Sunrun (NASDAQ:RUN) made a huge move in residential solar last night, agreeing to buy Vivint Solar (NYSE:VSLR), the No. 2 company in the U.S. by market share. The deal will get Vivint Solar shareholders 0.55 shares of Sunrun for each Vivint Solar share. The news sent shares of both companies sharply higher.
The deal is surprising given that it effectively creates a monopoly in the U.S. residential solar market. It also shifts Sunrun's business almost completely to a self-installation focus. That's a big change for a company that once considered itself more of a software solutions company than an installer of solar panels.
Why Sunrun is buying Vivint Solar
There are a few reasons Sunrun is buying Vivint Solar today. Management said it sees $90 million in cost savings or synergies, primarily from combining sales offices across the country. Sunrun and Vivint Solar serve many of the same regions, so it makes sense that the companies could save money by combining forces.
What management won't say is that taking out a big competitor will allow Sunrun to raise prices or keep them elevated in places where competition may be bringing margin pressure. Both Sunrun and Vivint Solar have struggled with rising costs, so they likely need to raise prices to generate better returns. This move may help in that department.
I think the kicker in this deal is an arbitrage between Vivint Solar's valuation and Sunrun's. Vivint Solar's market cap today (post-merger announcement) is $1.8 billion, about a 45% premium to the $1.25 billion in net retained value it holds on the balance sheet. This is a measurement of long-term value, so it's not trading at a big premium to that measure.
Sunrun, on the other hand, has a $3.2 billion market cap and $1.6 billion in net earning assets, or about a 100% premium. As the acquirer, Sunrun thinks it can get more market value from Vivint Solar's assets than Vivint Solar can by itself.
What a merger doesn't answer
The challenge I see in this deal is that it doesn't address the fundamental problems facing residential solar. Sales and marketing costs have been rising sharply for years as it becomes harder to find customers. This deal does nothing to change the strategy. In fact, Sunrun seems to be betting that Vivint Solar's boots-on-the-ground sales strategy will help its business.
Sunrun may also be pushing out its third-party installation partners by buying Vivint Solar. The company actually started by offering software solutions for third-party installers to grow their businesses. It was a software solution that thousands of small installers could leverage nationwide. Now that Sunrun is the biggest installer, third parties will likely look to partner with other software companies rather than sign on with their competition.
Ironically, this comes at a time when SunPower (NASDAQ:SPWR) is betting that its third-party digital solutions can make its partners more efficient. Maybe SunPower will now assume the role of the service and technology partner for local and regional installers, and Sunrun will own every part of the sales and installation business nationwide? It seems that's the way these businesses are going.
Will Sunrun succeed?
Historically, renewable energy stocks have not fared well after taking the title of biggest residential solar installer in the country. SolarCity needed a bailout from Tesla, Vivint Solar itself held the title for a while before its botched merger with SunEdison, and now Sunrun is taking its shot. At the same time, it's doubling down on its position that self-installation and self-financing of residential solar projects are the future, rather than selling systems to customers through cash or loan offerings.
I think as the cost of solar comes down, loans are the answer to sales growth, not more long-term financing. That's the problem I have with this deal today. Time will tell what direction the industry is headed, but Sunrun's bet is that third-party financing is here to stay.