SCTY - Solar City Corporation

[kevin4u2]

You make some interesting points, but their success is tied to making a profit... of which I have no idea how to make that math work.  It has nothing to do with being overvalued but more how to you value it in the first place.  Unless I can see how that works, I fail to see how you can determine a solid valuation based on the numerous assumptions that may or may not work out. 

 

Would this company exist without government subsidies?

 

Beyond that there are so many risks that need to be factored to make this a value investment (IMO).  Perhaps others are more confident in their abilities, I am not.  Here are risks as I see them. 

 

1) Grant application fair market valuations.  Their are questions about the value of the assets on the grant application process.  The company recognizes this a significant risk as there has been questions about inflated valuations of the equipment installed.

2) Net metering and other regulatory risk on the power transmission business.

3) The price of electricity from regulated utilities

4) Import tariffs on solar panels.

5) Access to credit

6) Rising interest rates

7) It's a huge cash sink hole

8) Huge leverage.

 

The government with a stroke of a pen can destroy this business.  Too hard pile.  Secondly, society would be better off if this business didn't exist.  It doesn't provide value, doesn't save the economy on a net basis, and the government is using other peoples money to finance this craziness. 

 

The subprime credit crisis was created by providing cheap credit to fund the purchase of assets that were no where near risk free.  Same thing is happening here.  Where is cheap money causing dislocations in the economy today?  Your looking at it.  Chanos fully understands this. 

 

Chanos is hinging his short thesis on the price of solar going down.  Based on what you are saying that their success is tied to lower prices, Chanos is right but it's going to zero for precisely the wrong reasons?

 

Also, I don't understand the condescension with "value investors" when topics like Solar City or Amazon or whatever.  If it is so egregiously overvalued, then it's a value investment from the other direction.  Which seems to be what you think about Solar City.  There are plenty of topics on things like ZINC or SHLD or other value traps, so should we stop talking about those, or do I only have to turn in my value investing card when I try to understand Solar City or Tesla?  There's plenty of money to be made both ways and there's thousands of other stocks out there. 

 

Perhaps a discussion of Solar City on a value investing board is getting your spidey senses tingling as a clear sign of overvaluation.

[ItsAValueTrap]

although I think utility scale solar is a better approach for solar generally.

 

I think that's one of the biggest risks for Solar City.  Utility scale solar has better economics, is better for the environment, and is better for poor people.

 

The current subsidies for residential solar basically consists of non-solar users subsidizing the solar users.  As residential solar usage increases, electricity rates will have to go up.  At some point, consumers may get really pissed off that their electricity bill is so high.  (This is sort of happening in Hawaii.)  The real problem in Hawaii right now is that the grid can't handle any more solar since the infrastructure wasn't designed for power to flow backwards. 

 

Also, the utilities are trying to push schemes that reduce residential solar subsidies.  Some utilities want to push for utility scale solar over residential solar.

 

Also, the residential solar subsidies are a form of regressive tax.

 

The current trend of residential solar doesn't look sustainable to me.  Then again, it's possible that this silly trend continues.

[johnny]

The Chanos short thesis somehow thinks cheaper solar costs over time will make customers want to default. It just makes my brain numb thinking how that's possible when that's the whole reason the company has been successful in the first place. Continued price drops make the value proposition better not worse.

 

I don't know much about Chanos' thesis (and I'm not sure I would agree, even if my guess is correct), but the logic of this sounds pretty straightforward to me:

 

If the efficiency of panels increases significantly while the costs continues to decline, then it is quite possible that a new, from-scratch system in 2025 would generate substantially more energy than your 2015 vintage system does. And it is quite possible that that 2025 system may cost substantially less than your 2015 installation did; in fact, imagine if the total 2025-era system cost is less than the NPV of your remaining PPA obligations (or principal on your loan, or whatever else the financing arrangement might be)

 

Since there is no plausible collateral (the panels are by then nearly-worthless, repossessing them is impractical, and the rest of the system cost is not recoverable), this should make the note somewhat questionable, right?

