By Contrarian PM :
SolarCity ( SCTY ) is the largest residential installer and financer of solar systems in the U.S. It's a controversial name to say the least with a trove of Elon Musk loyalists pitted against a large short interest of people that clearly doubt the financial viability of the enterprise. The company's GAAP financial statements show a company that loses money and consumes a massive amount of cash on a quarterly basis, however, SCTY's management provides their own metrics to help investors understand the value created by its long-term solar financing business. We will discuss these metrics in depth to determine how accurate or misleading they are.
Net retained value ((NRV))
Source: SolarCity 3Q15 Presentation
NRV is SCTY's flagship metric created by management to help investors and analysts understand the value creation of deploying and financing solar assets. Their exact definition is "Net Retained Value Represents Our Discounted Cash Forecast to Equity After Net Debt Outstanding". This number is easily manipulated and has been debated endlessly in this and other forums. Before we delve into how accurate the forecasts may or may not be we think it is worth pointing out how aggressive and misleading management is when it comes to this metric. As you can see in the slide above, the giant green letters at the top proclaim there is ~$33 per share of NRV. If you go lower on the slide in small letters there is a disclosure that management excludes $796 million of debt from the calculation and assumes it is settled as equity. Here is the issue, if you assume the convertible debt is settled as equity then you need to add 10.5 million shares to the number of shares outstanding. Something management clearly did not do to reach their $33 per share of NRV. If you take the basic share count and add the shares attached to the convertible debt, the NRV drops to $30 per share. If you actually treat the debt as debt (which is the reasonable thing to do given that the majority converts at $83.52 per share), then the NRV drops to $25.20 per share. This is not an argument of the appropriate discount rate, the value of the renewal, or whether management has reserved enough for maintenance; it is simply showing that they are intentionally overstating NRV per share by at least 10% in giant green letters in the most recent slide deck.
These accounting shenanigans with convertible debt obviously increased NRV by $796 million or ~$8 per share over the last two years. Issuing convertible debt, adding in the cash, not subtracting the debt and not adding the shares into the diluted share count has by far been their most efficient creation of NRV per share. In fact, they just created another $113M of NRV with their most recent convert issuance. Isn't solar a great business?
We also think the renewal is nearly worthless. With the rapid improvements in cost and efficiency in solar, why would anyone renew a lease on 20 year old panels? If they did, it certainly wouldn't be at the 10% discount Mr. Rive is assuming. SCTY has no bargaining power when it comes to renewal time. All the leasee has to do is refuse to renew. SCTY is never going to spend the money to take 20 year old panels down and redeploy them on another roof, which means they would just let the customer keep the panels for free rather than incur the extra cost. Best case, SCTY is able to keep the customer by installing a new and better system. In this scenario the renewal is still worth zero, but SCTY does save some money on sales and marketing 20 years from now. So, some quick math, if we treat debt as debt and assume the renewal is worthless, SCTY's NRV drops to $1.4 billion or $14.30 per share. We illustrate this all in the table below.
Economic Value Creation (( EVC ))
This is another metric introduced this year to once again try to help investors and analysts understand the value creation. We have already made our point about aggressive assumptions, so here we will be brief. A long-term debt interest rate of 4.5% (the rate assumed by SCTY) in what appears to soon be a rising rate environment is likely aggressive and small changes have fairly large impacts on the EVC. In fact, we saw a few headlines last week that the rate on company's most recent ABS may be nearly 6% vs the 4.5% assumption. Also, these do not appear to be after-tax estimates, which is extremely misleading for two reasons: 1) these are supposed to be future profits so why aren't they tax adjusted, and 2) while we don't know the terms of all of the tax equity financing, the depreciation is often given to the partner, which means these profits will be taxed at an extraordinarily high rate. Either way, EVC is likely vastly overstated. We could see an argument that SCTY will never actually make money so they don't have to worry about taxes and we would strongly agree.
