Summary

  • Solar asset bubble has burst as evidenced by the performance of recent IPOs as well as the meltdown at SunEdison, TerraForm Power, TerraForm Global and 8point3 Energy.
  • We discuss what SolarCity has to do with YieldCos and the difference between residential and utility assets and the implications on yields.
  • Could SolarCity value be zero? We think it is possible.

In the recent weeks, several solar companies have taken a very significant hit to their valuations. At the surface it may appear that this has to do with concerns about China, ITC, oil prices, threat of reducing margins and typical solar bear concerns. But a closer look at the solar industry indicates this not to be true. To understand the risk factors at play here, we recommend a preview of our earlier article, "Trading the solar earnings season."

Excluding the carnage in underperforming or debt ridden companies like RGSE Energy (NASDAQ:RGSE), Yingli Solar (NYSE:YGE) and Hanergy (OTC:HNGSF), the bloodbath has been severe among the solar asset holding companies.

A quick look at the solar stocks shows that very few of these asset holding companies have escaped unscathed. As a point of reference, here are the recent stock price trends of major solar asset holding companies.

TerraForm Power (NASDAQ:TERP), while not completely a solar asset vehicle, started out as one and still has most of its assets in the solar category. We have been very skeptical of this company since before its IPO. The stock now trades around $26 - at about a 40% discount from its peak.

8point3 Energy (NASDAQ:CAFD), the third most recent solar asset company to go public, has not been in the positive column since the IPO. Having gone public at $21, the stock now trades near $15 - approximately a 30% correction with a corresponding jump in the yield.

TerraForm Global (NASDAQ:GLBL), the second most recent IPO, arguably had one of the most ignominious of the starts in the group in terms of its welcome by the market. After expecting to be priced in the $19-21 range and then being priced at $15, the stock continued its slide since the IPO and now trades around $10.

SunRun (NASDAQ:RUN), another company that we are highly skeptical of, is the most recent solar asset company to get to market and has seen a miserable fate similar to its peers. It now trades around $10 - a 30% discount from IPO.

Vivint Solar (NYSE:VSLR) has been relatively unscathed from the recent turmoil due to its proposed acquisition by SunEdison (NYSE:SUNE). We have been critical of the company's business model and the chances of its survival past the ITC expiration, but SunEdison's acquisition has saved Vivint Solar investors. Unfortunately, SunEdison's shareholders paid for this misadventureand SunEdison is now at the forefront of the asset re-pricing debacle.

Just about the only solar asset company that has not seen significant price correction is SolarCity (NASDAQ:SCTY). It now trades around $50 - about a 20% correction from its recent highs.

But the current SolarCity stock price does not fully convey the magnitude of the correction that has taken place in the stock price. Within the last year, the company's installations have approximately doubled and the company's claimed "retained value" also has gone up by a similar amount but in spite of this torrid growth, the stock price has gone down.

So, what happened here? And has SolarCity already seen the worst of it?

It should be noted that all of these companies suffering severe downdraft share a common trait: these companies' valuations come from holding long-term solar leases and PPA using assumptions and valuations that defy industry trends. The problem is particularly acute when it comes to residential solar assets. The solar asset bubble, which we have often written about, seems to have finally busted.

While all the companies mentioned herein are solar asset holding companies, there some crucial differences between the companies. Investors looking at investing in the solar asset space need to realize that, in addition to constructs like YieldCo and Sponsor, there are fundamentally different attributes to different types of solar assets:

- For residential asset holding companies, the key risk factors are declining energy prices, utility actions, technology progression, expected improvement in aesthetics for future solutions, risk of reroofing, declining credit scores as the customer base expands, and cost of uninstallation

- For utility scale asset holding companies, the key risk factors are declining energy prices, risk of default of PPA by a utilities weakened by the emerging energy landscape, curtailments, cost of upgrades and plummeting PPA prices past end of the initial lease term, uncertain interconnection landscape and rising land leases.

- For commercial asset holding companies, the risk factors are somewhat of a blend of the residential and utility scale risk factors.

Due to these factors, we believe that investors in US based utility assets should demand yields in the neighborhood of 8%. The corresponding yields for US based residential assets should be in the 12% range.

For international assets, the yields should be significantly higher based on currency and country risks of the relevant geographies.

