SolarCity Corp. (SCTY.DL) announced a new cash equity investment in the company's projects on Monday morning. In total, $305 million will be invested between a fund affiliated with Quantum Strategic Partners Ltd. and five institutional investors that provided a loan. The transaction is a hybrid of equity capital in solar projects and an 18-year loan, but it's the cost of capital that should catch the attention of SolarCity and Tesla Motors (TSLA -2.76%) investors, who may acquire the company.
The rising cost of the solar business
One thing investors need to watch is the cost of funding solar projects. I highlighted last month that SolarCity has seen its cost of short-term solar bonds rise from 2% two years ago to 6.5% last month, a trend that's making it hard to create value from each installation. Long-term cash flows associated with solar are the reason borrowing costs are so important. If they have to be discounted at a high rate, the underlying project is less valuable.
Let's take SolarCity's own projections as a good example of how this works. In the second quarter, the company estimates that the value of the contracted cash flows from projects it installed were $3.26 per watt, assuming a 6% discount rate. This has consistently been the rate management has used to estimate the value of projects. If that discount rate were to go up to 8%, the value falls to $3.01 per watt. The difference for SolarCity is huge because the cost of installations last quarter were $3.05 per watt. At a low discount rate, the company is creating value, and at a higher discount rate, it's destroying value.
Monday's announcement was a debt and equity investment called "cash equity," meaning SolarCity is selling future cash flows from projects for cash today. And the blended rate SolarCity got in the transaction was 7.4%. That's much higher than 6% and nearly at the 8% level that would indicate SolarCity is losing money on each installation.
SolarCity is now a cash-strapped company
There are a couple of implications from the new financing announcement. One is that SolarCity's funding costs are getting higher over time, meaning it's generating less value for investors. Another is that it's selling most of the cash flows it will get from customers, meaning there's less and less upside potential in the future.
The flip side is that SolarCity has been able to get funding for its projects, keeping the company's operations afloat for now. That's a positive as SolarCity attempts to be bought out by Tesla Motors and transitions its business from financing leases and power purchase agreements to selling solar systems to customers with third-party financed loans.
The final point may be most important for those looking at the company today. If SolarCity can transition to cash sales or loans, it will generate up-front cash, lessening its reliance on financing transactions. If that's the case, today's rising financing costs won't matter nearly as much as they would otherwise. But that's a lot for a company like SolarCity to juggle, especially in the middle of a buyout process.