I recently took a look at Principal Solar, a reverse-merger solar developer roll-up play, and found it remarkably lacking in hard data. But there are a handful of other publicly traded pure-play solar installer/developers, as well as vertically integrated solar manufacturers such as First Solar (Nasdaq: FSLR), that have been developing projects with their own panels, and solar developer-operators such as Etrion.

The shape of the solar installation industry
Although Principal may not be providing enough information at the moment to make an informed investment decision, I wanted to decide whether the roll-up strategy made sense in the solar developer space. To do that, I talked to two sources actively involved in the space: Stephen Irvin, the CFO of the privately held solar installer Namaste Solar in Boulder, Co., and Rick Coen, principal at Empower Solar Consulting, a company that manages solar projects for clients such as builders, real estate developers, and government entities who have a few of the necessary ingredients (such as capital or real estate) for a project but lack the necessary technical or organizational expertise.

Together, Irvin and Coen paint a mixed picture of the industry for prospective developers. At the small, residential scale, there are practically no barriers to entry. There is a wealth of training material available, both in person and online, that enables even a one-man contractor to become certified to install solar. At the larger, commercial scale, the main barrier to entry is capital, not expertise. According to Coen, there is a national trend toward having the financiers own the solar project, and consultants like Empower can manage the project for them and bring together all the necessary expertise to develop a project, from the initial site assessment to final commissioning.

According to Irvin, the installer model looks a lot like a traditional contractor model. Gross margins are thin, from 15 to 30%, with residential systems typically receiving larger margins than commercial ones. Both see space in the current climate for a wide range of business models, driven by the immaturity of the industry and a wide diversity and frequent complexity of local codes and utility incentive programs that contractors must negotiate.

There are also advantages to scale. According to Irvin, large solar developers such as privately held Alteris Renewables have the buying power to negotiate better prices on solar panels, a significant advantage in a thin-margin business. Alteris was formed when private-capital firm Riverside Partners rolled up a bunch of companies in the Northeast. He sees a shift toward commercial and utility-scale projects, which also favor large firms because they have the balance sheets to provide the bonding capacity that large customers expect.

Public solar installers
Based on that discussion, I'd guess the sweet spot for a publicly traded solar developer/installers would be a large-scale, regional company, focused on a promising region and possibly residential solar installations (because of the higher margins.)

Promising markets include California, the Northeast, and Hawaii. The former two have strong incentives, while Hawaii's expensive electricity means that it's already close to grid parity.

Although not a complete list, here are the publicly traded installers I'm aware of.

Real Goods Solar
Real Goods Solar (Nasdaq: RSOL) calls itself a "leading residential and commercial solar integrator." It was bought by sustainable retailer Gaiam (Nasdaq: GAIA) in 2000 but was spun off again in 2008. According to Irvin, Real Goods used the money raised in the IPO to "acquire three solar installers in California." It also has a presence in Colorado, because of Gaiam's presence there.

Real Goods reported
a gross margin of 28.9% and its seventh consecutive quarter of profitability in Q1 2011, showing the effectiveness of the large-scale residential focused model. I think the company deserves deeper investigation.

Premier Power Renewable Energy
Premier Power Renewable Energy was founded in 2001 as the solar arm of homebuilder Premier Homes. Now it calls itself "a leading North American and European solar power company providing high-performance solar panel systems with consistently high quality for our commercial, agricultural, industrial, government, utility, and residential customers." Recent press releases show that the company has been completing large-scale projects in California and Italy.

The company has a tiny $20 million market cap and an 8.2% gross margin on $87 million in sales. It's marginally unprofitable, but it shows positive cash flow and no net debt. Yet with its thin gross margins, I don't anticipate a smooth or quick path to real profitability.

Principal Solar
Principal Solar has already been discussed in detail. Investors should stay away until adequate financial information is available.

Envision Solar International
I first looked at Envision Solar International a year ago, year ago, at which point it needed to raise capital to build its business. It's now reporting a healthy 36% gross profit margin, but on minuscule revenues of $347,000. An atypical solar integrator, it focuses on licensing "solar trees" and other parking-lot solar shading structures nationally. This approach may account for the out-of-line gross margins of a solar integrator, as it focuses mainly on engineering and leaves the sale of solar panels to third-party installers. However, given that its revenues are still a fraction of total expenditures (it lost $2.36 million over the trailing-12-month period), these margins may not persist as Envision continues to scale its business.

Acro Energy Technologies
Acro Energy Technologies was brought to my attention by J. Peter Lynch after I wrote the initial version of this article. I have not investigated the company, but here is the profile from its website:

"Acro Energy Technologies ... is focused on the consolidation and growth of renewable energy companies, initially in the United States solar market. Acro Energy Technologies has initiated its acquisition campaign in the solar integrator market through its recent addition of Acro Electric, Inc., the 8th largest residential solar integrator in California. Also, it has closed an asset purchase agreement with Light Energy Systems in Concord, California. Acro Energy continues to actively evaluate suitable acquisition candidates across North America and Canada."

The examples of Real Goods and Alteris show that there is a role for consolidators in the highly fragmented solar installer industry. But not all consolidators will succeed, and those that do are more likely to be steady cash earners, rather than high-flying growth machines. Do not expect to see a Google of solar installers any time soon, if ever.

If I were to invest in a solar developer today, the only real option would be Real Goods. I'd need to do more analysis before doing so, but the company's financial ratios and strength look promising. My biggest concern would be valuation, since solar installation is a traditional low-margin business, but the glamour of solar is likely to attract unsophisticated investors drawn to the flame of solar's bright future. At $2.42, Real Goods is trading at a pricey 12-month trailing P/E ratio of 34 but an inexpensive forward P/E ratio of only 10. Yet forward P/E ratios have meaning only when (possibly inflated) earnings expectations are met.

DISCLOSURE: No positions.

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results. This article contains the current opinions of the author and such opinions are subject to change without notice. This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

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