Beware Great Companies That Make Terrible Investments

Plug Power (NASDAQ: PLUG  ) and SolarCity (NASDAQ: SCTY  ) have been two of the hottest energy stocks of the last two years. The raw growth potential of these two companies is impressive; however, alternative energy is a sector fraught with snake oil salesmen peddling sky-high dreams but delivering mostly massive losses.

PLUG Chart

PLUG data by YCharts

This article will take a closer look at Plug Power and SolarCity, to first decide whether either might actually live up to its promised growth potential, and then explain why even this might not prevent long-term investors from losing money.

SolarCity: Brilliant future, terrible investment
Bloomberg estimates that rooftop solar will grow by 20% annually through 2020 and that Solar will make up 18% of energy generation by 2030.

SolarCity has a business model I love. It installs a solar power system on a rooftop for free and signs a 20-year contract with the owner for power generation at a lower cost than the customer is currently paying. Both parties win, with SolarCity becoming a cheaper competitor to the local power utility.

SolarCity's growth has truly been spectacular and is likely to continue to be for many years. Consider this:

  • Solar panel installations have grown from 31 MW in 2010 to a projected 1,000 MW in 2015, representing 100% compound annual growth for five years.
  • SolarCity's market share of rooftop solar has grown from 12% in 2012 to an estimated 41.8% in 2014.
  • SolarCity now has $2.5 billion in contracted revenue, up from $700 million in Q2 2012 and representing a 66.4% compound annual growth rate.
  • SolarCity currently has 100,609 customers but is targeting 1 million by mid-2018, a 70% compound annual growth rate.
So how can I love SolarCity, yet say it's a terrible investment? Because there are three factors that will likely result in long-term losses for current investors: mounting costs, sky-high valuation, and high share dilution.

SCTY Shares Outstanding Chart

SCTY Shares Outstanding data by YCharts

These factors are why analysts are predicting negative earnings per share (EPS) growth until 2023 and why current SolarCity Investors are likely to underperform the market over the next 10 years. 
 
Between 2011 and 2013 SolarCity lost $318 million and through 2015 it's expected to lose $734 million more.
That loss is probably conservative because of SolarCity's recent acquisition of solar panel maker Silevo. SolarCity paid $200 million cash (leaving it with just $320 million)  for Silevo's 32 MW of capacity. 
The justification for the Silevo purchase was to offset the cost of high US tariffs on Chinese solar panels that SolarCity was purchasing. 
In the long term this goal will be accomplished because SolarCity is planning on expanding Silevo's capacity 33-fold to 1 GW within two years. By that time Silevo's panels are expected to be 24% efficient, resulting in a 25% reduction in panels needed per system.
 
However, SolarCity has said it will cost $500 million to expand this capacity and it will likely owe Silevo an additional $150 million for meeting certain production growth goals. A few years later SolarCity plans one or more additional factories to expand capacity to 10 GW, requiring billions of dollars more. 

SolarCity will require $1.1 billion in new capital within the next two years to pay for its ambitious expansion goals, and that means substantial shareholder dilution. Combine this dilution with SolarCity's price/sales ratio of 32 and the stock is poised to drop massively during the next market correction. I would advise interested investors to put SolarCity on a long-term watch list and buy after such a crash.

Plug Power: the shareholder dilution king

PLUG Shares Outstanding Chart

PLUG Shares Outstanding data by YCharts

As the above two charts show, over the last 13 years Plug Power's revenues have grown by 2.73% annually yet its share count has grown by 31%/year while long-term investors lost nearly all of their money. In the last 18 months the share count has nearly quadrupled. Shares have soared because Plug Power operates in a potential $4 billion market, fuel cell-powered fork lifts and delivery trucks, and sales are projected to soar 350% between 2013 and 2015.

However, in the first quarter Plug Power reported revenues of just $5.6 million, down 12.5% from 2013. Meanwhile losses for the quarter grew 783% from $8.6 million to $75.9 million. Plug Power has a long track record of failing to deliver on growth promises. For example:

  • In 2009 Plug Power guided for gross margins in the mid teens on mid $40 million to low $50 million in revenue.
  • In 2012 Plug Power guided for positive gross margins and $40 million in revenue.
  • Revenues have never exceeded $33 million, gross margins never higher than -25%, and today's gross margin is -41.4%.

Foolish takeaway
SolarCity is a fantastic solar company with a terrific business model that might one day make a great investment . However, for now the only thing more impressive than its growth is its ballooning costs, which are accelerating. This means massive shareholder dilution is likely for years to come and at these valuations, SolarCity investors are at severe risk of losing money over the next decade. Meanwhile, Plug Power is a perfect example of a hype stock that never delivers on its promised growth potential and whose long-term shareholders have only obscene dilution and losses to show for their patience.

