Here's Why SolarCity is a Buy-and-Hold Investment

According to the U.S. Energy Information Administration, 2013 solar power installations will more than double solar capacity in the United States. That's big news for solar but just a blip in the energy industry since the solar power added represents just 4% of the year's newly built capacity. That's why new business models, like the one being taken by SolarCity (NASDAQ: SCTY  ) , may make more sense over the long term.

The big add
Two "massive" solar projects are set to double U.S. solar capacity. The Solana plant in Arizona produces 250-megawatts, or MW, of energy and the Ivanpah plant in California will produce 391MW. That's a grand total of 641 megawatts of power. For comparison purposes, Southern Company's (NYSE: SO  ) Kemper plant will produce 582MW once it's complete.

Source: U.S. Energy Information Administration

While the solar projects are environmentally friendly, they only work when the sun is out. That's a problem since people consume electricity 24 hours a day, seven days a week. Kemper will be able to run constantly. And, although it's a coal plant, Southern is using a suite of technologies that will make it the cleanest coal plant around -- capturing "at least" 65% of the plant's carbon dioxide emissions.

It may seem odd to compare a pair of solar-power facilities to a similarly sized coal plant, but that's the competition that renewable energy must deal with. Add in natural-gas fired plants and solar's "big" advance looks even less impressive. Southern, for example, has increased its use of natural gas from 16% of its generation capacity to 47%. While renewable sources like solar have a place, the technology isn't advanced enough to fully displace its competitors.

New models
That's where new models come into play. SolarCity installs solar systems on customer roofs. It then can sell or lease them back to the building owner or simply sell the owner the power the solar system generates. Any one solar installation is tiny, but as SolarCity builds out its portfolio it is slowly building itself into an electric utility. The company expects to have around 500 megawatts of capacity by the end of 2015.

The benefit of this model, however, is that it uses existing infrastructure -- e.g., buildings and homes -- in a new way and turns its customers into partners with long-term supply agreements and leases. One big SolarCity customer is Wal-Mart Stores (NYSE: WMT  ) , the largest retailer in the country with thousands of rooftops.

So far Wal-Mart has only installed a couple hundred solar systems, but that puts it well ahead of companies like Costco and Walgreen that are going down the same path. And SolarCity has the pleasure of helping Wal-Mart as it continues to build out this system. SolarCity also has deals with other companies looking to produce their own power and home builders offering rooftop solar systems as a custom add on.

And SolarCity is part of the utility build out, too. For example, while Southern is putting the finishing touches on its Kemper coal plant, SolarCity just inked a deal to build a utility solar system in Hawaii. The 15-megawatt system is small, but shows that SolarCity can count on growth beyond the Wal-Marts and environmentally concerned "mom and pops" of the world.

A stealthy fighter
While Solana and Ivanpah are important projects, they are stuck in the old utility world that's dominated by utilities like Southern Company and its coal and natural- gas plants. That's an uphill battle that will take years to fight and it's too soon to tell if victory is achievable.

SolarCity, which is still losing money as it builds out its model, has a chance to break that mold. It is taking what is still just a niche option and spreading it across the country in a way that reaches down and touches individuals at every level of life. That's a playing field that coal and gas can't touch, and it's one that could lead to years of growth.

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  • Report this Comment On November 22, 2013, at 2:29 PM, Beethzart wrote:

    Solar City has certainly been a solid investment since its IPO, but doesn't the recent letter from Senator Sessions and the possibility of a congressional investigation into solar tax credits merit at least a mention? At issue here is the amount at which the solar panels installed by Solar City are being valued. Solar City is using a clever "trick" here as a cornerstone of their business model (NOTE: By trick, I don't mean to imply anything illegal).