 

Basically, you're lending money to people that are buying an asset that, almost everybody seems to agree, is going to depreciate many times faster than the principal will get paid down (or the NPV of the PPA reduced, or whatever)

 

That said, the fact that these things are on peoples' rooves, etc. and part of their "house" may make the loans perform better than a strict economic analysis would indicate (kinda like mortgages). Even if the economics of "recovering" the panels make no sense, I can imagine using the theater of panel repossession as a method to shame defaulters and try to keep loans performing under marginal economics. But that's a much different actual business than "solar panel installer".

 

 

[Picasso]

Johnny, that's been the case for the entirety of Solar City's history. Older units are now overpriced compared to the 2015 panels and so they're technically underwater. But we haven't seen default rates go up to indicate this is a problem. So it's confusing to me why Chanos thinks that will suddenly change.

 

His thesis is essentially viewing Solar City as a subprime lender trading at prime risks. Stopping payments raises your electric bills so I don't know how that makes sense. There's no benefit I could think of to do that, unless there is something I am missing.

 

There are other reasons to dislike Solar City, I just didn't think that was one of them.  if that's true then both rising and falling prices for panels are bad for Solar City. Is that logical?  I think a lot of that is determined by how people view the company. If you dislike the industry you might think that way, if you think this is the Dell of utility companies then you might view lower costs as a positive.

 

The battery pack that Tesla has created for home use is supposed to bridge the gap that solves some of the negative solar economics. Some of this is for non solar use as well, such as managing peak loads which is supposed to reduce the level of demand on the grid. It remains to be seen if that takes off as something for mass adoption, but unlikely at this point without expensive installations of inverters.

[johnny]

Well do we actually know that those old systems are uneconomic? I should expect them to be, but what sort of visibility is there? I know that in LA at least there were all sorts of bizarre local subsidies in place in prior years. I have no clue how much the gradual elimination of those subsidies has minimized the net-cost change over the period.

 

But assuming that those subsidies weren't significant, and that those prior installations were substantially more expensive per-watt, then we have a separate issue: that would suggest buyers of that era weren't buying for economic reasons to begin with. In other words, the product being sold in 2010 wasn't an energy system, but more of a virtue-signaling status symbol that happened to produce some DC as a byproduct. That would make the vintage perform well, but generalize poorly.

 

It sure seems to me that current PV leads are interested for mostly economic reasons, and as such I don't think it is unreasonable to expect that they may respond more strongly to unexpected changes in the economics of the deal. Though as I said before, they could also lag for emotional reasons.

 

Also, since the module prices have tanked mostly in the past 5 years, we also have to consider that we've had a relatively charmed economy for the life of many of those loans. I don't think we can ultimately speak with total confidence about any PV borrower generation until we have at least one crunch under our belt.

 

That said, I really should look into what he's said in the matter (and maybe glance at SolarCity's 10k) before I clog up this thread with any more of my hip-shot guesses.

 

Right after this one.

 

if that's true then both rising and falling prices for panels are bad for Solar City. Is that logical?

 

It depends if you're talking about the business of lending or the business of installing. Falling module prices is just another way of saying "rapid depreciation" which is generally never going to be a good thing for an asset you are making super long-term loans against.

 

But obviously falling total cost should be good for volumes, which benefits the installation business, and certainly makes the lending operation grow.

 

The real issue, which has already been brought up, is that the cost advantages of utility scale do not disappear when module prices decrease. In fact, since the price of panels (and probably the inversion) is probably the closest thing to a linear cost item at the utility level, then doesn't that mean that declining panel prices make the utility-scale economic advantage even more decisive? It just isn't clear to me how rooftop solar wins, unless the utilities bungle the politics so bad that they end up having to deal with FIT forever.