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Read/Post Comments (11) | Recommend This Article (4)

Comments from our Foolish Readers

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  • Report this Comment On July 10, 2014, at 10:13 AM, lucho1981 wrote:

    I agree with most things this author mention, except how incredibly negative the article is about the future and how blind it is about current facts, in particular for PLUG. Regardless of secondary offerings and regardless of under-delivering, when physical visits are made and analysts opinions are raised and deals announcements are clearly made, like the one recently made with ACE, it is quite expected that a much better earnings results will be provided. I do expect PLUG to deliver at least for this year, and not to mention gas prices going up, etc. I would like to add that as an investor I don’t like secondary offerings at all, but the truth is that if the money is not utilized in salary raises, etc, but properly invested in company growth, the company production capabilities are better guaranteed and so the company value improves (at least in theory), that been said, let’s hope they do not do yet another secondary often any time soon. I am definitely bullish on this company at least for the short term, another secondary offering will make me look elsewhere.

  • Report this Comment On July 10, 2014, at 12:59 PM, greenhawk wrote:

    I tend to take (or value) advice from folks who have done even minimal homework on the stocks they purport to cover. Adam, try researching the (very well-publicized) terms of the Silevo deal at such places as ...

    http://recode.net/2014/06/17/solarcity-will-buy-silevo-for-3...

    The purchase was for STOCK, not cash, and the additional $150mm in earn-outs are also to be paid out in stock. As for dilution, factories are often financed not via equity issuance but rather via debt (which in SCTY's case is readily available, at very affordable prices). Not that this would amount to a free lunch -- interest charges will place additional drag on earnings, for instance -- but your blithe assumption that any future CapEx would drive additional dilution is at best imprecise, and at worst reckless.

    My foolish bottom line: I'll move along to other "analysts" to inform my view on SCTY.

  • Report this Comment On July 10, 2014, at 8:11 PM, AdamGalas wrote:

    greenhawk, you are correct, thank you for pointing out the acquisition was in stock and not cash.

    This means dilution for the existing shareholders but with SolarCity shares trading so high, using shares to make a potentially long-term accretive acquisition is smarter than paying cash.

    However, lets consider your assertion that Silevo's expansion won't be funded mostly with debt.

    Currently SCTY has $710 million in debt and -$785 million in annual levered free cash flow, and management says it will take $500 million to expand to 1GW of capacity. With a goal of 10 GW we are potentially looking at $5 billion in cap ex plus the expected losses that were projected through 2015.

    That's close to $6 billion in capital requirements and in 2016 the solar tax credit expires, which is likely to increase costs substantially.

    You say that debt will fund the expansion but Elon Musk chairs SCTY and Tesla just got downgraded to junk status for taking out its gigafactory loans. That was $2 billion Tesla took out, SCTY may need three times that much by 2020.

    If it decides to go the all debt route then it will reach junk status faster than Tesla and in an age of rising interest rates, that much debt will decimate SCTY's cash flows.

    If SCTY decides to go the equity route, which given their valuation is the smart option, it represents, at most 100% dilution through 2020.

    Given that this is a high-tech start up that's not bad, especially when you compare it to dilution fiends like Plug Power.

    As for Plug Power, yes its won some contracts but I'm waiting to see Plug post the kind of growth they've been peddling for 10 years and failed to materialize.

    Even if they can grow sales, their margins are getting worse, not better. If they increase sales 10 fold but losses 20 fold, then guess what, they'll need to issue more shares to stay afloat.

    Which brings me to lucho981's comment about hoping another secondary isn't around the corner.

    If PLUG can increase sales anywhere close to expectations its shares are likely to soar again, which will almost certainly trigger a large secondary, priced at a huge discount to the overvalued shares.

    When PLUG was at $10 a secondary was priced at $5, why a 50% discount? Because management couldn't convince anyone on wall street that additional, dilutionary shares were worth anywhere close to the hype fueled manic prices wall street was posting.

  • Report this Comment On July 10, 2014, at 10:12 PM, AdamGalas wrote:

    It just occurred to me that the Silevo acquisition, because its was all stock, strengthens my fear that SolarCity will go the equity route for raising funds.

    After all SolarCity could have taken out a loan to buy Silevo but they instead diluted investors. It was the smart move since the cost of equity at these valuations is far below the cost of debt but I find it hard to recommend investing in a company who has enormous capital needs and who's optimal strategy is to dilute existing shareholders.

