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SolarCity Would Face a Shifting Market Alone Without Tesla Deal

By Travis Hoium - Nov 12, 2016 at 9:06AM

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Cash and loan sales are growing within SolarCity, and that could be a challenge if the company remains independent.

SolarCity Corp (SCTY.DL) isn't giving a ton of information about its business to investors heading into its potential acquisition by Tesla Motors Inc (TSLA 2.55%), but we did get a glimpse into operations from the third quarter. 

Image source: Getty Images.

The big numbers

Revenue surged 76.1% in the third quarter to $200.6 million, and the company swung from a net loss of $19.1 million to a profit of $53.2 million. Results were greatly helped by system and component sales nearly tripling to $57.5 million and growth in the losses sold to non-controlling interests (tax equity). 

Sales costs per watt also dropped to $0.58 from $0.91 in the first quarter of the year, which helped total cost per watt decline to $2.89. That's still above where costs stood two years ago, but it's a positive that trends are heading in the right direction. 

What was less encouraging was another decline in full-year installation guidance to 900 MW. Coming into 2016, SolarCity's management thought it would install 1.25 GW of solar, and the company will come up well short of that. 

Trends to watch in the future

If the Tesla acquisition goes through as planned, SolarCity will simply be folded into the electric carmaker. But if the deal falls through, the trends taking place in solar energy will impact the company and its investors. 

One trend that's taking over the industry is a move to system sales through cash and loans. As I mentioned, $57.5 million in sales was outside of traditional leases, and the segment generated a 14.8% gross margin. This will continue to grow because 29% of bookings in September were loans or cash sales. If the business is going well, expect the margin figure to rise in the future. 

What'll be worth watching is if SolarCity can make enough on sales to cover operating expenses. The company currently has about a $1 billion annual operating expense run rate, and with 900 MW of installations, it would have to make $1.11 per watt above gross costs just to break even on an operating basis. It's possible, but margins will be worth watching closely. 

On the financing side, one concerning trend is the $3.02 in contracted value SolarCity says it generated in the quarter -- barely above its cost per watt. The value calculation also uses a very generous 6% discount rate, so it's conceivable that with a higher discount rate, SolarCity would be destroying value with every lease or power purchase agreement signed. For the non-cash sales side of the business to remain strong, SolarCity needs to lower installation costs, reduce borrowing rates, and charge customers more. Otherwise, the business will be on thin ice on its own. 

Residential solar is in a tenuous position

Given the residential solar industry's trends, we know growth is slowing, and most companies are moving to more cash or loan sales, which could end up making pricing highly competitive. That puts SolarCity in a difficult position if it doesn't become part of the Tesla empire. 

We'll see how the Tesla takeover vote plays out to see if SolarCity needs to worry about the industry trends changing its strategy. If the deal doesn't go through, the company will have to decide how it wants to build its business in a world where cash and loan sales are booming and competition is getting more fierce. 

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