One week ago, when SolarCity was trading around $30, prompted by Jim Chanos’ bearish take on the company we wrote a piece asking if “SolarCity is the next SunEdison“ in which we presented the Full Bear case as noted by Axiom’s Gordon Johnson, who incidentally had the only “sell” rating on the company ahead of last night’s earnings debacle (at which point there were also 12 Buys and 9 Holds), which has resulted in the company plunging 25% overnight, and is about 40% lower than when we first prompted readers to pay attention to Elon Musk’s solar venture.
Today, Gordon gives ZH readers an exclusive look at five points why the pain for SCTY has only just begun, and why – as we speculted – SolarCity may indeed be the next unfortunate bankruptcy in the sector.
Courtesy of Gordon Johnson:
Point 1:
So… they are saying they are going to be cash flow positive this year. Why? Simply put… their installation growth has slowed materially, due to: (a) competition (both from other solar companies and banks), (b) weaker freebies (i.e., incentives) from the US government, (c) less demand from consumers (who are making a lot less) for expensive solar panels, and (d) a saturated US market – see the figures below, and also notice, as per the last figure, that SCTY’s share in CA is down materially in Feb. vs. Jan. and 2015.
So… what do they do? They tell investors they are moving from being a growth-based company to being a value-based company. How they defined being a value-based company was by telling investors they would be cash-flow positive in 2016. However, this is where it gets interesting. Based on the accounting 1 class I took as a freshman in college, cash-flow positive is either defined by: (1) operating-cash-flow being positive, (2) operating-cash-flow ? CAPEX = free-cash-flow being positive, or (3) EBITDA being positive. But… this is not how SolarCity defines cash-flow. No, no… of course not. The way they define it is: free-cash-flow + any financing in the quarter = free-cash-flow.
Stated differently, you can run a company that burns $100s of millions of dollars in cash, yet take on massive amount of debt/leverage, and include this in your definition of free-cash-flow, and Abracadabra you’re a good business. At best this is financial illusion, and at worst outright deception (i.e., trying to get investors to accept a new definition for free-cash-flow). I guess, in this world where central bankers are solving massive leverage problems with even more leverage, perhaps SolarCity feels no one will call them out for this. But, I think it’s a very important dynamic to focus on as the narrative the company is telling people is built on an assumption of free-cash-flow which, at its core, is based on an improper definition.
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Point 2:
SCTY has restated the way it calculates its cost/watt (i.e., the key metric that derives their costs); and, in each quarter they’ve restated, their newly reported costs are lower. Their specific verbiage, as detailed below, is: “cost calculation methodology has been updated to exclude costs associated with operating the PowerCo portfolio that are now included and presented in our Recurring Cash Generation of PowerCo memo and to include cancellation costs that had not been previously included”. There are a number of other items that have been restated since we started covering this company (and, in each case, they are restated to SCTY’s benefit) – just this quarter, in addition to the change in the way they report costs, the way they report revenues and COGS were changed/revised. It’s almost as if the company is making it up as they go.
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Point 3:
A lot of people want to give SolarCity value for renewals in their portfolio (i.e., the assumption that after their 20yr solar contracts with customers are up, customers will renew those contracts using the same panels that were installed 20yrs ago). While we are assuming a value for SCTY’s “renewal portfolio”, which, again, assumes 20yrs into the future, 100% of the SCTY customers with SCTY systems on their roof will opt to renew the contracts with SCTY at prices that will be above (when adding in the escalators ingrained in SCTY’s contracts) the prices of technology 20yrs into the future (yes, you heard that right); stated differently, it’s the equivalent of assuming you will buy a computer from 1996 today for more than you would pay for a 2016 model? Probably not… thus, in reality the renewal value is not worth much, if anything – it’s an option.
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Point 4:
They had talked about a 4.5% blended cost of debt 4 months ago – rates have barely moved – and now, their capital costs are much, much higher at about 8.23%… if rates go up, then what happens?
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Point 5:
Last year, SolarCity burned over $800mn on 870MW of installs, or $0.92/W; this, or a loss on installations, is not being included in anyone’s cost calculations.
Overall, SolarCity is a company that perpetually burns OCF, FCF, and generates grossly negative EBITDA, with $2.4bn in net debt and business model predicated on perpetual capital issuance/needs (they buy solar systems, then lease them out to you/me over a 20yr period collecting cash over the lifetime of the project [which is why they perpetually burn money – it’s simply an asset vs. liability duration mis-match]).
Further, the way the stock is valued is very tricky (think 20yr DCF with hundreds of inputs that the company changes regularly), and not straight forward – i.e., an art, not a science. In pretty much every case like this I’ve seen in the history of investing (the most recent of which was SUNE, which we got similar emails to the ones we’re now getting on SolarCity when we turned negative on its shares around $20/share, to see it go to $0.22/share today), the stock does go to $0/share.
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While we agree that it is only a matter of time SCTY becomes the next SUNE, perhaps the real question for this typical Elon Musk construct is not whether the company is the next SunEdison, but whether Tesla will be the next SolarCity…
via http://ift.tt/1OfjEnX Tyler Durden