 

And as for the Tesla Powerall: as far as I can tell, the Powerall if anything makes it clear that the apparent attractiveness of residential solar is still something of an illusion. It gives you a figure with which to estimate how much it would cost to take a house "off-the-grid" while maintaining a conventional American life. And those costs don't pencil out.

 

Eventually batteries, we hope, will get cheap enough to change this. But of course, as they do, they will also change the utility economics as well, and ultimately it seems like the same argument would apply: the installation, maintenance, optimization of discharge, etc. will be way more economic at scales above "household" and it is hard to imagine how that changes.

 

Then again, Elon seems to be putting a lot of time into this distributed energy concept. So there must be something big I'm missing.

[Liberty]

People never got that mad about fossil fuel subsidies - not enough for much to change - and they add up to trillions of dollars (directly and indirectly, such as military expenditure to keep protect oil flows) over time. By the time solar subsidies are gone, solar will be cheap enough and the grid will be upgraded (storage getting cheaper everyday, some European countries already showing that massive quantities of wind and solar can be used). I wouldn't want to be swimming upstream against a Swanson's Law.

 

https://en.m.wikipedia.org/wiki/Swanson%27s_law

[johnny]

Agree with you completely Liberty, but I think it is important to note that in this context of extensive fossil fuel subsidization, we still ended up with a well developed grid, and centralized production, rather than havin a line of diesel generators in every garage.

 

When I look at how utility solar PPAs have been trending over time, I continue to just not really "get" the societal logic beyond distributed solar generation (in the first world, at least). The cost curve on the utility side is just mind-blowing.

 

Wholesale PPA pricing from solar projects has basically halved over the past 4 years. Has the same been true of residential solar installations? It seems to me that a utility-scale system, where ~50% of the total cost is Swanson-law eligible, is going to continue to extend its price competitiveness lead over residential generation, where those costs are more like a quarter of the total system cost.

 

I just don't get what the counter-argument here is. Is it simply the implicit assumption that FIT, etc. will be available forever for political reasons? Or is there something else that I'm missing that would explain why mini power plants that generate electricity at 3-4x the cost of utility generation have a permanent place in the first world?

[ERICOPOLY]

There are a couple of reasons why residential solar makes great financial sense to the person making the decisions -- the consumer with the rooftop:

 

Reason #1)

Remember that residential systems generate imputed tax-free income.  A residential solar installation owner with a 50% tax rate is no worse off even if the utility-scale system could generate power at 1/2 the cost. 

 

The way to normalize this issue would be to make electric utility bills tax deductible, but I don't think that will happen.

 

 

Reason #2)

The other thing is that with time of use metering, the solar generated is (for Southern California Edison users) crediting the utility bill with more than 40 cents per kWh during the daily peak pricing period.

 

 

Enough said.  It's better "home economics" than utility scale solar.

 

 

 

 

 

 

[Liberty]

Good points Eric.

 

Could it also be as simple as the fact that rooftop solar is something that people can actually do, while they have no impact on utility solar?

 

By that I mean that if the grid was already 100% utility solar, I doubt that people would put solar panels on their rooftops. But since right now the grid is mostly fossil fuels, those who want to get away from that see putting panels on their roofs as a way to change that, and since it actually costs them less than what they're paying their utility now, there's no downside even if there would potentially exist an even better opportunity if they somehow could invest in a utility solar installation.

[Pelagic]

Good points Eric.

 

Could it also be as simple as the fact that rooftop solar is something that people can actually do, while they have no impact on utility solar?

 

By that I mean that if the grid was already 100% utility solar, I doubt that people would put solar panels on their rooftops. But since right now the grid is mostly fossil fuels, those who want to get away from that see putting panels on their roofs as a way to change that, and since it actually costs them less than what they're paying their utility now, there's no downside even if there would potentially exist an even better opportunity if they somehow could invest in a utility solar installation.

