The explosive growth of residential solar companies over the past five years has been driven in large part by lease and power purchase agreements that allow customers to finance going solar for $0 down. These third party financing arrangements led to the dominance of the top three companies in market share: SolarCity Corp (NASDAQ:SCTY.DL), Vivint Solar Inc (NYSE:VSLR), and Sunrun (NASDAQ:RUN).
But for years now it's been apparent that third party financing wouldn't last as the industry's dominant financing source. And when loans became more available and overall costs plunged far enough that cash sales were possible, the lease would likely lose out. It's now apparent the transition is already taking place.
Third party financing is dying
A recent report from GTM Research highlights how fast the residential solar market is changing. You can see below that third party financing peaked at 72% of the market in 2014 and will be just 54% of the market this year. Over the next two years, the third party financing business is projected to decline to just 37% of the market.
This has a wide range of implications for solar installers, and they aren't all positive.
The solar business gets more competitive
When third party financing was dominant, factors like scale mattered a lot, particularly for aggregating financing effectively. Where SolarCity, Vivint, and Sunrun really separate themselves is being able to take large tax equity or cash flow securitization deals to Wall Street and finance them at a relatively low cost of capital. That's not a model small, local installers could easily replicate, leading to a competitive advantage for national installers.
As cash sales or loans gain market share, this dynamic changes. Loans are easier to distribute in small numbers through banks or specialized finance entities like Mosaic Solar, BlueWave, or Wunder Capital. And national installers don't have any cost of capital advantage over a bank that generates loans to make money. In short, as loans grow in popularity, the competitive advantage national installers had in financing disappears.
The decision for consumers then comes down to factors like components, quality, and price. The solar panel itself may matter to some customers, others may want the lowest cost, and others may simply want to support a local company. These are all factors where local or regional companies can compete with national installers. And without the national infrastructure, they could have an advantage over larger rivals. That's why the decline in third party ownership will likely lead to a shrinking market share for installers like SolarCity, Vivint, and Sunrun.
How solar companies will adapt
Installers are already starting to adapt to the new loan market and there will be positive and negative impacts. As they start offering loans through partners, they'll see cash come in more quickly and the margin on each solar system will be realized upfront instead of over a 20 year period.
What that could do is reduce the implied margin overall. If local installers have lower costs it'll put pressure on pricing and now customers can easily compare the price of different companies, something that was masked in third party financing. Customers may also want components, like high efficiency panels, that national installers don't carry.
Leveling the playing field may be painful
We know national installers are adapting to the market, but it's not yet clear what that'll mean for their financials. The upfront cash is nice, but low margins could be troubling and will impact profits given the massive overhead they've built to create a national infrastructure in the first place.
What investors will want to watch to see the competitive landscape is gross margin per watt on cash and loan sales and their ability to cover operating costs. If installers can generate a margin that more than covers operating costs it'll be both a strong sign for the business and give us a good way to gauge value long-term, which was difficult when using metrics like retained value.
Vivint's lower cost structure than Sunrun should be an advantage in the market's new reality. But don't assume that national installers will win out long-term. They could lose market share to smaller installers. And that's why I'm not bullish on any of the national installers today.
This could be a challenging transition and we shouldn't assume that the winners under the old financing model will be the same winners in years ahead. And investors need to adjust accordingly.