    Solar City has two methods of selling solar power to homeowners: SolarLease and SolarPPA. With SolarLease, the homeowner leases panels for five years. They cannot buy the panels with this plan, but they can renew their lease in five year increments. With SolarPPA, the homeowner can buy the panels, but only after the first five years. With both plans, the homeowner does not actually own the panels for the first five years. So who does? Well, that's where the trick comes in. The installations are sold to tax-equity investors at an inflated value over the actual installation cost. Why would an investor be willing to invest at an inflated value? Primarily because solar installations are elliglble for federal tax credits. The higher the purchase price of the solar system, the bigger the tax credit. Since the investors are actually buying the installations, they get the tax credits. Their total return is based on the amount of the tax credits received, the residual value of the installation, and a number of other factors such as depreciation. This is a great business model and is the reason Solar City has been so successful. Investors get a return on their investment while providing Solar City with the capital necessary for growth. Homeowners gets solar power without a lot of up front cost and Solar City generates recurring income.

    Now I want to be very clear about this. I'm not saying or implying that Solar City is doing anything wrong. Congress could cite them and even fine them, but that's not up to me to determine and I wouldn't want the job anyway. The real problem is that Solar City's busines model is entirely dependent on tax credits. Any change in the way solar tax credits are determined could dramatically affect the company. From Senator Sessions perspective, Solar City's practice of selling the installations at inflated prices to investors is costing the government money because it is generating higher tax credits. It wouldn't be very difficult for the government to close this "loophole" if they had a mind to. This could severely disrupt Solar City's business model because it would make investments in solar installations far less attractive to tax-equity investors. Hence, the capital necessary to fund growth could dry up. Since Solar City's long term viability is based on a substantial amount of growth, this could derail the company. It doesn't help that the 30% tax credits currently being offered by federal government are scheduled to be cut to 10% in 2017. At the very least, this means the clock is ticking on Solar City. They need to reach some sort of self sustaining level well before 2017. Moreover, the tapering of Quantitave Easing could put even more pressure on the government to close tax loopholes and reduce subsidies should they find it difficult to sell all the bonds they need to fund their insane spending. The bottom line is that any dependency on government support is risky.

    I like this company and I understand they have been under scrutiny before and survived, but a second investigation into the practices of this market doesn't bode well. At the very least, it adds a fair amount of risk to owning SCTY and I feel this is something any investor looking this company should consider carefully. The recent price action on this stock indicates that I am not the only with concerns.

  • Report this Comment On November 22, 2013, at 3:40 PM, TMFBlacknGold wrote:

    Reuben,

    The two solar projects you mentioned use concentrated solar technologies. They are only doubling >that< portion of the nation's solar capacity and really don't compare with SolarCity or traditional PV. Additionally, Solana can contribute power to the grid for up to six hours after sunlight with its unique storage capabilities.

    http://www.eia.gov/todayinenergy/detail.cfm?id=13791&src...

    --Maxxwell

  • Report this Comment On November 22, 2013, at 3:48 PM, Sandiego wrote:

    Relieve your fears, read Solar City's blog below concerning the many assumbtions made by Barron's.

    In August, Barron’s approached us and expressed interest in doing a piece on SolarCity’s business model. Unfortunately, at the time, we were in the middle of a securities offering process, and SEC regulations prevented us from commenting or answering any questions for the piece. When the article appeared on August 31, with the sensational headline “Dark Clouds over SolarCity”, it included a number of inaccuracies about SolarCity and the Section 1603 Grant program. The same quiet period rules prevented us from correcting those mistakes once the article was published.

    We completed our securities offering two months later, the quiet period ended, and we moved on. However, those same misstatements were repeated this week in a Barron’s blog post dated November 18. It’s difficult to fault Barron’s for the piece. The inaccuracies are understandable, given the complexity of the issues, and the fact that we had not addressed them. Yesterday we walked through the specific inaccuracies with the author on the phone, and we appreciated that opportunity. We would also like to take the opportunity to correct them publicly, here.

    Many of the false assertions and inferences in Barron’s August 31 article can be traced to a misinterpretation of the concept of “fair market value.” The article states:

    “The government asks solar-system owners to estimate the cost, or ‘fair market value,’ of their systems, on which tax credits are based. SolarCity appears to use a more complex measurement than some other solar installers. While analysts estimate that SolarCity’s costs are about $4 per watt, the company’s reported fair market value often exceeds $6. The higher the ‘fair value,’ the larger the tax credit.”