    I'd rather save my money for a day when the dilution is no longer necessary and cash flows are sufficient to sustain moderate amounts of borrowing at favorable interest rates.

  • Report this Comment On July 10, 2014, at 10:12 PM, AdamGalas wrote:

    It just occurred to me that the Silevo acquisition, because its was all stock, strengthens my fear that SolarCity will go the equity route for raising funds.

    After all SolarCity could have taken out a loan to buy Silevo but they instead diluted investors. It was the smart move since the cost of equity at these valuations is far below the cost of debt but I find it hard to recommend investing in a company who has enormous capital needs and who's optimal strategy is to dilute existing shareholders.

    I'd rather save my money for a day when the dilution is no longer necessary and cash flows are sufficient to sustain moderate amounts of borrowing at favorable interest rates.

  • Report this Comment On July 11, 2014, at 9:38 AM, dimestop wrote:

    an INVESTMENT IN SOLAR CITY...

    remember AT&T and the phone companies back in the earlier 20th century...

    you bought AT&T...stock and JUST SAT ON IT...

    AND IT KEPT "SPLITTING" and going up...

    I no of a "low wage janitor" who used to dump his little bit of extra money into AT&T stock...

    he left well over 500,000 of it TO THE FAMILY in his will..

    every one was shocked ...every one thought HE HAD NOTHING...

    SO "SOLAR CITY" is like that...

  • Report this Comment On July 11, 2014, at 4:59 PM, clanza875 wrote:

    If you do the math you will notice that a dilutive offering done at current market prices has no impact on the value of the shares (its a zero sum game). You're trading a portion of future profits for much needed equity now.

  • Report this Comment On July 11, 2014, at 4:59 PM, AdamGalas wrote:

    Well I agree that SolarCity is like a utility. One day it will probably pay a great dividend, because its business model is ideal for that. Or it will be once it scales up and becomes a cash flow machine.

    But keep in mind that in your example AT&T was a monopoly and fabulously profitable. They kept raising their dividend and splitting. SolarCity is burning through $785 million in levered free cash flow yearly and plans to invest $750 million into phase 1 of Silevo's expansion, up to 1GW from 32 MW.

    https://www.governor.ny.gov/press/11212013-high-tech-manufac...

    SolarCity says they eventually want Silevo to reach 26.5% efficiency at the cell level and 10GW of capacity, (annually). Based on this article it seems like that might take $7.5 billion in capital to accomplish.

    The timeline for that is around 2020, since SolarCity said it would expand Silevo's factory count "a few years after phase 1".

    So we have SolarCity with $750 million or so in expected losses through 2015, before its Silevo acquisition.

    Now we're starring at a major investment in a panel maker, and since most panel makers are not profitable, this will likely mean that SolarCity's losses will only grow faster and continue several more years compared to prior to the acquisition.

    Factor in the likely 2016 expiration of the solar tax credit, (which luckily will not affect demand for free solar installations) and SolarCity's cash flows may soon reach -$1 billion+.

    This would mean they might need to raise $9 or even $10 billion by 2020 to achieve their ambitious goals.

    In a rising interest rate environment and with Tesla being downgraded to junk status for just $2 billion in additional debt, SolarCity will need to use shares as currency to grow.

    I wish it the best and hope that shares rise as quickly as possible for as long as possible. That way they can raise the funds necessary with minimal dilution and I'll still end up owning them cheap after the next crash.

    By that time they'll have hopefully achieved the scale necessary to survive and grow without massive dilution making ownership safe for boring cowards such as myself, who yearn for the kind of sweet, sweet dividends that this business model will one day allow.

    At that point, SolarCity will indeed be like AT&T and make every janitor a very rich man;)

  • Report this Comment On July 11, 2014, at 11:54 PM, yahoo123 wrote:

    You are witting same thing every day about SCTY

    http://www.fool.com/investing/general/2014/07/08/which-1-of-...

    ??

    Do you have anything new ?

    If you are so sacred about SCTY but something else.

  • Report this Comment On July 12, 2014, at 11:53 AM, AdamGalas wrote:

    The great thing about companies like SolarCity is that there is so much news that one learns new things every day.

    Normally I don't write about the same company on two consecutive days however, that's how it worked out this week.

  • Report this Comment On July 21, 2014, at 1:51 AM, ThomasOil wrote:

    Adam, did you assume SCTY will need $5B at the same time to reach 100% dilution?

    But, they need far less in the first two years, and if they can drive the stock price higher, the dilution will be far less.

    Bears see SCTY will dilute badly to drive the stock price down, but bulls think the stock used as cash for acquisition to drive stock price higher.

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