Source: SolarCity 3Q15 Presentation
PowerCo Available Cash (( PAC ))
Yet another new metric introduced this year to help investors and analysts understand the value SCTY is creating. This metric is "Our Proxy for Steady-State Cash Flow". So this is basically a measure of the cash the installed assets generate today if the company were no longer spending money to attract new customers and install new systems. The trailing twelve month PAC was $112 million as of the last quarter. If we exclude tax equity distributions (that drop off in 7 years), then the number was $171 million. Those numbers however are inflated by SCTY's own admission (our emphasis added):
"PowerCo Available Cash" represents the net cash flows associated solely with our Power Business, which generates a predictable long-term cash flow stream from our Energy Contracts and the underlying solar energy systems that have cumulatively been deployed through the applicable period. It excludes the net cash flows associated with our Development Business, which is dedicated to investing in and financing new solar energy systems to grow our Power Business, and thus excludes (( A )) installation costs, (( B )) sales costs, and ((C)) G&A costs incurred through the applicable period. PowerCo Available Cash represents our core cash flow generation assuming no additional development of new customer installations, though if PowerCo were actually to separate from DevCo it would likely retain some portion of the G&A costs. PowerCo Available Cash is calculated as (1) total cash payments from all Energy Contracts installed through the applicable period, including PBIs and SRECs less the sum of (2) operations and maintenance, insurance, administrative and inverter replacement cash costs, (3) tax equity cash distributions, and (4) interest and principal repayment debt service on all non-convertible debt including solar asset-backed loans, aggregation facilities, revolving credit facilities, and Solar Bonds."
Source: SolarCity 3Q15 Presentation
SCTY has $1.9 billion of net debt, making it 15x levered on the cleanest possible cash flow metric the company can produce, that they then disclose in a footnote to the presentation is likely overstated. Now, we carry this a step further and run our own NPV calculation starting with these cash flow numbers because this should be another way to back into something close to Net Retained Value. We increase the PAC by 2.5% every year (escalator in the SCTY lease contracts), assume the step up after seven years, assume a 6% discount rate and assume a 90% renewal rate at a 10% price discount to year 20's price. We DO NOT assume a .5% degradation of the panels every year. This yields an NPV of $2.5 billion. Subtract the net debt of $1.9 billion and it leaves $600 million, or $6.12 for the equity compared to SCTY's estimate of $33.00. Even worse, over $500 million of this $600 million is completely dependent on a 90% renewal rate at a 10% discount to year 20's price. It is odd to us that this number does not come close to the company's NRV estimate. If you believe the assumption for renewals is aggressive then you may be looking at $1.00 per share in value over a 20 year period.
We would have annualized Q3's PAC, to give SCTY a full year of credit for the capacity installed in the last year but the number was actually lower than the TTM number SCTY provided. To say this another way, between equity raised at the SCTY level (not tax equity) and $1.9 billion of net debt, the company has raised total capital of over $3 billion to build assets that generate $112M in cash per year, or a 3.7% return on capital in an extremely optimistic scenario.
Source: SolarCity 3Q15 Presentation
Growth and Liquidity
During the last quarter SCTY's debt increased by $378 million. Remaining borrowing capacity declined by $97 million, leaving $493 million of capacity. Borrowings under the MyPower facility increased by $110 million during the quarter to $123 million. There was $77 million of remaining capacity on this line at September 30th, so we need to watch if it is increased soon. Total debt (not including capital leases which are basically debt) is $2.33 billion. $234 million of this is due in the next 12 months and with an additional $400 million due in the next 15 months. Cash and short term investments declined by $71M to $418M.
Not including tax equity, the company consumed approximately $450M of cash during the quarter (increased borrowings + decline in cash). This burn will likely go up in Q4 with an increase in installs. Total liquidity was $911M and will increase by $113 million when the Silver Lake/Musk/Rive financing closes. The company has two quarters of cash remaining without a significant increase in debt availability or a large capital raise. The company has promised more ABS drop downs that will increase room on their revolving debt facilities, but we have yet so see any of these. We are not debt experts, but we question how much more SCTY's lenders are willing to expand their credit facilities. As an attachment to their latest 10-Q, there were several exhibits related to the increase of the aggregation facility by $150 million. All four of the current lenders declined to participate in the increase, and SCTY added two new banks for the $150 million increase.
The other source of cash is Solar Bonds that the company is constantly offering through its website. They have had limited success selling these instruments with the majority being purchased by SpaceX earlier this year (red flag?).
After examining the extraordinarily complex financials of SCTY it appears the company is building little if any value for shareholders in what should be the best of times. Rooftop solar incentives are likely to decline in the future with likely changes to net metering rules in many states. Management's pivot on the Q3 call toward slowing growth and focusing on cash is likely born out of necessity. While lenders might be more comfortable with solar as an asset class, SCTY is over levered on its asset base in our opinion and we frankly don't see a path to anything close to the deployment guidance for next year.
We plan a follow up article to examine the aggressive assumptions behind SCTY's cost per watt (especially in Q3), but prefer to see the new targets to be presented at the analyst day. We will also do a deep dive on the accounting of the MyPower product and the reported retained value versus the numbers on the company's balance sheet.
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