Why I'm Investing in SolarCity

Great long-term investments do not always look like a value in the present day. Shares of SolarCity (NASDAQ: SCTY  ) have risen over a whopping 400% since the company's IPO in December 2012. The company is still unprofitable, has negative free cash flow, and is facing increasing resistance from traditional energy utilities. Still, despite the stock's run-up in 2013 and financial rough patches, the company strikes me as an incredible investment opportunity for the long haul compared to other solar businesses such as SunPower  (NASDAQ: SPWR  ) and First Solar  (NASDAQ: FSLR  ) .

Finally, a sensible solar business model 
The beauty of SolarCity's business model lies in its simplicity. The company does not design or manufacture solar panels, in contrast to SunPower and First Solar. Rather, SolarCity is a solar installation and leasing business. SolarCity works with individual and commercial customers (including Wal-Mart and Google) primarily through long-term contracts to lease the use of solar panels.

SolarCity covers the entire upfront cost of the solar panels and installation, setting the company apart from SunPower, whose installation financing options are comparatively more complex. SolarCity's "Direct Financing" program locks customers into a pay-as-you-go plan, typically with 20-year contracts. In other words, SolarCity covers the major immediate cost of installing the solar panels, after which the company receives monthly energy payments from its respective customers. These payments tend to be 5%-15% less than your typical energy bill. 

SolarCity's business model provides a sizable moat from direct competitors, because it requires extensive short-term investment coupled with long-term commitment. SolarCity's strategy currently hinges on two important factors: 1) Obtaining new customers at a rapid rate, and 2) Reducing the costs of the solar installation and maintenance. 

Once SolarCity locks a customer into a long-term contract, which includes monitoring and maintenance services on the solar panels, the company has a relatively steady source of cash flow for the next 20 years. These "nominal contract payments," the estimated future cash flows remaining on SolarCity's existing contracts, have increased from $500 million in 2011 to $1.7 billion so far in 2013.

Young, innovative, and dedicated management 
SolarCity's management team is one for the books. The company was cofounded in 2006 by two brothers, Lyndon and Peter Rive, who are 35 and 38 years old, respectively. Lyndon serves as CEO, while Peter serves as COO and CTO. The Rives' cousin happens to be none other than multi-billionaire entrepreneur and technological wiz Elon Musk, who serves as SolarCity's chairman and owns 25% of the company. 

Lyndon Rive describes his vision for SolarCity "to be your next energy company" and the "most compelling energy company of the 21st century."

SolarCity is essentially in the process of becoming a national utility business, developing long-term relationships with individual homeowners and businesses. The company currently operates in 14 states on each side of the United States. Bringing on an average of one customer every five minutes, the company has seen its cumulative customer base grow 38.55% to 82,235 customers so far in 2013. 

Lyndon Rive intends to have 1 million "rooftop customers" by 2018, more than a tenfold increase from the company's current customer base. Put in other terms: The company has hardly scratched its future potential. 

The company's solar installations are financed in two ways: directly through the company's capital expenditures ("investing activities") and through financing arrangements with investing partners and lenders ("financing activities"). For instance, in 2011 Google partnered with SolarCity to create a $280 million fund for SolarCity's residential projects.

Evaluating future prospects
The investing and finance partnerships explained above enable SolarCity to cover the hefty short-term installation costs required by its business model. Ideally, as SolarCity expands, the cash flows from the company's existing contracts will be sufficient to finance the installation costs of new contracts. 

SolarCity has managed to produce positive annual cash flow since 2011. Operating cash flow has grown from $60.33 million in 2012 to $182.94 million so far in 2013. However, so far in 2013 SolarCity has invested $507.7 million in solar energy systems (either leased or to be leased), so there is still a ways to go before free cash flow is positive and the company can finance these investments primarily out of its own cash flows. 

It is important to remember that SolarCity's contracts do not result in immediate cash on the books. Rather, SolarCity's contracts represent long-term streams of future cash flow, which is already beginning to have a quick and positive impact on the company's cash flow generation. 

SolarCity is also making key investments to reduce its installation costs. Just this month SolarCity completed a $158 million acquisition of Zep Solar, a company on the forefront of technology to install and mount solar panels. Zep Solar describes its mission as making "the jobs of solar installers easier, safer, and more profitable-and, in so doing, to provide a major reduction in the cost of solar." Score one for SolarCity. 

