One of the biggest questions investors face in the solar industry right now is: What is residential and commercial solar really worth?

So far, we have two public companies -- SolarCity (SCTY.DL) and SunPower (SPWR -0.80%) -- making a big push into residential solar, and it's important to look at the value they've created in this business.

I've put together a table with the second-quarter numbers for SolarCity and SunPower. Note that SunPower only breaks out the residential business in quarterly reports, and based on a presentation earlier this year, the company adds about 30% more in commercial business. SolarCity's figures include both residential and commercial.




Q2 2013 Installations

53 MW

18 MW

Cumulative Installations

329 MW (assumes 85% of systems are leases)

118 MW

Cumulative Contract Payments

$1,409 million

$528 million

Estimated Retained Value/MW



Note: SunPower's retained value estimate is for a California residential system and SolarCity's is estimated installed and booked retained value.

The new convention that's become common in the industry is to estimate the value of a solar project based on the current value of cash flows, or its retained value. That's what the bottom figure on the table is, although the figures aren't exactly equal. SolarCity's retained value doesn't include any overhead or selling costs. SunPower's estimate includes "costs to sell and allocation of corporate overhead." 

To get an idea of installed value, we can multiply retained value per watt by cumulative installations, which gives a value for SolarCity of $417.8 million, and for SunPower the figure is $206.5 million. That's an estimate of the current value of what's already installed, but a lot of the value in solar companies is what will be installed in the future, and the value per watt is on the rise.

Putting a value on the future of residential solar
To get a feel for the value of solar leases, I've built a model calculating the present value of past and future installation's retained value for SolarCity and SunPower. I've assumed a growing retained value per watt of $1.40 in 2013 for SolarCity (based on predicted rise in RV in Q2 conference call) and $1.50 per watt for SunPower. Current information suggests SunPower gets slightly more value out of each watt installed, but I've made a conservative investment for both companies.

From there I predict a consistent decline of $0.10 per watt/year in retained value to $1.00 per watt, respectively, until I calculated a terminal value in 2019. This would be consistent with growing competition, higher interest rates, and lower installation costs for solar. I also assumed that SolarCity grows more quickly than SunPower, consistent with recent figures. For SolarCity I've pulled out an estimated overhead cost, which should already be built into the SunPower numbers. 

My model shows $5.7 billion in value for SolarCity and $2.4 billion for SunPower. Considering SolarCity's leasing business is about twice the size of SunPower's and it's growing faster, the relative value seems about right.

When compared with a $2.8 billion market cap for SolarCity and a $2.9 billion market cap for SunPower, that leaves a lot of upside for investors. Don't forget that residential and commercial solar leasing is only a small portion of SunPower's business.

A lot of unanswered questions
As with any model or projection, there are a lot of unknowns that need to be filled in. The challenge valuing residential and commercial solar leases right now is in projecting the business model that will become popular in the future. It appears that leasing will be popular for the next few years, but as costs fall it may become more economical for homeowners and businesses to buy systems outright or use mortgages or other financing and capture more value themselves. I doubt that any company could get away with generating a 50% margin in solar (about the retained value/installed cost per watt) long-term. 

In the case of SolarCity, two-thirds of my modeled value is in 2019 and beyond, meaning that there's a lot of risk in a changing business model. Also, keep in mind that nearly half of SolarCity's estimated retained value comes from lease renewals in 20 years. SolarCity has only $662 million in total retained value at the moment and only $364 million under contract, compared with a $2.9 billion market cap. That's a lot of expected growth in both installations and profitability.

The same can be said for SunPower's solar leasing business, which is more profitable but probably won't grow as quickly. The good news for SunPower investors is that the company makes modules, builds utility-scale projects, and has international sales so it's definitely more diversified. The value above is only for the leasing business. 

Foolish bottom line
There's a lot of value to be had in residential and commercial solar leasing, but the challenge is knowing how much value to put on these stocks. SolarCity certainly has more upside if the leasing model continues outstanding growth, but SunPower is the safer stock in my opinion. How you invest in solar will depend on how you see the industry playing out and what your risk tolerance is.