The bear thesis for SolarCity (NASDAQ: SCTY ) is no secret.
Bears have long had valuation problems with the stock. Specifically, many don't believe that the company should assume a 6% discount rate or a 90% renewal rate after 20 years for its retained value calculations. They believe the company should use a higher discount rate because a lot can happen during 20 years, including electricity prices falling on an annual basis or a higher than assumed percentage of homeowners defaulting on their solar lease/PPA contracts. They also believe that the actual renewal rate after 20 years will not be as high as 90% because SolarCity's customers will likely opt for lower cost panels at that time.
The bears point out that if SolarCity uses a 10% discount rate and a 66% renewal rate after 20 years, the company's retained value would only be around half of what it is now.
In addition to valuation problems, the bears believe that SolarCity will see more competition going forward as other companies enter, electric utilities fight back, and the U.S. government ratchets down its generous solar subsidies.
The SolarCity optimists are undeterred, however. Here are three reasons why the bear thesis may only be relevant in a bear market:
Problems with the bear thesis
First, other solar companies such as SunEdison (NYSE: SUNE ) , a company that Greenlight Capital owns, also assume a 6% discount rate for their retained value calculations. Even though there are some differences (SunEdison builds utility scale projects while SolarCity installs rooftop solar panels), the principle is that SolarCity is not alone in assuming the low discount rate.
Second, SolarCity's stock price itself is an asset. In a lot of ways, SolarCity's market capitalization is like cash on a balance sheet. It works the same way when SolarCity acquires companies. If management does a good job acquiring and integrating companies, SolarCity can evolve into something different from what it is today. SolarCity can build its moat and increase its growth through a roll-up strategy.
Third, SolarCity has the ultimate competitive advantage in Elon Musk. As long as Elon Musk retains his Midas image and keeps his SolarCity shares, SolarCity's cost of capital will likely be lower than its rivals. And as long as Tesla is successful, SolarCity will likely have a leg up against its competitors in terms of battery storage and marketing.
The bottom line
When viewed through traditional value investor lenses, SolarCity's valuation doesn't make sense. The market is giving SolarCity a lot of credit for future growth and execution. If that growth does not materialize, or if the bull market ends and the market assigns SolarCity a higher cost of capital, the bears could very well be right in their thesis.
But when viewed through growth investor lenses, SolarCity does represent an opportunity. Solar's levelized cost of electricity will only decrease as solar panels become cheaper and installers reduce soft costs. Even if retained value without subsidies/lenient assumptions is marginal today, it won't be marginal in the future. The total electricity generation market is a trillion dollar market, and SolarCity has competitive advantages.
Over the course of time, most overvalued stocks revert back to the mean. But some high-flying stocks just keep on outperforming. The difference between the ones that outperform and the ones that don't is execution. And execution is something SolarCity certainly does not lack.
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