SolarCity Part I: Chanos Wrong on Dell, Again Wrong on SolarCity

“The amount of energy necessary to refute bullshit is an order of magnitude bigger than to produce it.”

Before starting this post, I just want to point out this quote. In order to disprove erroneous ideas and improperly understood facts, a significant amount of energy is required. However, as I’m pretty outraged by this latest smear campaign by Jim Chanos, I’ve decided to start a series of posts on SolarCity. This first one will focus on Chanos’ credibility. Hereafter, I will focus exclusively on SolarCity’s business and valuation.

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If you’re wondering who Jim Chanos is, he’s the infamous short seller who is often brought on CNBC because of his bold, and often wrong, predictions about the various stocks that he bets against. He got his reputation by betting against Tyco and Enron, two of the most celebrated short positions any investor could ask for in starting a career in shorting.

The reason I know who Chanos is is simple. He has now shorted two companies that I invested in long-term. The first was Dell, which if he kept his position in, he had to have lost a fair amount of money, because he was short throughout the deal talks when Michael Dell ultimately took them private. He doubled down on his statements throughout the merger talks, saying he wondered if Mr. Dell was even looking at the numbers. Well, as a fundamentalist value investor who owned the stock, it was obvious Mr. Chanos didn’t understand what he was looking at. At a 25% premium to the previous price, at $24 B, the stock was roughly taken private around 8x earning power. I bought in closer to 6x earnings, maybe even 5.5x. But regardless, it was fairly obvious to me that the business had enough earning and staying power to do well in the future. Mr. Dell took it private to further realize the same vision.

Another investor who uses television to their advantage, Carl Icahn, was asked about Chanos. Just as with my suspicions, this was his reaction to Chanos being short Dell:

“I’ve been on the other side of him [Chanos] many times and I’ve made fortunes being against him,” said Icahn. “I don’t mean this in a derogatory way, but I don’t see Chanos on the Forbes 400 list.”

Even more importantly, however, is the current maelstrom surrounding SolarCity, my top stock position today. Chanos has recently, and very loudly, come out short against them.

SolarCity

SolarCity is the most misunderstood stock in the market today. With everyone fixated on short-term profits, it’s no surprise that this business is punished for not having any. Despite the lack of accounting profits and very confusing cash flows, I believe SolarCity to be of the highest caliber business, one day likely to reach a market cap of >$100 billion. Comparing that to today’s price, that’s roughly 25-30x your money or more.

The problem with someone like Chanos shorting this stock is that it is too complex for him. If he got Dell wrong, he certainly will (and did) miss the mark on SolarCity. The business will take me many blog posts to explain – and I do plan on doing exactly that now that the business is so cheap. You’ll have to take my word for it now, but GAAP losses are not what they appear. Nor are the incredibly convoluted cash flows that the business generates each year.

Chanos called the company a subprime lender on television, only to have the CEO come on later to say the average FICO score of their customers is 750 (my father is a surgeon and he may not even have a FICO score this high). Rather than rescind his comments, Chanos found other areas to complain about.

Chanos thinks that as solar panels get cheaper, and give consumers a better deal, early adopters will be frustrated with their old contracts and seek to default on them. However, the bulk of the hardware cost declines have already been realized. They will continue to get cheaper, yes, but it will not be half as cheap or whatever percentage Chanos has concocted up.

Additionally, he is valuing this business based on book value, just as he did with Dell. This is pretty stupid, as the business is not a bank and worth far more alive than dead. It really is just a lazy way to measure the worth of a business.

Lastly, and I rarely give analysts credit, an analyst at Raymond James had some great thoughts on Chanos’ short: “Chanos’ position shows a lack of understanding of SolarCity’s business model,” Pavel Molchanov, an analyst at Raymond James Financial Inc., said in a phone interview. He has the equivalent of a buy on the stock. “Utility rates keep going up, and so for the SolarCity customer, it’s almost certainly going to be cheaper.”

To sum it up perhaps best in the words of the SolarCity CEO:

“I think it’s a high risk to take a short position in a company that’a growing 50 percent a year,” Rive said in a phone interview. “Every part of the business is operating extremely well.”

Best advice I can give to you is to avoid Chanos. He’ll only lead you astray.

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About Andrew Schneck

I am a value investor focused on misunderstood securities and industries, with an eye for long-term stock ownership.
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