SolarCity (NASDAQ:SCTY.DL) has recorded some of the most remarkable gains among its peers on the stock market ever since going public in late 2012. Its stock has gained over 440% since going public. This has largely been driven by its attractive business model, which has allowed it to grow its customer base at a feverish pace. Unlike other installers who require customers to make upfront cash payments, SolarCity foots all the installation costs upfront and then leases the solar system back to the home or business on whose roof it sits. This results in a win-win situation in that SolarCity gets a long-term stream of periodic payments and the home or business owner saves up on their monthly electric bill by as much as 15%, as argued by fellow Fool Reuben Brewer.
Agreeably, SolarCity's model is not only exceedingly attractive to bargain-hunting customers, but also hard for competitors to match, explaining why SolarCity commanded a leading 26% of the U.S. residential solar photovoltaic market as at April compared with the 8% that its closest competitor, Vivint Solar, commanded. This is according to data from GTM Research. Comparatively, SolarCity had a market share of 12% in 2012, signaling the tremendous growth that its unique model has inspired. The renewable energy bigwig further expects to achieve 1 million customers, or a 70% compounded annual growth rate, by 2018 on the back of its compelling business model.
While these numbers are certainly tantalizing, one can't help but wonder where SolarCity gets the capital to meet hefty upfront installation costs for all its customers. Not only is SolarCity still deep in the red, but the collective annuities paid by existing customers cannot sufficiently support the kind of investment needed to attain the scale it targets.
Off-balance sheet financing
Deep-pocketed off-balance sheet investors, including Google and US Bancorp, have over the years been injecting capital into off-balance-sheet funds that they set up with SolarCity. Under such agreements, the investors put in the lion's share of the cash in a fund in which SolarCity also has a small stake. SolarCity uses the cash from the fund to install solar systems for customers. Once SolarCity has secured a long-term lease and a power purchase agreement from a customer, the solar assets are transferred to the balance sheet of the investment funds -- the ones majorly owned by said deep-pocketed investors.
When the owners of the funds, such as Google and US Bancorp, own solar assets, they make revenue at two key points. First, they receive periodic cash inflows from customers who have leased the SolarCity systems. Second, they enjoy a raft of government incentives, including grants and tax breaks of up to 30% that the government pays to owners of solar assets; this, in investment parlance, is known as solar tax equity investing.
At the end of it, the key providers of capital get something, and SolarCity accesses sizable off-balance sheet financing to support its cash-hungry business model.
Share price appreciation not an option
While the agreement that SolarCity has with its off-balance sheet financiers screams of financial innovation, it has one downside -- how does SolarCity eventually revert the fund's solar assets back to its balance sheet?
A typical tax equity investor -- the providers of off-balance sheet financing -- owns 90-99% of the solar assets for five or so years and then exits. Thereafter, the project developer (which is SolarCity in this discussion) can buy out the tax equity investors' stake in the solar assets. This allows it to fully realize the annuities paid by customers who lease its systems, as well as enjoy the tax benefits of owning solar assets, effectively expediting the process of becoming profitable.
But it is not as simple as it sounds. Despite receiving tax credits and periodic income, the amounts thereof don't usually cover the initial investment that tax equity investors make in the off-balance sheet fund. Accordingly, these investors typically demand a premium over and above their initial investment, besides the annuities and tax credits they have already received, in exchange for their stake in a developer's solar assets. While SolarCity is inclined to reacquire the solar assets, it doesn't have sufficient cash flow or profit to pay this premium. This means that its only source of capital for such an undertaking is equity, as debt compels it to own sizable assets as prerequisite, which it doesn't as of yet.
Share price appreciation is thereby not an option, but mandatory, as it is the only way that SolarCity can draw more capital per unit share on the stock market in order to successfully repossess its solar assets and reach profitability faster.
Share price appreciation is SolarCity's only play (as shown over the past years), and will continue to be, at least until after five years or so when it has built sufficient capital surplus (the amount it raises in excess of the par value) to comfortably reacquire its solar assets from tax equity investors.
Consequently, there is still some strong growth ahead for long-term growth investors as the company will continue modeling itself as a pure growth play in order to drive its share price upward.