    As anyone who follows the solar industry knows, solar project owners are eligible to claim a 30% investment tax credit, or ITC, on the cost to acquire their systems. Under the Section 1603 program, the owners could choose to get a cash grant for the same 30% of the value, instead of the tax credit. These credits and grants are not based on the “cost” of a solar system, as the article implies, they are based on the price paid to acquire that system, whether the buyer is a homeowner or an institutional investor. Businesses as a general rule set prices higher than their costs. The price that a willing buyer pays a willing seller is the “fair market value” of the system.

    Contrary to what the Barron’s article states, SolarCity does not use a “more complex” method than similar installers in valuing solar projects, and solar companies cannot “estimate” the fair market value in applying for grants under Section 1603. That fair market value – which of course is the price the buyer actually paid for the system – must also be determined by an independent appraiser. The IRS provides guidelines for appraisal methods for establishing the fair market value of assets. These approaches have been in place for decades and are used across a broad range of asset classes, including housing, research and development, and oil & gas. All of SolarCity’s solar power systems have been appraised by third parties, using Uniform Standards of Professional Appraisal Practice (USPAP) standards, and following IRS guidelines. The entire energy industry uses the same methodology that is stipulated by the IRS. SolarCity does not use a different methodology than other providers to determine fair market value. Appraiser Cohn Resnick’s paper on the valuation of solar assets details this process. Moreover, for large projects, Treasury requires that applicants also provide a “cost certification” from yet another expert, an independent auditor, which confirms the accuracy of the independent appraiser’s valuation. Finally, beginning in June 2011, Treasury began publishing fair market value guidance for solar projects, and SolarCity’s appraised fair market values have been at or below all the guidance that has been provided.

    Following its misinterpretation of fair market value, the other primary inaccuracy in the August 31st article involves a flawed analysis of solar project databases. From the article:

    “Barron’s recently reviewed a database listing 153,628 solar contracts in Arizona and California, and found that SolarCity’s reported values are significantly higher than those of similar companies. In Arizona, its values exceeded rivals’ by 35% in 2011; 15% in 2012; and 20% this year, through mid-August. In California, the company reported higher market values than the industry from 2008 through 2011, and again in 2013.”

    The California database in question is the California Solar Initiative (CSI), and if you read the CSI website you can see how clearly different SolarCity is from companies Barron’s describes as ‘similar’. From the CSI’s FAQ:

    “The current $/watt data available for California Solar Initiative projects present difficulties when comparing host customer-owned and third-party-owned systems (e.g. leases or power purchase agreements (PPAs)). The reported costs for host customer-owned systems are simple, as they reflect the purchase price inclusive of parts, labor, permitting fees, overhead, and profit. Third-party-owned systems, on the other hand, are reported in a variety of ways, and may also capture costs for additional services.”

    Click here to read further for CSI’s explanation of these differences.

    SolarCity is unusual in that it finances, develops and installs the majority of its solar projects. Most of SolarCity’s competitors in the lease and power purchase agreement category don’t build the systems themselves, but rather acquire them from third-party contractors. When SolarCity’s competitors report for the project database, they report the amount they paid the third-party contractor. That is a lower number than the price they sell the system for, but the price is the value the grant or tax credit is based on. In short, Barron’s mistakenly assumed that the system costs reported in published databases like CSI are the same as the fair market values that Section 1603 applicants are allowed to claim. They are not. This misinterpretation contributed to a flawed analysis that appeared to show a much greater difference in price (and by implication, grant or tax credit) than actually exists.

    Barron’s also misrepresents SolarCity’s liability to investors. The August 31 article states that “if its obligations to those partners aren’t met—because of a decrease in government aid, defaults on lease payments, or other hiccups—the company might need to raise additional funds. These and other concerns suggest that SolarCity’s outlook could be considerably cloudier than its market value implies.”

    SolarCity doesn’t indemnify project investors for a decrease in aid, lease defaults or other hiccups. The company merely stands behind the fair market value of our systems. SolarCity and its financing partners are owners of the systems and both take ownership risk as part of the transactions.

    Barron’s also makes statements about SolarCity’s business model and financial health that we find to be misleading, namely:

    “Like other renewable-energy companies, SolarCity is dependent on government subsidies to make a profit.”

