I have been writing an investment thesis on American Express, so forgive the gap since my last post. I don’t mean for a series of articles on a company to stretch on for weeks. My apologies.
SolarCity is a very special type of company, and is uniquely positioned to be the dominant player in residential solar in the country (and later, potentially the world).
Residential Solar, An Overview
Residential solar is the business of leasing solar panels to customers and then installing them on their roofs. The customer ceases to pay anything but a marginal amount to the utility – sometimes even selling excess power back to the utility – and their electric bill is replaced by a solar panel lease contract (or a power purchase agreement). This has several advantages, the main being that the lease payments are cheaper than the electric bill on day 1. That is – the day the panels are installed, your electric bill would fall from, say, $100 to $90, and your payments are a lease to the SolarCity rather than paying directly for power from the utility. Second, utilities’ costs and therefore electricity prices continually rise at the rate of 3-5% per year. This has occurred since the early 1900’s. This means that if a customer locks in a 20-year, fixed rate lease on their solar panels today, the savings they generate will only increase over time as utility prices go up and the lease payments remain the same. Lastly, and not nearly as significant as the immediate savings or economics of the lease contract, there are intangibles such as the ability to generate green energy and show up neighbors in having the latest cool technology.
There are two types of companies entering the residential solar space. The first group are what I’ll call the “legacies” – large solar manufacturers or utility holding companies- some of which have been in the energy industry for 50 or more years. The second group are the asset-light “startups” such as SolarCity, Vivint, Verengo, and SunRun. They are all focused on the same goal of capturing the residential solar customer base, but the first group of legacy companies has less capital invested in making this happen. Additionally, since they have existing businesses – even though they have more resources in some cases – they haven’t invested as aggressively in building out a residential platform. Some have even been accused of chasing growth at the expense of their existing businesses.
The distinction here is simple. Unlike SunEdison or NRG Energy, SolarCity and the other “startups” are focused exclusively on residential solar (and to a smaller extent commercial solar, which I’ll get to later).
Between the residential solar companies, SolarCity is by far the largest. In their latest investor presentation, SolarCity states that they are larger than their next 36 largest competitors combined and have a 36% market share. This share has increased every year from 6% to 7% to 11% to 17% to 25% to 33% to 36% for the years 2009-2015. My expectation is for this gap to continually widen, and that SolarCity may hit 50% market share in residential solar organically sometime in the next decade.
Porter’s five forces of competition- while crude and rudimentary- are the five forces that impact a firm’s competitive chances for success. The five are the threat from buyers, suppliers, substitutes, new entrants, and existing competitors. Of the five, many have (correctly) posited that by the far most important force is that of new entrants, and the barriers they must overcome to compete in the industry. This is highly relevant in residential solar, as the barriers to compete effectively with SolarCity are virtually insurmountable at this point, and the gap will only continue to widen. This is the main source of their competitive advantage.
The reason for this is that SolarCity is one of, but not the only, the first movers in the industry. All the major residential solar companies started around the same time – between 2006-2009 – and all had differing levels of funding. SunRun had an initially lead on SolarCity, although they did not pursue the same level of funding, and are now significantly behind. Elon Musk, founder of 3 billion-dollar plus companies (PayPal, SpaceX, Tesla Motors), was one of the main funding sources for SolarCity and he remains their largest shareholder (21%). He also serves as their Executive Chairman and provides advice to the Rive brothers, who run the company as CEO and CTO.
Additionally – in the same vein as their competitive advantage through barriers to entry – it is hard to build out a large organization that benefits from economies of scale the way SolarCity does. They have incurred accounting losses and negative cash flows each year since going public late 2012 and this is all in the name of one day having a large sales force, customer panel maintenance team, and access to the cheapest capital. SolarCity was the first – and only – solar company to offer consumer solar bonds that could be bought through their website. They also were the first to get highly attractive securitized solar funding for their growth, which cost far less than borrowing from tax equity investors or the banks. Finally, buying panels in bulk (or one day producing them yourself, as SolarCity currently plans) gets a steeper discount as well. All of these combined, in addition to superior technology on an efficiency and installation cost basis, leads to an insurmountable moat around the business for new entrants.
And if you don’t have to worry about new entrants, all you must do is assess existing competition. The “startups” I discussed earlier are not much of a threat, as they are the same model as SolarCity but far earlier in their development. One – Vivint Solar – was a private equity-owned home security business that leveraged its customer base to start offering residential solar. Now that all their existing customers have been cross-sold to, and that they are only around 8% market share, it seems their growth will slow in comparison to SolarCity, who has signed up all their customers organically since the start. Ultimately, these companies will have a place in the industry but never to be larger than SolarCity.
The second type – the “legacies” – have the resources and access to capital that might be able to disrupt SolarCity’s chance at being the top dog. But as of now, it appears they are missing their chance to build out a full organization and I don’t envision any of them making a major play to be the industry leader.
Commercial solar – the business of massive solar farms for utilities – is a very different model. The margins are smaller, the efficiency is lower, and one of the crucial things that make utilities non-competitive with residential solar also apply here. The transmission and distribution of electricity is expensive and inefficient, compared to panels on your own roof. You must maintain the miles of equipment and you lose a portion of your energy before it reaches the source of use. Commercial solar has these disadvantages the same way the utility does today.
However, commercial solar is still an opportunity in states where it is required, and these are often very large projects. Berkshire Hathaway’s regulated utility holding company – previously named MidAmerican Energy – is one of if not the largest commercial solar investor in the country. The returns are virtually guaranteed, partially subsidized by the federal government, and the returns are pretty decent. As a result, money is pouring into these projects around the country.
SolarCity bids and competes for these contracts, and it is roughly 10-20% of their total installed capacity. It presents an enormous opportunity, as both commercial and residential are at <1% market penetration rates, but the focus seems to be more on residential at today’s juncture.
As should become obvious, there is a lot to say about SolarCity and it is difficult to get it all together in a cohesive form. I have a finished report on them that is 23 pages long and it should likely be much longer. I also have a slide deck on them that is 66 slides long. Needless to say, this isn’t your Coca-Cola or Wal-Mart type investment. It requires significant study and the best I can do is to illuminate the most material aspects thereof.