Solarcity (SCTY) is a company that sells renewable energy to customers at prices below utility rates. They buy solar panels from other companies (BenQ Corporation, Canadian Solar Inc., Suniva Inc., Trina Solar Limited and Yingli Green Energy Holding Company Limited and others). Then they sell these panels to residential or commercial customers directly or lease for periods up to 20 years. These are structured either as leases or power purchase agreements. The lease customers pay a fixed monthly fee with an electricity production guarantee. The power purchase
agreement customers pay a fee based on the amount of electricity the solar energy system produces. Most of their lease customers are people who can't afford to pay for a solar installation upfront.
agreement customers pay a fee based on the amount of electricity the solar energy system produces. Most of their lease customers are people who can't afford to pay for a solar installation upfront.
According to Solarcity's last 10-K, these are their competitive advantages:
1. Lower cost energy . We sell energy to our customers at prices below utility rates.
Every Solar company out there does this.
2. Long-term customer relationships . Our business model enables us to develop long-term relationships with our customers. Most of our customers agree to a 20-year contract term, positioning us to provide them with additional energy-related solutions during this relationship to further lower their energy costs.
Companies like Vivent, SunRun or Sunpower are offering the same.
3. Easy to switch . We have developed an integrated approach that allows our customers to access distributed renewable energy generation simply and efficiently. By providing the sales, financing, engineering, installation, monitoring and maintenance ourselves, we are able to control and oversee the entire process while providing a superior experience to our customers.
Again, all companies mentioned above are vertically integrated.
4. Significant size and scale . Our status as the leading installer of solar energy systems in the United States enables us to achieve economies of scale in both installation and capital costs, enabling us to offer our customers electricity at rates lower than the retail rate offered by utilities.Ok, they are the biggest on the market right now.
5. Innovative technology . We continually innovate and develop new technologies to facilitate our growth and to enhance the delivery of our products and services.
The company has exactly 0 R&D expenses. It buys solar panels from third-party manufacturers.
6. Brand recognition . Our ability to provide high-quality services, our dedication to best-in-class engineering efforts and our exceptional customer service have helped us establish a recognized and trusted national brand.
That's great, but most customers will choose the provider with best price anyway.
The company has no clear competitive advantage and is only a leader in terms of capacity installed. Others are quickly catching up and new companies are entering the field.
Where is the real problem?
The federal government provides an uncapped investment tax credit, or Federal ITC, that allows a taxpayer to claim a credit of 30% of qualified expenditures for a residential or commercial solar energy system that is placed in service on or before December 31, 2016. This credit is scheduled to reduce to 10% effective January 1, 2017. A tax credit is a sum deducted from the total amount a taxpayer owes to the state.
Because Solarcity generates 0 profits (the company lost 56 million last year), it creates joint ventures, VIEs (Variable interest entities) and funds with other companies, which can use this advantage. The way it works, is that SCTY creates a separate company, sells bonds and buys and solar panels for these proceeds. The payments and tax credits from their customers then flow to the bondholders with the company getting little or no cash. And it gets worse, because these funds and SPVs (special purpose vehicles) come with covenants and restrictions:
We guarantee our fund investors that, in the event of a subsequent recapture of ITCs (U.S. Treasury grants) by the taxing authority due to our noncompliance with the applicable ITC guidelines, we would compensate them for any recaptured ITCs. Generally, such obligations would arise as a result of reductions to the value of the underlying solar energy systems as assessed by the U.S. Treasury Department for purposes of claiming U.S. Treasury grants or as assessed by the IRS for purposes of claiming ITCs or U.S. Treasury grant.
The Department of Treasury and Department of Justice started an investigation into SCTY, in July 2012, alleging the company might have inflated the costs of solar panels to get higher tax credits for fund investors. More on this subject can be found in this Forbes article. If they are found guilty, Solarcity might be obliged to pay back a large sum of money, given that they claimed upwards of 900$ million in tax credits.