    This statement implies that renewable energy companies are subsidized in a way that carbon-based fuels are not. It’s no secret that all forms of energy are incentivized. The incentives that the solar industry receives are a tiny fraction of the overall subsidies that have been provided to nuclear, oil & gas and coal over the years. However, solar systems also generate direct returns to the taxpayer that aren’t just measured in cleaner energy or jobs. Solar lease payments are taxable as income, and the federal government recovers the cost of incentives paid for financed solar systems over time by collecting income taxes on the lease payments. In 2012 the U.S. Partnership for Renewable Energy Finance published a study titled “Paid in Full” that found that a leased residential solar system can provide a 10% nominal rate of return to the federal government on the initial tax credit paid over the expected life of the solar asset.

    Like many young companies at our stage, SolarCity is focused on growth, and we reinvest the majority of our revenue into growing operations, building projects and hiring. Because we recognize most of the costs to acquire customers upfront, but recognize the majority of our revenue over twenty year periods, we are not currently profitable on a GAAP (Generally Accepted Accounting Principles) basis. Nevertheless, we were cash flow positive in the second fiscal quarter of 2013, and we expect to be cash flow positive in the fourth quarter of 2013, and on a go-forward basis thereafter.

    SolarCity currently employs more than 4,000 full-time workers. Every single one of those jobs is in the United States, and many were created during the deepest recession of our lifetimes. We are currently hiring an average of more than 15 new employees each workday. SolarCity has built projects with local workforces in more than 2,500 different American cities and towns. We are providing services to more than 82,000 customers, including the U.S. Army, Air Force, Marines and Navy, a number of the Fortune 500, and more than 300 schools and universities. We have raised funds sufficient to finance more than $3 billion in solar projects. We are privately financing a series of solar installations for military families across the country that is expected to be the largest residential solar project in American history when completed.

    Returning to Barron’s, the final element of the article worth noting is the discussion of the fact that Treasury Department’s Section 1603 Grant Program is undergoing a broad review, and that the review includes SolarCity. That’s not news: SolarCity first reported in October 2012, over a year ago, that we had received a request for documents from Treasury, and we have since discussed Treasury’s inquiry and its progress in more than two dozen public filings. The issue in the inquiry is the fair market value of solar assets. We are absolutely certain that we have followed the 1603 Program’s rules and guidance. As we explained above, in applying for Section 1603 grants, we have relied on independent appraisers using well established IRS guidelines, and all of our projects were valued at or below the guidance that Treasury itself had published for the industry beginning in June 2011.

    Every few months, a news outlet reports on this issue as if discovering it for the first time. The Barron’s articles are only the latest example, but felt we owe it to our customers, partners, employees, and shareholders to set the record straight. The inaccuracies in these articles obscure the tremendous progress the entire solar industry has made to reduce costs and expand adoption. Fair market values have fallen significantly in the past few years, and incentives per system have decreased dramatically at the state and federal level. In the states where solar is most popular, such as Arizona and California, the industry no longer relies on state deployment incentives in many locations. Nationwide polls show support for solar across the political spectrum. These trends will only continue, regardless of who bets against them.

  • Report this Comment On November 22, 2013, at 4:20 PM, Ccaptain wrote:

    I agree with Beethzart it's only a matter of time with solar city. I think they will have real issues to account for with this investigation. one example i have heard of (not confirmed) If they sell a pre-paid 20yr lease for $6k and give the home owner a purchase option at the end of the 20 yr term for 34k and value the system for grant purposes at 27k and a third value at 29k something does not add up especially when there isnt a real income stream to be resold as it was paid up front. So something is off to warrant the second round of investigations...

  • Report this Comment On February 22, 2014, at 1:50 PM, seldom958 wrote:

    Re statement; " they only work when the sun is out" in the article.

    This statement simply is not true. I had a PV system installed on my house in Sacramento, CA about twelve years ago and marveled that even with an overcast sky (NO SUN) and a slight rain the meter was slowly moving forward. I always would run outside and check it.

    Of course with the sun out it moved much faster and with a really bright sun it would move backward, which means I was making more electricity than I needed, and was sending electricity back to the Utility for which they paid me.

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