From other companies in the industry we know that the installation of solar systems is brutally competitive. A quick look at RSOL’s financials gives you a good idea: they lost $4M on $21M of revenues in Q2 2012 and currently have a market cap of $15M which is well below book value. Basically, the market is assuming the company will stay unprofitable and any value left will go towards debt holders.
So how can Solarcity avoid getting thrown into the same pot? They will be pointing towards their fully integrated business model, their strong brand and the recurring cash-flows from their residential solar leases. In this post I will focus on what I think is the most interesting of the three: the profitability of their residential lease product. Especially when considering that Solarcity has often been selling cash-purchase solar systems at negative gross margins over the last few years. Great for customers, crummy for investors.
But since most of Solarcity’s business is coming from solar leasing, understanding the economics of those leases is crucial. Here is a key disclosure made in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations”:
Solarcity’s revenues are recognized over the term of the lease (usually 20 years) whereas the main capital costs are depreciated over the useful life of 30 years. Customers have different choices at the end of the 20 year lease agreement (including having the system removed from their homes) and there is no data on what will actually happen (the first leases will expire in 2027). Depending on which option the average customer chooses, GAAP might produce inflated gross profit margins on these leases. The effect could be significant: if all costs were to be recognized over 20 years, Solarcity's gross margins could be 30-50% lower.
Unfortunately, that still doesn’t paint the full picture of the profitability of Solarcity’s leases. The consolidated financial statements create a complex web that is very difficult to untangle. They leave us guessing how the economic rent is divided between the third-party fund investors and Solarcity. Without knowing the economics (NPV, IRR, etc) of one lease unit or one investment fund, it’s unclear whether Solarcity is currently widely unprofitable because it’s investing in future profitability or whether it’s just generating unprofitable business. It will be fascinating to see how public investors will receive the stock. It will largely depend on whether they will buy into the company's growth story and whether they can get comfortable with the accounting and profitability of Solarcity's leases.