So how much of Solarcity's assets do these funds, SPVs, VIEs and joint ventures actually own? Based on the company's last 10-K report:
SPV: In November 2013, the Company pooled and transferred qualifying solar energy systems and associated customer contracts into a SPE, and issued $54 million aggregate principal amount of Solar Asset Backed Notes.
Lease pass-through arrangements: Under these arrangements, the Company’s wholly owned subsidiaries finance the cost of solar energy systems with investors for an initial term ranging between 10 and 25 years.The cost of the solar energy systems under the lease pass-through arrangements as of December 31, 2013 was $420.4 million.
Variable interest entities: Wholly owned subsidiaries of the Company and fund investors formed and contributed cash or assets to various solar financing funds and entered into related agreements. The carrying aggregate value of VIEs is 759$ million.
For one VIE fund, the Company estimated a reduction in the U.S. Treasury grants to be received of $22.9 million through December 31, 2012. In this particular VIE fund, the Company was obligated to contribute additional capital in the form of solar energy systems or cash to purchase additional solar energy systems
So in aggregate, funds or various vehicles own the cash flows and assets totaling 1.2$ billion, out of the company's 1.85$ billion solar assets (66%). The funny thing is, that SCTY recognizes revenue from these entities as their own, and later distributes proceeds to them. That means that 66% (107$ million in 2013) of their revenue does not belong to shareholders.
Does this sound familiar? Giving people something they can't afford for free, and then packing it together and selling it to investment funds? Smells like 2007.... What happens if you decide to default on your Solarcity payment after 10 years, are they going to take down your panels from the roof, what will probably cost more than they are worth by then?
Other problems
1. Regulation
Under current law, the Federal ITC will be reduced from approximately 30% of the cost of the solar energy systems to approximately 10% for solar energy systems placed in service after December 31, 2016. In addition, U.S. Treasury grants are no longer available for new solar energy systems. From their report: "Changes in existing law and interpretations by the Internal Revenue Service and the courts could reduce the willingness of fund investors to invest in funds associated with these solar energy system investments. We cannot assure you that this type of financing will be available to us. If, for any reason, we are unable to finance solar energy systems through tax-advantaged structures or if we are unable to realize or monetize depreciation benefits, we may no longer be able to provide solar energy systems to new customers on an economically viable basis. This would have a material adverse effect on our business, financial condition and results of operations." The business is solely dependent on regulation and the future whims of politicians.
2. The company misstated it's financial statements:
In connection with the audit of our consolidated financial statements for the year ended December 31, 2013, we identified four material weaknesses in our internal control over financial reporting. Correcting the issue will increase the cost of solar-system sales by $16 million to $20 million for the nine months ended Sept. 30 and $20 million to $23 million for 2012.
3. Rising interest rates could hurt their business (10-K report):
"The majority of our cash flows to date have been from solar energy systems under lease and power purchase agreements that have been monetized under various financing fund structures. One of the components of this monetization is the present value of the payment streams from the customers who enter into these leases and power purchase agreements. If the rate of return required by the fund investor rises as a result of a rise in interest rates, it will reduce the present value of the customer payment stream and consequently reduce the total value derived from
this monetization. Rising interest rates could harm our business and financial condition."
4. Solarcity capitalizes the purchase and installation costs of the panels:
Payments for the cost of solar energy systems, leased and to be leased were 716$ million in 2013, the company capitalizes this expense as a balance sheet asset and depreciates it over a useful life of 30 years. That means that 10 years from now, it will carry obsolete and probably worthless solar panels at 60% of their cost. It also reduces the yearly loss on the income statement.
5. There are no earnings and never will be
As detailed above, most cash flows and earnings will flow to the bondholders and fund investors, which are senior to SCTY stockholders. Even if there is anything left, it will be eaten up by sales and administrative costs. In addition, the company borrows heavily and issued 21% more shares this year for acquisitions and options.
So who is making money on this scheme?
1. Investors in Solarcity's SPVs, VIEs and funds
2. Solarcity founders and employees
3. Homeowners, who get solar panels at affordable prices
Who is losing?
