Saying the word “solar” on an investing blog might be a lot like dropping an f-bomb in the middle of a church. The solar industry has been nothing short of a total money loser for investors who have tolerated rapidly declining margins, changing subsidies, and intense competition. Suffice it to say, the only people who will get rich from solar might just be the people who use the panels for tax credits.
Or maybe it will be the installers. SolarCity (Ticker: SCTY) wants you to believe that, while there's no money in making panels, there is money in putting those solar panels on other people's rooftops.
The SolarCity Way
SolarCity is another eco-friendly, science fiction-style project from Elon Musk, the PayPal co-founder turned rocket scientist (SpaceX) and new age automobile tycoon (Tesla Motors). SolarCity designs and then installs solar panel arrays on customer rooftops.
Customers either pay in full at the time of purchase for both installation and the solar panels, or they can choose a creative leasing offer which gives them the right to pay for the panels over 20 years by purchasing power from SolarCity at a specified rate. The result is the same; a customers' home is decked out with solar panels and powered by the sun, and thanks to lucrative tax credits, the electricity agreement is cheaper than electricity bills from the local utility.
It's a win-win. Consumers get low cost “green” electricity and SolarCity makes money on the installation and financing agreement. This win-win makes SolarCity an interesting business model for consumers in that the company is:
- A market leader in a new, developing space. Solar panel prices continue to drop, making them more and more competitive with coal or natural gas power plants for electricity generation. There is plenty of reason to believe that solar panels could be the future, and installation could be a multi-billion dollar business each year.
- Offering a differentiated product with leasing. Most solar panel installers do not have the scale or financing to offer a better solar leasing deal to customers. With the exception of SolarCity's offer, customers have to either finance the purchase and installation themselves with cash or forgo installing solar panels.
- A proxy to play falling solar panel prices, since the company benefits from more installations as solar panel prices fall. This is opposite of the solar panel manufacturing industry, which would like to see consistent, if not rising prices for solar panels.
But for all the upsides, the risks loom large. I think the risks may make it uninvestable.
Risks to SolarCity
Wall Street might be falling for a new hyped investment without fully examining the risks. In particular, I think the risk in investing in SolarCity comes from:
- Competition – While there is little to no competition at the current time, there is little that would stop a competitor from entering the business on its own. Utilities, for example, could borrow far more cheaply than SolarCity and offer an even better deal to customers on a dollar for dollar basis than SolarCity, which is still an unprofitable start-up venture.
- Legal/Legislative Risks – SolarCity currently exists because of two legal items. First, solar panels and installation are heavily subsidized from federal, state, and local tax credits. Secondly, utilities are required to repurchase excess power from individuals who have installed solar panels at above-market rates. Without support from one or both of these subsidies, SolarCity's business model would fall apart. Utilities may eventually find that they have to compete with SolarCity so as not to continue throwing money away to repurchase power from at-home solar panel users.
- Rate Risk – Solar is workable because the upfront cost of panels is on the decline, but also because the long-run cost of financing continues to fall. A rise in interest rates from generational lows could negatively impact SolarCity's ability to install panels at economically feasible prices.
Can you predict competition, tax credits and favorable laws? It's hard. On one end, the solar industry is a powerful lobby that can sustain the favoritism that makes it a workable and investible industry. On the other hand, the solar industry competes directly with utilities, which have their own powerful lobby and likely aren't too happy they're forced to pay above-market prices for electricity every time SolarCity puts up a new panel.
Additionally, bankers and utility companies are likely wondering why they aren't taking a slice of the pie. Utilities can raise funds for leases at a lower rate than Solar City. Bankers who finance SolarCity would likely be much happier to work with the impressive balance sheets of utility companies over SolarCity. And surely local installers would be capable of completing installations on behalf of competitors and utility companies. Plus, with the tax credits, SolarCity will need to wait to get paid for its invoices, which could be a crutch on cash flow.
I'm willing to wager that SolarCity will change the way we think and deliver electricity to end users. Distributed electricity generation is a great idea. But I'm not so willing to believe that SolarCity will be the company that gets rich from this new and growing industry.
As a potential solar power user, SolarCity seems great. As an investor, I think it belongs in the “too hard” column; there are too many risks and no moat to be found.
What are your thoughts on SolarCity and the future of the solar industry? Is installing and leasing a trend for the future?