 

Perhaps there's a new market for utility scale solar selling ownership stakes to individuals. There is probably a meaningful amount of people who for one reason or another can't have solar on their own roof yet still pay a utility bill and would like the benefits solar provides. Keeping the same tax incentives for installing solar panels at a utility site as are currently available for rooftop installation would likely shift demand away from rooftop solar and toward utility scale while still allowing the consumer to directly own solar generation.

[awindenberger]

There are a couple of reasons why residential solar makes great financial sense to the person making the decisions -- the consumer with the rooftop:

 

Reason #1)

Remember that residential systems generate imputed tax-free income.  A residential solar installation owner with a 50% tax rate is no worse off even if the utility-scale system could generate power at 1/2 the cost. 

 

The way to normalize this issue would be to make electric utility bills tax deductible, but I don't think that will happen.

 

 

Reason #2)

The other thing is that with time of use metering, the solar generated is (for Southern California Edison users) crediting the utility bill with more than 40 cents per kWh during the daily peak pricing period.

 

 

Enough said.  It's better "home economics" than utility scale solar.

 

Regarding point #2, I think that within a few years we will see peak pricing shift due to the amount of solar power that will be generated during the day in California. Utilities will want to drastically drop the pricing in order to encourage more use during daylight hours.

[johnny]

There are a couple of reasons why residential solar makes great financial sense to the person making the decisions -- the consumer with the rooftop:

 

Reason #1)

Remember that residential systems generate imputed tax-free income.  A residential solar installation owner with a 50% tax rate is no worse off even if the utility-scale system could generate power at 1/2 the cost. 

 

The way to normalize this issue would be to make electric utility bills tax deductible, but I don't think that will happen.

 

 

Reason #2)

The other thing is that with time of use metering, the solar generated is (for Southern California Edison users) crediting the utility bill with more than 40 cents per kWh during the daily peak pricing period.

 

 

Enough said.  It's better "home economics" than utility scale solar.

 

On 1, that is a great point that I feel silly for not considering. Ultimately I do not think the effect eclipses the huge efficiency gap between residential and utility, but it certainly counts for something.

 

On 2, you're helping me surface my primary question. Why on Earth is your utility buying your kWhs at 40 cents, when they could be buying it from a farm at 4 cents? How distorted must the policies and regulations in place be to produce such an effect, and how prudent is it to invest on the thesis that those distortions are going to remain in place indefinitely?

[ERICOPOLY]

There are a couple of reasons why residential solar makes great financial sense to the person making the decisions -- the consumer with the rooftop:

 

Reason #1)

Remember that residential systems generate imputed tax-free income.  A residential solar installation owner with a 50% tax rate is no worse off even if the utility-scale system could generate power at 1/2 the cost. 

 

The way to normalize this issue would be to make electric utility bills tax deductible, but I don't think that will happen.

 

 

Reason #2)

The other thing is that with time of use metering, the solar generated is (for Southern California Edison users) crediting the utility bill with more than 40 cents per kWh during the daily peak pricing period.

 

 

Enough said.  It's better "home economics" than utility scale solar.

 

On 1, that is a great point that I feel silly for not considering. Ultimately I do not think the effect eclipses the huge efficiency gap between residential and utility, but it certainly counts for something.

 

On 2, you're helping me surface my primary question. Why on Earth is your utility buying your kWhs at 40 cents, when they could be buying it from a farm at 4 cents? How distorted must the policies and regulations in place be to produce such an effect, and how prudent is it to invest on the thesis that those distortions are going to remain in place indefinitely?

 

 

Regarding your question on #2:

 

Why on Earth is my utility charging me 40 cents per kWh if they are only paying 4 cents for it?

 

I think these policies help to keep them honest -- if they don't like paying me 40 cents per kWh, perhaps they'll take into consideration the fact that I don't like paying them 40 cents per kWh either.

 

They can lower their rate if they want to pay me less -- the ball is in their court.