1. Taxpayers
2. Shareholders of SCTY
So here we have a 4.5 billion dollar company, making 56$ million in sales (112$ million this year if they reach the target), losing money every year, burning cash every quarter, with declining asset values and misstated financial statements. Not to mention intense competition, DOT investigations and technology, which will be probably much cheaper a few years from now. I wouldn't pay a dime for such a business, and I'm going short if the price declines further.
1. Lower cost energy . We sell energy to our customers at prices below utility rates.
Every Solar company out there does this.
2. Long-term customer relationships . Our business model enables us to develop long-term relationships with our customers. Most of our customers agree to a 20-year contract term, positioning us to provide them with additional energy-related solutions during this relationship to further lower their energy costs.
Companies like Vivent, SunRun or Sunpower are offering the same.
3. Easy to switch . We have developed an integrated approach that allows our customers to access distributed renewable energy generation simply and efficiently. By providing the sales, financing, engineering, installation, monitoring and maintenance ourselves, we are able to control and oversee the entire process while providing a superior experience to our customers.
Again, all companies mentioned above are vertically integrated.
4. Significant size and scale . Our status as the leading installer of solar energy systems in the United States enables us to achieve economies of scale in both installation and capital costs, enabling us to offer our customers electricity at rates lower than the retail rate offered by utilities.Ok, they are the biggest on the market right now.
5. Innovative technology . We continually innovate and develop new technologies to facilitate our growth and to enhance the delivery of our products and services.
The company has exactly 0 R&D expenses. It buys solar panels from third-party manufacturers.
6. Brand recognition . Our ability to provide high-quality services, our dedication to best-in-class engineering efforts and our exceptional customer service have helped us establish a recognized and trusted national brand.
That's great, but most customers will choose the provider with best price anyway.
The company has no clear competitive advantage and is only a leader in terms of capacity installed. Others are quickly catching up and new companies are entering the field.
Where is the real problem?
The federal government provides an uncapped investment tax credit, or Federal ITC, that allows a taxpayer to claim a credit of 30% of qualified expenditures for a residential or commercial solar energy system that is placed in service on or before December 31, 2016. This credit is scheduled to reduce to 10% effective January 1, 2017. A tax credit is a sum deducted from the total amount a taxpayer owes to the state.
Because Solarcity generates 0 profits (the company lost 56 million last year), it creates joint ventures, VIEs (Variable interest entities) and funds with other companies, which can use this advantage. The way it works, is that SCTY creates a separate company, sells bonds and buys and solar panels for these proceeds. The payments and tax credits from their customers then flow to the bondholders with the company getting little or no cash. And it gets worse, because these funds and SPVs (special purpose vehicles) come with covenants and restrictions:
We guarantee our fund investors that, in the event of a subsequent recapture of ITCs (U.S. Treasury grants) by the taxing authority due to our noncompliance with the applicable ITC guidelines, we would compensate them for any recaptured ITCs. Generally, such obligations would arise as a result of reductions to the value of the underlying solar energy systems as assessed by the U.S. Treasury Department for purposes of claiming U.S. Treasury grants or as assessed by the IRS for purposes of claiming ITCs or U.S. Treasury grant.
The Department of Treasury and Department of Justice started an investigation into SCTY, in July 2012, alleging the company might have inflated the costs of solar panels to get higher tax credits for fund investors. More on this subject can be found in this Forbes article. If they are found guilty, Solarcity might be obliged to pay back a large sum of money, given that they claimed upwards of 900$ million in tax credits.
So how much of Solarcity's assets do these funds, SPVs, VIEs and joint ventures actually own? Based on the company's last 10-K report:
SPV: In November 2013, the Company pooled and transferred qualifying solar energy systems and associated customer contracts into a SPE, and issued $54 million aggregate principal amount of Solar Asset Backed Notes.
Lease pass-through arrangements: Under these arrangements, the Company’s wholly owned subsidiaries finance the cost of solar energy systems with investors for an initial term ranging between 10 and 25 years.The cost of the solar energy systems under the lease pass-through arrangements as of December 31, 2013 was $420.4 million.