Foolish bottom line
SolarCity's mission is to make solar energy an accessible, affordable, and convenient energy alternative to individual customers across the United States. The company's rapid growth of new customers demonstrates that more than environmental connoisseurs are taking advantage of solar energy. In the most recent quarter SolarCity deployed a quarterly record of 78 megawatts of energy; residential megawatts deployed increased an astonishing 151% year over year. 

SolarCity is making the transition to solar energy worthwhile to many individuals and businesses. Many challenges face SolarCity, including push-back from traditional energy utilities, but I have a high level of confidence in the dedicated management team of this young and rapidly expanding business.

The stock does not look cheap, valued at $4.7 billion. The ingenuity of Elon Musk and the Rive brothers will come with a hefty price tag. Investors without patience and a strong stomach for volatility would be wise to sit on the sidelines. However, as SolarCity takes the lead in transforming the U.S. energy market, I anticipate rich returns over the next ten years and beyond.  

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Read/Post Comments (5) | Recommend This Article (11)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 31, 2013, at 6:24 AM, sikiliza wrote:

    This is a really good analysis. Thanks!

    It forced me to take another look at the stock as well as the prospects for the company. I will definitely check my biases at the door and dig through the company's filings and presentations to gain a better understanding of its business model.

  • Report this Comment On January 02, 2014, at 10:47 AM, dlwatib wrote:

    I've read this much on SolarCity before. Unfortunately it still leaves me with quite a few questions, mostly related to who owns what.

    So, who owns the solar panels once SolarCity installs them, SolarCity or the customer. Put another way, at the end of the contract, does the customer own the panels free and clear, or does he have to keep paying SolarCity for electricity coming from his own roof? If SolarCity owns the panels, does it have to pay rent for customers' rooftops?

    Meanwhile, SolarCity is having to constantly raise capital, mostly through securities backed by what? Physical solar panel assets? Income streams? How much is SolarCity going to be impacted by a rise in interest rates, whenever this occurs?

    In short, what are you really buying when you buy a share of SolarCity? Are there unencumbered hard assets and income or just a lot of good will and marketing and servicing expertise?

    Clearly SolarCity is not a slam-dunk investment, even if you love what they do and are ready to sign up yourself and all your friends, family and neighbors as customers.

  • Report this Comment On January 02, 2014, at 11:43 AM, ifool100 wrote:

    I think it's an elegant concept for a company. Sell customers once, get a predictable stream of income for 20 years. As solar panels become cheaper, add the extra cash to your income. Your customers are thrilled because their electricity costs less. You're thrilled because your COGS keeps dropping. The guarantee is that your true source of income will never change. The sun is always free. All you have to do is gather and store it.

  • Report this Comment On January 02, 2014, at 12:16 PM, ffbj wrote:

    I think the borrowed money comes from future income stream projections. I think you own the panels after paying them off. Of course there still may be maintenance issues.

    First you should check if they operate in your state.

    Currently they are in approx. 15 states. Most of them in the sun belt and with higher electric utility rates.

    Arizona, is leading the fight against solar adoption.

    Traditional utility companies are trying to limit net-metering (you get paid for the energy you produce at market rates). Utilities are powerful and keep trying different things to make the switch over to solar less attractive, like charging solar users additional fees.

    Even if you used no electricity at all you still have to pay a connection fee, if you get disconnected you pay a fee to reconnect. Just look you utility bill. For me, on average additional fees and taxes account for around 25% of my bill.

    It's the old against the new and we all know how entrenched the utilities are. They will brook nothing that will threaten their income stream, and spend millions on lawyers and pay-offs to politicians to stop it. It would better for them to embrace solar and put that money to better use than trying to prevent the logical, environmentally, and economically more sound option of solar power, but they won't.

    They, (utilities) claim that solar users are creating more instability in the grid when actually the opposite is true, that they are freeloading on the grid and should pay a fee for that when we all have to pay line fees and grid maintenance fees regardless. Bottom line: when it comes to utilities believe nothing they say in regards to solar power.

  • Report this Comment On January 02, 2014, at 12:22 PM, ffbj wrote:

    States where they operate:

    Arizona

    California

    Colorado

    Connecticut

    Delaware

    Hawaii

    Maryland

    Massachusetts

    New Jersey

    New York

    Texas

    Washington

    Washington D.C.

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