When Sunrun (RUN -0.37%) announced it was acquiring Vivint Solar (VSLR), my first reaction was that it saw Vivint as something of a value in the solar market. Sunrun was more highly valued in relation to the retained value (a proxy for the present value of all solar installation cash flows) each had on their balance sheet, so it could be seen as an arbitrage opportunity.
As time passes and the dust settles, I think there's more to the move than that. Sunrun has seen its bargaining power with suppliers shrink, sales costs are skyrocketing, and new products like virtual power plants may need more scale than Sunrun currently has. Put it together and Sunrun is trying to take power back in the solar industry and build the future of renewable energy stocks in the process.
Fixing the cost curve
The odd change over the last few years is that the cost of residential solar installations has been going up rather than down. Over a long period of time, costs should go down as installers and manufacturers get more efficient, but that's stagnated recently.
There are a couple of reasons costs are on the rise today. One is that sales and marketing costs are going up as it gets harder to attract the next incremental customer. At Sunrun, sales and marketing costs have risen from $0.52 per watt in 2017 to $0.70 per watt in 2018 to $0.77 per watt in 2019. That's not a sustainable trajectory, but with more scale those costs may finally start to fall. At least that's the theory.
On the supplier side, we've seen SolarEdge (SEDG 0.95%) and Enphase Energy (ENPH -1.09%) grow to larger market caps and higher net income than Sunrun despite the fact that they're simply component suppliers. Owning a larger network may allow Sunrun to squeeze these suppliers more and lower its own hardware costs.
These are good reasons for the acquisition to take place. But the biggest reason may be looking years ahead.
Energy storage and the future of residential energy
The biggest change in energy over the next decade may be the introduction of what's called virtual power plants. In general, these work by essentially tying together hundreds or thousands of small energy storage systems and bidding them in one big chunk into energy markets like a power plant. The more energy storage systems you control, the more energy you can bid and the more flexible you can be in adapting to the grid's needs.
Regulators and utilities are just now starting to learn how to use virtual grids in the electric grid, and that's happening just as residential energy storage is starting to reach scale. If Sunrun has the most residential solar installations, it should be able to leverage that into adding the most energy storage systems, leading to the largest virtual power plant network in the country.
A decade from now, the virtual power plant business alone could be a huge percentage of Sunrun's profits. This summer alone, Sunrun has announced virtual power plant agreements with SCE in Southern California and Orange & Rockland Utilities in New York. Building scale in the virtual power plant business now could be a great move.
Making a big play in renewable energy
Residential solar companies have traditionally had a hard time generating value for shareholders because they're in constant need of new funding. But Sunrun is trying to build the scale and network to have a sustainable business that will be able to compete with even the biggest utilities on the open energy markets. If the plan succeeds, this could become an energy giant in the U.S. And that's the strategy Sunrun's management has laid out for its business long-term.