Unfortunately, the yields from current vehicles do not reflect these realities. Part of the problem lies with the companies and their Wall Street investment bankers who are busy promoting these companies and bringing them in to market with artificially high valuations.

However, we believe this bubble dynamic has changed significantly after a series of disastrous IPOs, and VivintTerraForm Global and SunRun which we have written about and the more recent meltdown at SunEdison, TerraForm Power, TerraForm Global, and 8point3. It is clear from the current valuations of these companies that the commentary from management and the sell side firms about the safety of these assets and pitch for low yields is no longer resonating with investors.

To be sure, in spite of the recent correction, we do not believe we have reached an equilibrium in solar asset valuations. While the yields at the above mentioned YieldCos have increased significantly due to the correction, we believe the yields are still significantly below what the quality of the assets indicates.

In our view, to get to a more reasonable yield level, there's likely a further 25% downside to many of these assets.

For example, a reasonable yield for TerraForm Power, considering the asset mix, is likely at least 10%. If the Vivint Solar acquisition goes through, this number will climb as the asset mix includes more speculative residential assets. But even with a 10% yield, and looking forward to 2016 DPS of $1.75 puts the value of this equity at around $17.5. That is about 35% below current levels.

In the case of SolarCity, we believe the correction is likely to be far worse. In the past we have estimated the value of the company is likely close to $15. This would imply about a 70% correction from the current level.

However, given the lack of good disclosures on the company's retained value metric and the tendency of the management to divert attention using bogus metrics such as Power Available Cash or PAC, we fail to see any underwriting discipline at the company and we are increasingly skeptical if the company has generated or will generate any value at all.

To evaluate SolarCity's earnings power and risk, the company needs to provide considerable additional disclosures on the following lines:

- IRRs with retained value sensitivity (with 0% and 10% renewal rates with and without uninstallation) pre and post ITC.

- A table that shows the default assumptions behind the assets of SolarCity by each asset bucket.

Segment/Credit Quality

Remaining PPA life

Current PPA rate

Avg Escalator

Est Renewal Rate

Est Renewal PPA Price

Est Cost of non renewal

Default rate years 1-5

Default rate years 6-10

Default rate years 11-15

Default rate years 16-20

 

- If and where possible, the company should also track and disclose the type and age of the roof at installation as remaining roof life is likely to have significant impact on the contract life.

- The age of the customer also could be an important factor especially in the older demographic where the customer may not survive the contract.

Such tables and information for PPAs, leases and loans will let investors assess the major risk factors of SolarCity assets.

Until the solar asset model is well established, this type of actuarial data is necessary to understand the underwriting risk factors. Without this type of detail we do not believe there's a reasonable way for investors to estimate the value of SolarCity assets.

In our view, with the risk factors present, the residential solar contracts are likely to have lives in the 10- to 15-year range which is less than half of the 30-year life span assumed by SolarCity and its peers.

Investors should note that the IRR situation is likely to get progressively worse as customer credit scores drop and ITC and other benefits reduce. If the company's management were to make proper underwriting assumptions and disclosures, we would not be surprised to find that the company's IRR adjusted for renewals and defaults is below the cost of capital under several scenarios. If so, the value of the company is likely to be worth closer to "0" than any other number.

Summary:

With the recent stock market events, the frailty of the solar asset models are now in full view. The asset models, especially the YieldCo/Sponsor model, has taken a severe hit and we believe an equilibrium in prices has yet to be reached.

We believe that disclosing assumptions will go a long way in understanding and potentially fixing the broken business models of these companies.

Investors should not make any mistakes when it comes to disclosures of these solar asset companies - especially a company like SolarCity. The comparison of SolarCity to YieldCos is apt given the company itself is guiding based on a CAFD like metric and asking investors to go down this path in evaluating the company.

Similar to what we are seeing with YieldCos, sooner or later, the assumptions implied in the SolarCity model will be vetted by the market and when that happens the consequences are not likely to be pretty.

We would stay away from all solar asset holding companies until the disclosures get better and the assets are more reasonably priced. While most of the above mentioned asset holding companies have another 25% downside risk, we believe SolarCity's downside could be as much as 70% to 100%.

Our View on SCTY: Sell Short

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

Source: SeekingAlpha

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