Image: SunPower.
Renewable energy presents a very tempting multi-trillion dollar opportunity for investors, but that opportunity has brought out a lot of the worst practices of Wall Street. Financial engineering has become commonplace, as companies like SunEdison (SUNEQ), SolarCity (SCTY.DL), and Vivint Solar (VSLR) tried to convince investors they had value despite reporting losses quarter after quarter. It's become common to create new value metrics like retained value or economic value added because GAAP accounting measures don't paint a very positive picture of these companies.
This strategy of defining your own value creation metrics works as long as the market believes it, but in the last nine months the market has questioned everything from the discount rates companies use to calculate value to the reliability of counterparties. When that happened, the house of cards some renewable energy companies were built on collapsed.
Why the renewable energy model has fallen apart
The core problem in renewable energy is that most companies can't afford to build and own the systems they develop long-term. They're constantly in need of new sources of funding, whether it's from tax equity partners, debt markets, or equity markets.
Instead of building and selling projects, companies like SunEdison, SolarCity, and Vivint Solar have decided they can keep the most value if they own the assets they build. Long-term, that's probably true -- but that requires billions of dollars in financing. These companies are constantly going to investors with new needs for tax equity and securitized debt offerings. When the well runs dry, the business model collapses quickly (see SunEdison).
Just look at SolarCity's own financing presentation from its recently reported earnings. Management has been able to finance $2.73 per watt installed, which is actually more than its $2.71 per watt installation cost. The company is presenting this information as a way to show that it's generating cash from each installation it completes.
Source: SolarCity earnings presentation.
But look closely at what that financing requires. A tax equity investor is needed, rebates and prepayments have to be in place, debt is needed from aggregation facilities, and asset-backed securities can be used to generate value from any cash flow left. If the machine is working the model should create a lot of value for shareholders. But what happens when the machine breaks?
SolarCity plans to install 1.25 GW of solar in 2016, and if it maintains costs of $2.71 per watt that means $3.4 billion of financing will be needed in the next twelve months alone. That's not a hole SolarCity can fill if financing markets freeze.
Built to last in renewable energy
Without a balance sheet the size of a big oil company, or maybe a small country, no renewable energy company could survive without access to financing. But companies can mitigate their risks if they manage their balance sheets carefully and have enough financing options.
One necessity is multiple options for financing renewable projects once they're built. A company could hold them on the balance sheet, sell the tax equity portion, sell a majority stake, sell the entire project, drop it down to a yieldco, or use a combination of any of those options. SunEdison, SolarCity, and Vivint Solar either don't have all of those options available to them or have chosen not to develop these options.
On the other hand, SunPower (SPWR 7.34%) and First Solar (FSLR 6.12%) have a joint yieldco, have been selling all or part of projects for years, and have the ability to build projects on the balance sheet. You can see the strong cash balance below, which allows for flexibility selling project to buyers for the right price on their timeframe.
SPWR Cash and Equivalents (Quarterly) data by YCharts
Net income from SunPower and First Solar means that even on a GAAP basis we know the companies are adding value. No need to make up their own value metrics to prove that.
This isn't to say that SunPower and First Solar are without risk. Rather, they have less risk because of their diverse business models and strong balance sheets. When you're reliant on project financing to survive, leverage is the enemy, and they've done a good job staying away from large debt loads.
Is your renewable energy stock built to last?
It's often more exciting to invest in renewable energy companies that can use financial engineering to drive rapid growth, but that's proven to be a better way to lose money in renewable energy rather than make money. It's easier to make money betting on companies that can slowly build projects and sell them for a profit or own them long-term.
You won't see companies like SunPower or First Solar doubling installations every year, but they'll be around a decade from now, something we can't necessarily say about all other renewable energy companies.