[Guest longinvestor]

https://www.nvenergy.com/renewablesenvironment/renewables/greenenergy/

 

For those who want to buy renewables without installing their own rooftops. The rate difference between normal energy sources choice versus 100% renewable is $89 versus $121 per month; Delta of $32 per month = $384 per year = $3840 for a decade = $ 7680 for 20 years.

 

Makes a lot of $$ sense to avoid installing rooftop solar and buy it from the utility. Lots of people are doing this, my brother does this in TX. I also don't like to take on the job of climbing onto my roof to keep the panels clean or worry about hail, windstorm damages etc.

[awindenberger]

https://www.nvenergy.com/renewablesenvironment/renewables/greenenergy/

 

For those who want to buy renewables without installing their own rooftops. The rate difference between normal energy sources choice versus 100% renewable is $89 versus $121 per month; Delta of $32 per month = $384 per year = $3840 for a decade = $ 7680 for 20 years.

 

Makes a lot of $$ sense to avoid installing rooftop solar and buy it from the utility. Lots of people are doing this, my brother does this in TX. I also don't like to take on the job of climbing onto my roof to keep the panels clean or worry about hail, windstorm damages etc.

 

Its terrible deals like this that make people really excited to sign up with Solar City. Instead of paying more for using renewable energy, Solar City will let you pay less (at least in the short term). Of course you are locked into a contract that likely will be overpriced in 10yrs, but most people only look at the short term.

[Liberty]

http://www.bloomberg.com/news/articles/2015-10-06/solar-wind-reach-a-big-renewables-turning-point-bnef

 

Interesting piece about how wind and solar can affect the capacity factor of fossil fuels and thus make them comparatively more expensive.

[Guest longinvestor]

http://www.bloomberg.com/news/articles/2015-10-06/solar-wind-reach-a-big-renewables-turning-point-bnef

 

Interesting piece about how wind and solar can affect the capacity factor of fossil fuels and thus make them comparatively more expensive.

BHE's strategy of owning an entire contiguous  region(WA, Alberta, OR, UT, CA, NV,AZ..) including the transmission assets within will reap the full benefit of this load factor with diversity of energy sources. Their participation in the CaISo, the energy imbalance broker for the Western region will make it a very competitive player.

[benhacker]

released 4th quarter earnings.

 

~$700m loss for 2015.

 

debt has YTM of 16% now.

 

Company still measures their forecasted value creation metric using a 6% discount rate, pre-tax.

 

I don't get it, but I might be too old school.

[TorontoRaptorsFan]

I'm so grateful I got out at $52 per share when it had that quick run-up with legislation in California favoring it.

 

 

[johnny]

The chart for this stock is insane and I wouldn't be surprised if, despite having no fundamental connection, SCTY vol is directly contributing to the changing sentiment on Tesla.

[benhacker]

I think there are a lot of psychological and money flow similarities between TSLA and SCTY that certainly will effect them similarly on a short term basis in terms of market price....  But I think TSLA is fundamentally sound, and SCTY is not so any short term over correlation is probably a potential opportunity... relatively speaking.

 

SCTY bonds now trading >20% YTM.

 

I don't see how a business with these financial characteristics and this debt pricing has a $2B equity cap.

 

Picasso, is there a price at which this debt would interest you (I know you follow Tesla, figure you have some opinion on SCTY)?  Think a pair trade makes sense?  I'm still naked short after adding pretty heavily on the slide down... but now looking for my exit...

[Picasso]

Musk invested in a business of the Rive's before 2008 hit.  When that business was sold in 2008 and Musk received his share, it was a nice size windfall that 100% saved Tesla and SpaceX.  His companies would have failed without the success of his cousins.  On that alone, I don't think you'll see SCTY hit $0.  I'd like to think that Musk would get involved and help resolve any SCTY capital issues as long as there aren't the kind of defaults that guys like Chanos are expecting.  Not even Musk could resolve that.  But Tesla is going to be dependent on SCTY being a viable business since their energy business is paired up in the big way with SCTY. 

