Please ensure Javascript is enabled for purposes of website accessibility

Valuing SolarCity Is More Complicated Than It Seems

By Victor Lai, Lai - Dec 11, 2013 at 2:01PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

After a stellar year, is SolarCity expensive? That question is more complicated than it seems.

SolarCity (SCTY.DL) is up by more than 535% since its IPO. Given that the company is still reporting losses, it's easy to think that its stock is expensive. However, there are some unique challenges to understanding what SolarCity is worth. Here are two issues to consider before attempting to value the stock.

Rise of the lease arrangements
In the past, going solar wasn't practical for many consumers due to the high costs of installing solar systems. In 2008, SolarCity introduced an option for customers to "go solar" with little to no upfront costs.  

This is done with lease and power agreement arrangements where customers pay monthly fees for the systems and power instead of buying equipment outright. According to Standard & Poor's, about 60% of SolarCity's revenue will come from these arrangements by 2015.

Many of SolarCity's competitors offer similar arrangements. For example, SunPower (SPWR 4.61%) started to offer lease arrangements in 2011. SunPower has a market cap of $3.6 billion and $2.5 billion in annual sales. Real Goods Solar (NASDAQ: RSOL) is another example. The company has a market cap of about $96 million and annual sales of about $98 million.

Issue #1: earnings versus reality
Consumers seem to like the arrangements. According to SolarCity's most recent 10Q filing, over 90% of third-quarter solar system sales were done through lease agreements. The issue with these arrangements is that they're actually very complex. Here's an example of how the agreements are often structured at SolarCity.

  1. SolarCity creates a "financing fund" into which investors contribute money.
  2. The fund uses the money to buy solar power systems from SolarCity -- this generates cash and revenue for the company.
  3. The fund leases the equipment to customers and receives monthly payments from those customers.  
  4. The fund allocates to investors (that can include SolarCity itself) their respective shares of customer payments over time.
  5. Repeat.  

To top it off, established accounting standards handle these arrangements with special treatment. For example, while SolarCity may receive an upfront payment of $30,000 from a financing fund, that payment may be recorded as incremental revenue over time. In other words, it could be recorded as $1,000 in revenue per year for 30 years (to replicate a lease).

The result is that the revenue and net income on SolarCity's financial statements may not be an accurate reflection of its current sales and earnings. This can be observed by comparing SolarCity's net income to its cash flow from operations. 
Year 2009 2010 2011 2012 TTM
Net Income -26 -39 44 -64 -55
Cash Flow 2 -4 18 60 248

 Source: Morningstar, BCM

Notice that SolarCity's net income went from negative $2 million in 2009 to negative $64 million in 2012, but meanwhile its cash flow from operations went from $2 million to $60 million. Also note that cash flow more than tripled from 2011 to 2012 and has already quadrupled in 2013. 
In terms of valuation, SolarCity's negative earnings make it look expensive or impossible to value (its price to earnings ratio is -63.) However, in terms of cash flow SolarCity looks reasonable. Its price-to-cash-flow ratio is about 14, which is lower than the industry average of 17.  
The point is that net income may not be a reliable measure for valuing SolarCity because of how it recognizes revenue. Investors need to look beyond reported earnings to understand the company's actual results. 

Issue #2: monetization of tax benefits
The government offers various tax credits and incentives tied to the purchase and use of solar power. SolarCity is able to monetize these tax benefits by selling them to its financing funds for cash and recognizing the proceeds as revenue.

In other words, SolarCity makes money from what are basically government tax subsidies. The subsidies make it possible for SolarCity to offer no-upfront-cost solar systems with monthly payments that are less than those of incumbent electric power providers.

However, the tax benefits won't be around forever, and that's clearly an impending problem. SolarCity's management recognizes this as a significant risk. Consider the following statement from the company's most recent 10Q:

Reductions in, or eliminations or expirations of, governmental incentives could adversely impact our results of operations and ability to compete in our industry by increasing our cost of capital, causing us to increase the prices of our energy and solar energy systems, and reducing the size of our addressable market. In addition, this would adversely impact our ability to attract investment partners and to form new financing funds and our ability to offer attractive financing to prospective customers.

Ultimately, this variable is tied to unpredictable legislation. How do you price that risk into valuation? What's the "discount rate" for uncertain government policy? It's complicated and subjective to say the least. In SolarCity's case, it is also something that must be considered. 

The bottom line
As with any investment, I think it's crucial to have a clear understanding of how a company generates profits, not just today but also into the future. Without that, it's hard to determine fair value for the stock.  

This is all easier said than done for SolarCity, where revenue and earnings are complicated by a mix of funds, investors, taxes, and accounting quirks. At the very least, I'd want to know how SolarCity plans to attain profitability without government subsidies.  

That being said, this isn't a recommendation for or against SolarCity. I'm just pointing out that SolarCity is more complicated than it may seem. Those considering an investment in SolarCity should look beyond the headlines and reported numbers to develop a genuine understanding of the business and its long-term prospects.  

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

SunPower Corporation Stock Quote
SunPower Corporation
$15.90 (4.61%) $0.70
SolarCity Corporation Stock Quote
SolarCity Corporation

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning service.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 05/17/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.