SolarCity has defied skeptics so far and is now entering the crucible of the IPO roadshow process. Our first impressions and a look at the industry and their competition should help us get started. The deal is likely to appeal to investors liking a “big story” with good management and strong momentum. The big question in my mind is why equity investors would do so without a divident or at least a policy of having one. Management asserts that this is a “DCF story” but it’s hard to take that to the bank unless you are a bond holder.

Deal Facts

Underwriters: Goldman, Credit Suisse, BofA
Co-Managers: Needham, Roth
Symbol: SCTY, Shares: 10,000,000, Price Range: $13 – $15, Deal Size: $140,000,000
Shares Outstanding: 71,708,364, Enterprise Value: $1B, Revenue: $150M, Multiple: 7x

Notes from the Roadshow

They start out with the core appeal of solar – to ultimately pay less for cleaner and more natural power. It’s an “aspirational” message. Suggests that “solar is ready to become a mainstream power source.”

The company is aiming at the distributed “rooftop” market and exploit a spread between utility pricing and solar. The model is based on consumers signing a 20 year contract. The financial structure is a key to how the company is able to make money.

In the commercial segment the model is more about “locking in” costs for electricity over the long term and knowing that costs will be inline with budget no matter where energy prices go. (Which has been up for some years now.)

Company results have been good in terms of revenue growth with $832M of contracts so far. The waiting list is a few months long although installation is said to require only a few days. Number of customers has been growing at a fast rate. over 21,000 signed YTD versus just over 5,000 in the same period a year ago.

The market opportunity is clearly large even just in the 14 states the company now operates in. SolarCity is using a channel approach to expand fast enough to capture market share. They are focused on Home Depot in particular. Also working with home builders like Pulte (PHM) and Toll Brothers (TOL) and Tesla (TSLA) to power their charging stations. Of course Tesla is also a kind of “related party transaction” with Elon Musk involved in both companies, at Solar City he serves as Chairman of the Board and probably wields substantial influence there.

Two large end market customers are US military housing “SolarStrong” and Walmart (WMT). All the systems are “free” in exchanged for locking in energy rates for the long term.

Scale is cited as a key barrier to entry with 28 operating centers with over 2,300 employees. In addition the technology and process expertise for end-to-end to success is unique to SCTY. They are vertically integrated so they can own and control the entire process.

Unlike other solar players Solar City has a substantive software and data facet to their business value and operational abilities. The solution includes web-based monitoring and management tools that customers like.

Given the 20-year contract the company sees the opportunity to “upsell” customers with additional products for energy efficiency. These can include better subsystems, batteries, electric vehicle charging. (to what degree is this stealth financing for Musk and Tesla?)

The two brothers, Lyndon and Peter Rive, running the company founded and sold “Everdream” to Dell. Everdream was an early SaaS company offering remote desktop management. There relative lack of experience and young age (35 & 38) might be a yellow flag for investors. However their team is made up mostly older and more experienced management.

Roadshow slides are available at: /roadshow-archive/

Financial Model

A 20 year contract gives the company substantial visibility once signed. There is also a 10 year renewal option. Cash flows are fixed and the costs are known.

Credit quality is good since people always pay their electric bill – before car payments and even mortgages. SCTY uses a 6% discount rate for this asset class.

Claims a $38K present value when a contract is signed. The $23K of cost is financed which gives $24K of value to financing, leaving $15K for SCTY. Not clear if they are using a 20 year or 30 year contract life for this analysis. If lots of the value comes from years 21-30 we will have a problem. The assumption on energy costs in 2032 is that they will be 20% less.

So far financing the rooftop installations has been fairly easy. Over $1.5B has been raised from 14 lenders so far. Tax credits also play a role in both the model and the financing side of the business.

A major question here is valuation which management asserts should be purely a DCF model. But investors have lately clamored for dividends and yield. So is this structure the right one for such a company?

GAAP rules will make the financials look bad since investments all get expensed up front and returns amortized over 20-30 years. So SCTY will be reporting their own business metrics – volume, financing, costs and cash.

Conclusion

Solar City (SCTY) will likely be seen as the “quality play” on solar energy in much the same way that Tesla (TSLA) has, so far, been seen as the quality play on electric vehicles.

Initially the shares will trade on the emotion and excitement of the story and the “giant opportunity” the company is going after. Bull will say something along the lines of “it’s only a $1B value for a company going after a profitable current market of $600B!” With logic like that tethering the price will be difficult.

But after the excitement wears off the shares will trade on the metrics and to what degree they are accelerating or decelerating. In addition the assumptions behind the long term model – electricity rates, residual value, maintenance costs and tax incentives, will be sometimes re-evaluated.

Over the very long term it remains to be seen how realistic the “upsell” component of the model will be. It could be a more powerful story than the immediate opportunity to upgrade homes and business to solar. Our research has turned up situations where a program of improvements can dramatically reduce energy consumption in the common home. Those savings would provide fuel for a massive growth engine. Still too early to know if SCTY will be that company.

Meta

Management: Elon Musk, Lyndon Rive, Peter Rive, Robert Kelly, Tobin Corey, Linda Keala, Mark Roe, John Stanton, Ben Tarbell, Seth Weissman
Board: Elon Musk, Raj Atluru, John Fisher, Antonio Gracias, Donald Kendall, Nancy Pfund, Jeffrey Straubel
Investors: Silver Lake, Draper Fisher Jurvetson, Valor Management, Kenmont Capital Partners, DBL Investors
Address: 3055 Clearview Way, San Mateo, CA 94402

 

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1 Comment

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