Great long-term investments do not always look like a value in the present day. Shares of SolarCity (SCTY +0.00%) have risen over a whopping 400% since the company's IPO in December 2012. The company is still unprofitable, has negative free cash flow, and is facing increasing resistance from traditional energy utilities. Still, despite the stock's run-up in 2013 and financial rough patches, the company strikes me as an incredible investment opportunity for the long haul compared to other solar businesses such as SunPower (SPWR +0.00%) and First Solar (FSLR 0.27%).
Finally, a sensible solar business model
The beauty of SolarCity's business model lies in its simplicity. The company does not design or manufacture solar panels, in contrast to SunPower and First Solar. Rather, SolarCity is a solar installation and leasing business. SolarCity works with individual and commercial customers (including Wal-Mart and Google) primarily through long-term contracts to lease the use of solar panels.
SolarCity covers the entire upfront cost of the solar panels and installation, setting the company apart from SunPower, whose installation financing options are comparatively more complex. SolarCity's "Direct Financing" program locks customers into a pay-as-you-go plan, typically with 20-year contracts. In other words, SolarCity covers the major immediate cost of installing the solar panels, after which the company receives monthly energy payments from its respective customers. These payments tend to be 5%-15% less than your typical energy bill.
SolarCity's business model provides a sizable moat from direct competitors, because it requires extensive short-term investment coupled with long-term commitment. SolarCity's strategy currently hinges on two important factors: 1) Obtaining new customers at a rapid rate, and 2) Reducing the costs of the solar installation and maintenance.
Once SolarCity locks a customer into a long-term contract, which includes monitoring and maintenance services on the solar panels, the company has a relatively steady source of cash flow for the next 20 years. These "nominal contract payments," the estimated future cash flows remaining on SolarCity's existing contracts, have increased from $500 million in 2011 to $1.7 billion so far in 2013.
Young, innovative, and dedicated management
SolarCity's management team is one for the books. The company was cofounded in 2006 by two brothers, Lyndon and Peter Rive, who are 35 and 38 years old, respectively. Lyndon serves as CEO, while Peter serves as COO and CTO. The Rives' cousin happens to be none other than multi-billionaire entrepreneur and technological wiz Elon Musk, who serves as SolarCity's chairman and owns 25% of the company.
Lyndon Rive describes his vision for SolarCity "to be your next energy company" and the "most compelling energy company of the 21st century."
SolarCity is essentially in the process of becoming a national utility business, developing long-term relationships with individual homeowners and businesses. The company currently operates in 14 states on each side of the United States. Bringing on an average of one customer every five minutes, the company has seen its cumulative customer base grow 38.55% to 82,235 customers so far in 2013.
Lyndon Rive intends to have 1 million "rooftop customers" by 2018, more than a tenfold increase from the company's current customer base. Put in other terms: The company has hardly scratched its future potential.
The company's solar installations are financed in two ways: directly through the company's capital expenditures ("investing activities") and through financing arrangements with investing partners and lenders ("financing activities"). For instance, in 2011 Google partnered with SolarCity to create a $280 million fund for SolarCity's residential projects.
Evaluating future prospects
The investing and finance partnerships explained above enable SolarCity to cover the hefty short-term installation costs required by its business model. Ideally, as SolarCity expands, the cash flows from the company's existing contracts will be sufficient to finance the installation costs of new contracts.
SolarCity has managed to produce positive annual cash flow since 2011. Operating cash flow has grown from $60.33 million in 2012 to $182.94 million so far in 2013. However, so far in 2013 SolarCity has invested $507.7 million in solar energy systems (either leased or to be leased), so there is still a ways to go before free cash flow is positive and the company can finance these investments primarily out of its own cash flows.
It is important to remember that SolarCity's contracts do not result in immediate cash on the books. Rather, SolarCity's contracts represent long-term streams of future cash flow, which is already beginning to have a quick and positive impact on the company's cash flow generation.
SolarCity is also making key investments to reduce its installation costs. Just this month SolarCity completed a $158 million acquisition of Zep Solar, a company on the forefront of technology to install and mount solar panels. Zep Solar describes its mission as making "the jobs of solar installers easier, safer, and more profitable-and, in so doing, to provide a major reduction in the cost of solar." Score one for SolarCity.
Foolish bottom line
SolarCity's mission is to make solar energy an accessible, affordable, and convenient energy alternative to individual customers across the United States. The company's rapid growth of new customers demonstrates that more than environmental connoisseurs are taking advantage of solar energy. In the most recent quarter SolarCity deployed a quarterly record of 78 megawatts of energy; residential megawatts deployed increased an astonishing 151% year over year.
SolarCity is making the transition to solar energy worthwhile to many individuals and businesses. Many challenges face SolarCity, including push-back from traditional energy utilities, but I have a high level of confidence in the dedicated management team of this young and rapidly expanding business.
The stock does not look cheap, valued at $4.7 billion. The ingenuity of Elon Musk and the Rive brothers will come with a hefty price tag. Investors without patience and a strong stomach for volatility would be wise to sit on the sidelines. However, as SolarCity takes the lead in transforming the U.S. energy market, I anticipate rich returns over the next ten years and beyond.