Variable interest entities: Wholly owned subsidiaries of the Company and fund investors formed and contributed cash or assets to various solar financing funds and entered into related agreements. The carrying aggregate value of VIEs is 759$ million.
For one VIE fund, the Company estimated a reduction in the U.S. Treasury grants to be received of $22.9 million through December 31, 2012. In this particular VIE fund, the Company was obligated to contribute additional capital in the form of solar energy systems or cash to purchase additional solar energy systems
So in aggregate, funds or various vehicles own the cash flows and assets totaling 1.2$ billion, out of the company's 1.85$ billion solar assets (66%). The funny thing is, that SCTY recognizes revenue from these entities as their own, and later distributes proceeds to them. That means that 66% (107$ million in 2013) of their revenue does not belong to shareholders.
Does this sound familiar? Giving people something they can't afford for free, and then packing it together and selling it to investment funds? Smells like 2007.... What happens if you decide to default on your Solarcity payment after 10 years, are they going to take down your panels from the roof, what will probably cost more than they are worth by then?
Other problems
1. Regulation
Under current law, the Federal ITC will be reduced from approximately 30% of the cost of the solar energy systems to approximately 10% for solar energy systems placed in service after December 31, 2016. In addition, U.S. Treasury grants are no longer available for new solar energy systems. From their report: "Changes in existing law and interpretations by the Internal Revenue Service and the courts could reduce the willingness of fund investors to invest in funds associated with these solar energy system investments. We cannot assure you that this type of financing will be available to us. If, for any reason, we are unable to finance solar energy systems through tax-advantaged structures or if we are unable to realize or monetize depreciation benefits, we may no longer be able to provide solar energy systems to new customers on an economically viable basis. This would have a material adverse effect on our business, financial condition and results of operations." The business is solely dependent on regulation and the future whims of politicians.
2. The company misstated it's financial statements:
In connection with the audit of our consolidated financial statements for the year ended December 31, 2013, we identified four material weaknesses in our internal control over financial reporting. Correcting the issue will increase the cost of solar-system sales by $16 million to $20 million for the nine months ended Sept. 30 and $20 million to $23 million for 2012.
3. Rising interest rates could hurt their business (10-K report):
"The majority of our cash flows to date have been from solar energy systems under lease and power purchase agreements that have been monetized under various financing fund structures. One of the components of this monetization is the present value of the payment streams from the customers who enter into these leases and power purchase agreements. If the rate of return required by the fund investor rises as a result of a rise in interest rates, it will reduce the present value of the customer payment stream and consequently reduce the total value derived from
this monetization. Rising interest rates could harm our business and financial condition."
4. Solarcity capitalizes the purchase and installation costs of the panels:
Payments for the cost of solar energy systems, leased and to be leased were 716$ million in 2013, the company capitalizes this expense as a balance sheet asset and depreciates it over a useful life of 30 years. That means that 10 years from now, it will carry obsolete and probably worthless solar panels at 60% of their cost. It also reduces the yearly loss on the income statement.
5. There are no earnings and never will be
As detailed above, most cash flows and earnings will flow to the bondholders and fund investors, which are senior to SCTY stockholders. Even if there is anything left, it will be eaten up by sales and administrative costs. In addition, the company borrows heavily and issued 21% more shares this year for acquisitions and options.
So who is making money on this scheme?
1. Investors in Solarcity's SPVs, VIEs and funds
2. Solarcity founders and employees
3. Homeowners, who get solar panels at affordable prices
Who is losing?
1. Taxpayers
2. Shareholders of SCTY
So here we have a 4.5 billion dollar company, making 56$ million in sales (112$ million this year if they reach the target), losing money every year, burning cash every quarter, with declining asset values and misstated financial statements. Not to mention intense competition, DOT investigations and technology, which will be probably much cheaper a few years from now. I wouldn't pay a dime for such a business, and I'm going short if the price declines further.
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