Source: SolarCity.
SolarCity is essentially two companies in one, with the development company and the power company. -- Lyndon Rive, SolarCity CEO
With one sentence, SolarCity's (SCTY +0.00%) CEO Lyndon Rive may have made the best case there is to split the company in two. SolarCity is a development company whose value is either being masked or enhanced by the power company, and having two companies would allow SolarCity to be a far more transparent company.
The case for two SolarCitys
The way SolarCity is currently constructed, it has a sales and installation unit whose goal is constantly increase sales and lower costs for building solar systems, and it has a power-generating unit that collects contracted payments from customers, finances systems, and does any necessary maintenance the systems need. But the big reason a split would make sense is how the company funds itself.
From a financing perspective, SolarCity itself finances the installation of projects from the point of a sale until the system is up and running. It then sells them to tax equity investors, who collect tax benefits, and eventually takes control of the system again once tax benefits are exhausted. Once the system is generating revenue, the systems would be in the "power company" as Rive calls it.
The problem for investors is that we don't know how much value the installation company is generating at the current cost structure, and it's very opaque what risks the financing side of the business is taking. If systems were sold to a separate company once they're completed, would it be a high-margin business, or would it produce very low margins, like other construction businesses?
SolarCity gives us projections about value creation in retained value or payments under contract, but investors are left guessing at what value the installation and financing arms are really creating.
A SolarCity commercial solar installation. Source: SolarCity.
A more transparent contractor
The "development company" is really nothing more than a contract installer. In that way, it's competing against Vivint Solar (VSLR +0.00%), SunPower (SPWR +0.00%), and dozens of others based on price alone. If SolarCity has the lowest cost, it would be able to sell to its power company and generate a higher margin than competitors. If it doesn't, the sales price to the power company would indicate that.
Being separated from the power company would also set the company up for a future that will likely be more competitive. If the investment tax credit (ITC) expires as planned in 2017, it will mean installers will have to compete more on price on installations, with financing going to companies specializing in loans, like banks.
A split with the financing arm could allow SolarCity's sales and installation arm to prove it's highly valuable no matter what the financing arm looks like. Right now, I'm not sure whether the development unit would be profitable as a stand-alone company or not.
SolarCity is really a bank acting like a solar company
If you look at SolarCity's financials, you'll see that it's losing money each quarter because it's not selling systems, and most of its revenue is from long-term contracted payments under leases or power purchase agreements. It even launched a loan product last year that could soon finance a majority of its installations. In essence, SolarCity is more like a bank than a solar contractor.
If SolarCity reported contracts and contract performance more like a bank or REIT, or even a YieldCo does, it would make the company's finances more transparent and even provide cash flows to investors through dividends. We could see what value the installation side is creating and, based on contract performance, judge the value of long-term financing.
I'm not sure if SolarCity's power company's value would be higher as a separate company, but the company would be more focused and could even bid on utility- and commercial-scale projects, much like independent yieldcos can today. In the name of transparency, I think SolarCity would be better off having the power company as a separate entity.
Two companies in one
In many ways, SolarCity is two separate companies operating as one, and that confuses the way investors can look at the company. As two entities, it could show its value both as a project installer and a system owner, in much the way SunEdison, SunPower, and First Solar are (once the SunPower/First Solar yieldco is launched).
I don't think management will split SolarCity in two anytime soon, but I think it makes a lot of sense given the benefits and risks of each business. But transparency might not be as important to management as it should be to investors.