 

SCTY convertibles trade at near 20% yields but that's mostly because the coupon rate is so low (1 5/8th's).  The rest of the capital structure is still fairly normal (between 3-8%) so I don't really see the kind of distress one could imply by looking at the convertible yields.  I'd have to go into the market and see how many convertibles you can really buy at those prices but that looks quite interesting to me.  In general I don't really like the economics of SCTY but I don't think that debt will get impaired.  I wasn't tracking them so thanks for bringing them up. 

 

I could see both sides of a short SCTY and long the convertibles work out well.  A move from $50 to $75 on the convertibles and a move back below the IPO price on SCTY seems entirely possible.  But they seem like two entirely different trades, not really hedging to short one and long the other.  They might converge in the long-term but short-term will do the complete opposite of what one could expect.

[benhacker]

Thanks for your thoughts Picasso.

 

I'm curious if you dig more, what you see.  I'm not seeing anything in the capital structure at 3-8%.  I'm seeing a bunch of stale debt pricing and/or ABS that hasn't been traded in several months or more.  Everything that's active has been obliterated.

 

Low coupon or not, 20% YTM isn't an aberration, at least I don't think...  >>$1m face has traded above 15% in the last few days... and nothing is trading below that, at least looking at TRACE.  These convert issues trading (1.x% and 2.x% issues due in a couple of years) are the big daddies of the capital structure... so I think they are the rule, not the exception for pricing.

 

Appreciate anything you see and share in advance.

 

Cheers,

[Picasso]

There have been solar bonds issued as recently as January with 3.5% yields but you're right nothing outside of ABN.  At the time of the last 3.5% solar bond, convertibles were still yielding around 12%.  But they are obviously dwarfed in size by the convertibles.

 

Low coupon convertibles just trade funny.  I mean if you think about it, SCTY issued $566 million of the 2019 notes at a 1.625% yield with an 83.53 conversion price.  Was SCTY really going to go above that conversion price?  They were able to get a stupid low rate when investors wanted upside on the stock.  The reason I say it's kind of hard to place their cost of capital at the convertible yield is because if you buy those convertibles at $55 (and I'm sure you know this, but in case others don't), your actual cash yield is only 2.9%.  You have to accrue like a zero coupon bond and it's kind of tricky because the yield to maturity blows out even though the cash yield doesn't change by very much.  So even at the current bond pricing, SCTY could issue new convertible bonds (when these come due or if the market has the appetite) but with a 2.9% coupon and some conversion price (say $20) and they would probably trade for par if SCTY is still trading around these levels. 

 

An example of this might be the SunEdison capital structure.  They have some 2% 2018 convertibles @ $15 strike.  Those trade for $24 and a 67% yield.  Then they have some 5% 2018 convertibles @ $7.5 strike.  Those trade for $74 and a 18% yield.  The lower yielding are secured versus the others at senior unsecured (the convertibles at $24 have a slightly higher cash yield), but the SUNE capital structure is so screwed up that I don't think it plays that wide of a difference.  Or maybe it does, but I see plenty of other examples (WAC comes to mind) where they tap unsecured convertibles when the market lets them, then move into more secured lower cost lending which explains the move lower in SCTY's convertibles.  It's likely you'll see higher cost secured lending (anything is higher cost than 1.625%) and it's going to hurt the credit position of those convertible bond holders given how aggressive SCTY is with their expansion.  But I don't really view that current convertible yield as their true cost of capital.  We won't know until they start issuing less bubbly type of debt.

 

tldr; high yields on convertibles because of low coupons, market knows they'll get pushed out by new secured lending, more credit risk = busted convertible but YTM not equal to debt cost of capital

[awindenberger]

Its amazing to see what kind of junk the market is willing to accept when its euphoric, and how high the yields get when its in the dumps.