy or sell any security.
Potbelly Quiet Period Expiration Is Delicious For