For high-growth solar stock SolarCity Corp (SCTY), things haven’t exactly been shining over the last few quarters. Despite SCTY’s ambitious plans, numerous factors have pushed some pretty dark clouds in front of the residential solar kingpin.
Those dark clouds — including the end of net-metering in several key states — have managed to send shares of SCTY stock down in a big way. Year-to-date, SCTY is down 47%.
However, the storm clouds may finally be parting for SCTY.
SolarCity just announced a new fund-raising initiative that could help it turn the tide and reduce one of the main risks with owning SCTY stock. The residential solar installer is still a very risky bet compared to other large-scale solar stocks like First Solar, Inc. (FSLR). But if the new initiative works as planned, it should help SCTY shine at least for a while.
SolarCity Always Needs Fund Raising
The problem for SCTY has always been getting its installations on people’s roof tops. Demand is certainly there as the company continues to sign-up new customers at rapid rates. However customers don’t always have the $10,000 to $35,000-plus needed to actually pay for a roof top solar array. This forced SCTY into providing financing and leasing options or customers.
At first, that was pretty easy. But when you hit the scale that SolarCity has, it becomes gradually more difficult to tap your local bank branch for a loan. In order to keep the gravy train going, SCTY has turned to securitization.
Securitization is basically the practice of bundling thousands of debts or pieces of debts together and selling off those pieces to bond investors. Historically, mortgages and credit card receivables have been the main recipients of securitization, but anything from auto loans to debt tied to corn harvests can be bundled.
If it sounds familiar, you’re right on the money. Securitization of risky mortgages by tranches is basically what caused the credit crisis and Great Recession.
SCTY has typically bundled the cash flows from its panels as most are tied to long-term, 20-year price contracts. That was great as it gave SolarCity instant cash it could use to install new panels. But then the Nevada Public Utilities Commission voted to end the practice of net metering — which allowed firms like SCTY and Vivint Solar Inc (VSLR) to clip “extra” cash flows from the difference in retail and wholesale electricity prices.
Suddenly, SolarCity’s cash flow-based bonds weren’t backed by the same amount of cash flows per panel. Investors got spooked and ran. The beauty about securitization is that it pushes the risk of default off of the balance sheet of the issuer and into the hands of bondholders. With cash flows from each array not as juicy, SCTY is being forced to securitize bonds at much higher rates.
Enter the Tax Credits
With cash flows per panel not looking like the slam-dunk it always was, SCTY needed to go back to the well and look at something else. It just doesn’t have the cash on hand to keep growing at its current rate. What it did was look at juicy tax credits tied to many of its panels.
The firm announced this week that it had sold $40 million worth of bonds tied to solar renewable energy certificates on several of SolarCity’s underlying projects. A single SREC is created for every mega-watt hour of solar electricity a panel produces. These certificates are valuable instruments as they often are sold to power producers that need to meet solar renewable energy targets set by state regulators.
Basically, the renewable portfolio standards set forth by various state governments dictate how much solar energy must be created in that state. When a utility can’t meet that — because it has too many coal-fired plants or whatever — it can either add solar capacity or buy some SRECs to compensate.
Instead of getting those SREC credits, SolarCity will just forward them on to its undisclosed banking partner. Presumably, the banking partner will sell them for a profit. This is the first time that SREC’s have been securitized and could represent a huge pool of potential for SCTY over the course of its entire portfolio.
Investors seem to like the idea. SCTY shares have rebounded sharply since the deal and a few other traditional financing deals were announced. Since the beginning of March, SCTY stock has risen 54% — with the bulk of those gains coming the last few weeks of the month.
SCTY Is Still a Risky Bet
The ability to continuously tap the credit markets is key for SCTY to survive. And as such, it represents one of the major risks to SolarCity and its underlying businesses. The new SREC securitization bonds represent a new avenue for SCTY to tap in order to keep the sun shining.
However, they aren’t without risks.
Renewable portfolio standards are the kind of solar-positive legislation that can just vanish in an instant depending on who is running a state government. The bonds may work for SCTY today, but in a few months or years, who knows.
Secondly, SREC prices in the secondary markets are tied to supply and demand. Rising solar adoption essentially creates more of these things. And with more utilities opting to add solar farms to their generation assets, there may not be a need for them much longer.
So, on one hand, the bonds are great for SCTY. On the other, perhaps they are not worth a 50% jump in shares.
All in all, SCTY still represents one of the riskier business models in the solar industry. That model could pay-off over the long term and the recent SREC bond offerings help kick the can further down the road.
For risk-seeking investors, SolarCity makes for a prime pick. Just be aware that there are moving parts to SCTY.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.
