SolarCity Corp: Sun-Dazed Investors Get Burned

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For many investors, SolarCity Corp (NSDQ: SCTY) has become the face of solar power in the US—a testament to CEO Elon Musk’s considerable talents as a pitchman.

But a charismatic leader and a business model that threatens to disrupt the utility industry can’t paper over the company’s dismal financial results.

Most of SolarCity’s fans probably haven’t taken the time to wade through the firm’s most recent annual report, filed with the Securities and Exchange Commission (SEC) on Feb. 24, 2015. After all, who wants numbers to get in the way of a good story?

Although SolarCity has delivered impressive revenue growth for a company seeking to build a business and establish a new industry, the firm remains spectacularly unprofitable, losing more money with each sale.

SolarCity’s operating loss as a percentage of revenue came in at 71.7 percent in 2012; that is, the company spent $1.72 for every $1 of revenue, before interest expense and other non-operating items. This figure climbed to $1.91 in 2013 and $2.39 in 2014. In other words, SolarCity spent 40 percent more than it did in 2012 to generate $1 in revenue.

Marketing and administrative expenses have ballooned at a much faster rate than sales. Last year, the company’s marketing expenditures consumed 93.6 percent of every $1 in revenue, up from 54.7 percent in 2012. Administrative expenses likewise jumped to 60.6 percent of revenue in 2014 from 38.7 percent.

A company that consumes more cash than it brings in must raise money from third parties to keep the ship afloat. CEO Elon Musk has excelled in this capacity at SolarCity and Tesla Motors (NSDQ: TSLA), another company that runs primarily on hype and outside funding. (See Tesla Motors: The Car is Electric, The Stock is Not, Part I and Part II.)

But unlike successful start-ups that progress toward sustainability and gradually wean themselves off outside capital, SolarCity’s appetite has become more voracious as its revenue has grown.

In 2014, the company’s operating cash flow came in at negative $217.9 million—and that number excludes the more than $1.16 billion in payments for the solar-power systems that the firm leases to customers.

How has SolarCity made up this shortfall? Only a forensic accountant could tell you for sure. But the largest funding items in the company’s statement of cash flows include:

• “borrowings under long-term debt” ($337 million);
• “proceeds from the issuance of solar asset-backed notes” ($263 million);
• and “proceeds from investment by non-controlling interests and redeemable non-controlling interests in subsidiaries” ($778 million).

The money obtained from these three sources has increased significantly over the past three years, with conventional borrowings growing by 144 percent and investments by non-controlling interests quintupling. As for securitization of the company’s existing leases, cash from this activity has quintupled since 2013.

Will SolarCity be able to tap these liquidity sources for even more cash in 2014 and beyond? If not, the company will fall apart in a hurry. And with the stock trading at 18.5 times sales, it’s no wonder that bets against the company hover around 32 percent of its float.

There are better plays on solar power—and these companies actually turn a profit.

NRG Energy (NYSE: NRG), for example, continues to ramp up its rooftop solar business and expects to lease 35,000 to 45,000 systems by the end of 2015. The firm also has utility-scale solar-power installations in the works. And NRG Energy’s 2.8 million customer relationships in its unregulated power markets, gives the firm a huge advantage on marketing, administration and installation costs.

Even regulated utilities have entered the game, investing in larger solar-power projects to build their rate base and rolling out residential rooftop systems to develop a new sales channel.

Dominion Resources (NYSE: D), Duke Energy Corp (NYSE: DUK), El Paso Electric (NYSE: EE), Pinnacle West Capital Corp (NYSE: PNW), PNM Resources (NYSE: PNM), Southern Company (NYSE: SO) and Xcel Energy (NYSE: XEL) have all pursued this strategy.

Unlike SolarCity and other incumbent rooftop installers, these utilities can afford to pursue rooftop solar as a sideline while they continue to grow their rate base and earnings by building large-scale power plants.

Not only do these stodgy utilities boast superior economics to SolarCity, but also these firms have existed for decades and will be around for the long haul to support their contracts.

As for the equipment side of the business, last week’s installment of Income Insights highlighted a growing challenge: a surplus of capacity that exceeds power producers’ demand for new solar farms. (See First Solar and SunPower’s Yieldco: Building Value or Cashing Out?)

Bottom Line: The disruptive business model of distributed rooftop solar power has emerged as a growth engine for established utilities—not the nail in their coffin that some fear-mongering pundits have envisioned.

We’re working on a special report on the winners and losers in renewable energy that will be available exclusively for Conrad’s Utility Investor subscribers.

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