Two years ago Wired identified 10 promising cleantech IPO candidates and today only one, solar microinverter company Enphase, has managed to successfully IPO. It’s been a bleak period for IPOs in the cleantech space with Brightsource pulling its IPO last minute when it became clear that the deal wasn’t going to price well and with nary a whisper these days of a once promising Silver Springs Networks IPO. But with reports that SolarCity will IPO this week or next, we have the first realistic possibility in some time of VCs exiting, a small sign that capital markets may be loosening and that investors may be willing to use their green to invest in green.
SolarCity is a solar installer of commercial and residential rooftop solar systems, but it’s business model is more dependent on finance principles than simple operational strategies related to selling, installing and maintaining solar systems for its customers.
It’s competitive edge centers around being able to waive the considerable up front purchase costs of solar systems in exchange for long term leases or power purchase agreements. Which lands them squarely in the game of financing all those installations and which makes their business model essentially revolve around two core issues:
1) SolarCity’s cost of capital
2) The competitiveness of their electricity pricing
So let’s look at the risks and opportunities on each side of the model:
Cost of capital
1) Tax Equities will Sunset: SolarCity has financed their solar installations by raising $1.57 billion in “tax equity” funds where investors put up cash and in return receive the 30 percent tax credit that the federal government provides for renewable energy projects. Analyst Anthony Kim at Bloomberg New Energy Finance has called this a “ticking clock” since the tax incentive falls to 10 percent at the end of 2016. When the tax incentives decline, SolarCity will have to look for new avenues of financing, which could be more costly.
2) Securitization, anyone?: It’s no secret that Wall Street banks want to securitize lease payments on solar modules and sell them as solar backed securities. In this awful interest rate environment where a 10 year treasury note fetches a scant 1.6 percent return, everyone is hungry for fixed income products that provide better returns at low risk. While there’s an investment hangover from mortgage backed securities, it may actually be easier to walk away from paying your mortgage than living in a house with no electricity because you defaulted on your solar lease payment. Solar backed securities could wind up marketed as low risk, leading to lower capital costs for SolarCity.
Any way you slice it, Solar City is going to have to figure out new financing schemes to keep its cost of capital as low as possible. In order to securitize solar systems, they have to be appraised and depreciated, which has already been somewhat challenging for SolarCity as it’s currently locked in a dispute with the Inspector General surrounding how it valued its systems when applying for the 30 percent tax credit. A negative outcome here would lead to the government seeking cost recovery as well as penalties.
1) Utility rates: SolarCity competes against the rates utilities are charging customers for electricity. In fact, the company makes the case in its S-1 filing that between 2000 and 2010 retail electricity prices increased by 3.4 percent annually. Solar prices are largely fixed and if panel prices continue to spiral downward, SolarCity’s input costs could get even better. Meanwhile, SolarCity can guarantee rate pricing for it’s customers.
The graphic below, taken from the S-1, shows how SolarCity stacks up in its key markets of Arizona, California and Hawaii. The tiers refer to different levels of rate payers in each state as SolarCity goes after each market by targeting the highest tiered rate payers.
2) Two wild cards: The two wild cards in terms of SolarCity’s rate competitiveness are natural gas pricing and installation costs. If natural gas maintains its incredibly cheap pricing, then the market could get more difficult for SolarCity, particularly as it tries to expand beyond states like California which have given SolarCity a big boost by mandating renewable targets. Most utility power generation is moving off coal toward natural gas, and if natural gas stays cheap for an extended period, there’ll be pressure on utilities from public utility commissions to keep rates low.
On the positive side for SolarCity is the potential for reduced red tape and regulation to significantly lower the price of installing a solar system. Germany pays on average just $8,000 for a 4 KW solar system while that same system costs $20,000 here. That’s largely due to much easier permitting and inspecting in Germany. It’s a big if, but if domestic solar installers can convince the government (and utilities) to streamline the process, then solar systems could get extremely competitive very quickly.
SolarCity is far from profitable right now and there’s evidence that its operating expenses and net losses are growing just as its revenue is, which isn’t a great sign. Ideally we’d want to start seeing some economies of scale and a reduced growth rate for net losses and operating expenses as revenue grows.
Part of the reason for this is that SolarCity is reinvesting its revenue as it wants to expand. And if the company can keep capital costs in check and keep moving down its rate pricing, then it has a chance to be profitable one day.