In yesterday’s column, I started raising some red flags about SolarCity’s (SCTY) upcoming IPO.
I kept it general, though, revealing how the broader market trend for cleantech IPOs remains unfavorable. And how, based on my initial review, the company doesn’t boast stellar fundamentals.
But given the buzz surrounding the deal – and all things alternative energy related, for that matter – I’ll concede that my general overview probably won’t deter most investors.
So, as promised, let’s dig into the opportunity in greater detail. And we’ll finish up our analysis on Monday.
When we’re done, I’m certain you’ll share my sentiments about the IPO’s long-term prospects. They’re extremely uncertain, at best.
Lots of Risks, Questionable Rewards
When it comes to investing, more uncertainty equals more risk. And when it comes to SolarCity’s IPO, uncertainty abounds.
That’s not just my opinion, either…
“It’s such a new business model in terms of a company going public that there’s a lot of confusion or lack of knowledge about what SolarCity really is,” says Anthony Kim, a solar analyst at Bloomberg New Energy Finance.
It’s time to eliminate that confusion.
In its simplest form, SolarCity’s business consists of leasing rooftop solar panels for residential, commercial and government use over long periods of time. It then packages the expected cash flows from those leases to raise additional capital from institutional investors, which then funds further expansion.
No doubt, it’s a novel model. But it’s packed with risks, including the following:
~ Risk # 1: Regulators, Mount Up!
The company’s unique setup allows it to avoid regulation as a utility. For now, that is.
I say that because SolarCity plans to develop larger systems for commercial and government customers, which the company admits “has the potential to impact our regulatory position.”
Any such regulation would “materially increase” the company’s operating costs. And as an investor, we know that higher costs lead to lower profits – and, in turn, lower stock prices.
~ Risk # 2: Customers Have No Skin in the Game
Based on the company’s road show, it appears that SolarCity’s leases are like alarm system leases. That is, you keep them forever. Even if you move.
This setup presents some natural problems. What if you move from a house you own to an apartment? The solar system can’t move with you. What if you die before your lease is up?
You get my point.
There’s very little chance that customers will actually stick around for the full 20 years. And since this is such a new offering, there’s no way to estimate the stickiness of customers. So unless you have faith in Wall Street being too conservative, chances are, SolarCity’s management underestimates this impact. So there will be much higher costs associated with contract cancellations.
These aren’t the only problems SolarCity faces when it comes to customers. It also must contend with credit risk.
I know everyone swears that utilities are the most recession-resistant and credit-irrelevant businesses in the world. After all, everyone pays to keep the lights on. But SolarCity isn’t a utility.
Remember, customers put no money down to have a solar power system installed. Afterwards, they’re still connected to the traditional power grid.
So what’s stopping them from stiffing SolarCity? Absolutely nothing. SolarCity might be able to remotely disable the system, but it can’t turn off a customer’s power completely.
Bottom line: SolarCity has no leverage to force customers to honor their contracts. And if customers stop paying, it means that the cash flows intended for institutional investors take a hit.
This is a bad debt problem just waiting to happen.
~ Risk 3: Too Dependent on the Dollar
Virtually no one’s counting on the U.S. dollar to be a bastion of strength. Yet SolarCity’s business requires it.
How so? Well, it buys a significant amount of its solar components from China. So it’s exposed to foreign currency risk.
In turn, it needs the U.S. dollar to hold its ground – or appreciate versus the Chinese yuan – to keep its costs down. I challenge you to find any analyst who expects a strong dollar or weak yuan.
Long story short… SolarCity’s product costs appear destined to increase. And they could really tick higher in a hurry if the United States toughens its import policy on Chinese goods. (Currently, the government charges a 35% tariff on the solar panels that SolarCity buys from China.)
Again, higher costs lead to lower profits and lower stock prices. Not interested!
~ Risk 4: If It’s Broke, SolarCity Pays to Fix It
When you lease a car, any mechanical defects are the responsibility of the dealer. Same goes for SolarCity. Any issues with the company’s systems are ultimately its responsibility.
But we’re not talking about 36-month lease terms here. We’re talking about 20 to 30 years. Big difference.
And solar panels haven’t been installed on a massive scale, so it doesn’t inspire any confidence in the expected maintenance required over that period.
Plus, there are no guarantees that solar manufacturers will be around that long, either, eliminating SolarCity’s ability to push the liability onto them.
~ Risk 5: When The Inevitable Happens, It’ll Hurt
When interest rates go up – and that’s the only direction they’re going to head in the foreseeable future – SolarCity’s financing costs will rise. This will leave the company with two choices:
- It can pass the increase onto customers. That means customers will save less and SolarCity’s systems will be less appealing compared to traditional utilities.
- It can absorb the higher costs, instead. But that means SolarCity will profit less.
Notice a theme, here? Rising costs, declining profits? That’s not a good thing.
I’m sure you’ll agree that neither option bodes well for the long-term investment appeal of the company.
And this isn’t all that’s working against SolarCity. On Monday I’ll share five more risks that are threatening the company’s operations and investment prospects. So stay tuned.