With its recently announced acquisition of Vivint Solar (NYSE:VSLR), SunRun (NASDAQ:RUN) has set a course to become the largest vertically integrated installer and owner of solar generation in the US. But scale alone does not guarantee shareholder value. To succeed, SunRun will have to prove that adding scale also makes the company more efficient.
How SunRun has evolved over time
SunRun started as a pure-play financial services provider for residential solar installers in 2007. In that model, SunRun provided software tools and access to financing to residential solar installers across many states in the US. Solar installers became a "channel" that allowed SunRun to achieve scale quickly.
With its acquisition of installer REC Solar in 2014, SunRun shifted to a hybrid model. It worked with installers or "channel partners" to reach some households, but ran its own "direct to consumer" installation business to reach others.
Vivint, on the other hand, sold and installed residential solar systems from day one. It specialized in a door-to-door "direct-to-home" sales model that produced steady growth since 2011.
By acquiring Vivint, SunRun ensures that its direct-to-home sales method will play a larger role in its business. This sales tactic has proven effective for Vivint -- but it's also more expensive than SunRun's approach.
Looking at Vivint's and SunRun's income statements for Q1 2020 we see that while SunRun spent $0.33 of every revenue dollar it earned on sales and marketing, Vivint spent $0.43 -- or 30% more.
And looking at SunRun's presentation about its plan to acquire Vivint, it seems like SunRun sees Vivint's expertise in direct-to-home sales as "complementary" to its own – in other words, it doesn't appear poised to de-emphasize Vivint's sales approach.
Sales and marketing costs (also known as "Customer Acquisition Cost" or "CAC") are one of the largest line items in the cost of residential solar systems, along with component costs and operations and maintenance. And these costs offer the most opportunity for savings. So why is SunRun buying a rival that will likely drive up its cost of deploying systems and make its business less efficient?
Is it all about scale?
Scale has its benefits, to be sure. With the acquisition of Vivint, SunRun will own over 3 gigawatts of solar capacity -- more than most traditional US utilities right now, with the exception of NextEra. And Vivint and SunRun have been growing their customer counts at a combined 27% yearly, suggesting that the combined SunRun will likely continue to lead in installed capacity for years to come.
Scale improves leverage. The combined company will be able to negotiate better deals with its suppliers, lowering its cost of goods sold for things like inverters and solar modules. It will also be able to attract even more capital for its financing business at even better terms, since large pension funds and tax equity investors will likely see opportunities to put more of their money to work.
In recent years, SunRun's scale has also allowed it to innovate and enter related businesses. For example, in early 2019, SunRun announced it had signed an agreement to provide capacity to ISO New England, one of the largest grid operators in the North East. Instead of buying a new plot of land to build a traditional power plant, ISO will rely on the solar generation and storage capacity that SunRun will install on homes' rooftops throughout ISO's service territory over the next two years.
Scale also adds stability. As smaller solar outfits struggle to endure the economic uncertainty of the next few quarters, a larger SunRun should be able to better weather the storm.
And scale boosts brand recognition, which can lower CAC significantly over time.
But scale also brings increased competition
As a company becomes No. 1 in any market, it essentially draws a target on its back.
Former potential channel partners may see a larger SunRun, with a bigger emphasis on direct-to-home, as a competitor rather than a potential provider of financing. They might decide to switch allegiances to pure-play finance providers who don't compete with them, such as Sunnova (NYSE:NOVA). And the residential solar installation market is very fragmented at this time: After the acquisition, SunRun will likely own only around 20% of the US market. That means that about 80% of the market will be looking for ways to beat SunRun.
Other solar installers with significant brand recognition, such as SunPower (NASDAQ:SPWR) and Tesla (NASDAQ:TSLA), will fight harder for their piece of the pie as well. A few days before SunRun made its Vivint acquisition public, Tesla announced that it was cutting the prices for its solar systems by one third or more below prevailing market prices. Sunpower is shedding its solar module manufacturing business as it prepares to become more focused on residential solar financing and services.
In light of those challenges, scale alone may not guarantee success for SunRun. Foolish investors should monitor whether the acquisition creates a more efficient and competitive SunRun; whether it can leverage its brand and use technology to lower its CAC below its current 33% of revenue; and whether it announces large capital placements at even better terms than it has been getting from its investors to date.