It is rare to see such a a strong sell report from the sell-side, but Axiom just did that with Elon Musk‘s SolarCity (SCTY) and placed a price target of $7 (the stock is currently trading at $26.45 – so that indeed is rare. ZeroHedge first reported the full report (H/T to him) and readers can see the full report below. Stay tuned also for Elon Musk’s other company which has attracted short sellers, Tesla Motors. The car company reports earnings after the close today (I think).
Axiom Capital Management Investment Thesis on SolarCity Corp (SCTY).
Is The Entire Sell-Side Incorrectly Giving SolarCity Corp (SCTY) Credit For Cash It Can’t Access?
- The Good, the Bad, & the Ugly. In a widely anticipated move (evidenced by the recent outperformance of SCTY’s shrs), yesterday SCTY announced its first-ever cash equity deal w/ John Hancock Financial (“JHF”). Under the terms of the deal, SCTY will sell 95% of the cash flows generated from a portfolio of 201MW of residential & commercial solar projects to JHF over the next 20yrs. The Good: in return for the cash flows, SolarCity will receive $227mn in upfront equity, while retaining a 5% minority interest over 20yrs; including tax equity investments + upfront rebates/prepayments, this transaction will raise $3.00/W in total financing (or ~$603mn), & reflects a blend of $2.35/W for commercial projects & $3.24/W for residential projects; the IRR is ~8.2%; the majority of the installations were completed in ’15; the projects are spread over 18 states, w/ no single state comprising >35% of the portfolio; & the avg. FICO score for the residential customers is 744. The Bad: when looking at just the cash equity proceeds from this deal ($227mn) – while we recognize an additional $376mn in cash, ~$346mn of which is tax-equity (“TE”), has already been received, while, technically, TE is available for general corp. purposes, given it’s largely been spent to offset the CAPEX of the systems themselves (meaning, in reality, it is not available), we feel the relevant metric to analyze is the cash equity received, or the cash available for new project investment/debt retirement – adjusting for SCTY’s 5% ownership, a more normalized ?50% mix of SREC’s from CA, and then applying these metrics to SCTY’s existing installed base of 1.67GW (i.e., 1.8GW of cum. deployed GWs – 177MW of MyPower loans [MyPower loans have no tax equity]), adjusted for debt, the Silevo earn out, unrestricted cash, the book value of MyPower, the full renewal value, & a 35% tax rate, we derive a fair value for SCTY’s PowerCo of just $0.71/shr (Ex. 6). The Ugly: $2.71/W in costs (Ex. 7) – $1.38/W in tax equity (Ex. 8) – $0.07/W in rebates/repayments (Ex. 9) = $1.25/W in funding needs; yet cash equity proceeds from JHF were just $1.18/W, meaning SCTY sold at a loss. Caveat emptor.
- Dark Clouds Ahead? We believe a mild bookings trend borne out of SolarCity’s decision to leave NV, & withdraw MyPower, will compel an annual guidance cut when the company reports earnings next week.
SolarCity Corp (SCTY) – Investment Conclusion
SolarCity’s share price has traded down 48.2% YTD, underperforming our custom weighted-average Axiom Module/Cell OEM Index (i.e., JASO, TSL, YGE, JKS, CSIQ, CSUN, HQCL, SCTY, FSLR, SPWR, Neo Solar, Motech, Gintech, and E-Ton), which is down 31.0% YTD, and our custom Axiom Polysilicon OEM Index (GCL, WCH, DQ, REC, OCI, SOL, Sino-Am, and TBEA), which is up 5.4% YTD. Furthermore, along the same YTD timeframe, SCTY has underperformed our Axiom PV OEM Index (MBTN and ASYS), which is down 35.0% YTD, while the broader market index (as measured by the S&P 500) has returned 1.0% YTD. See Exhibit 3 below for recent share price performance and Axiom’s ratings for the stocks that make up our custom indexes.
The Good – a Nice Deal… on the Surface. There are a number of anecdotal positives associated with this deal, to include: (a) it is with a respected counterparty in John Hancock Financial (“JHF”), (b) SCTY is retaining 5% of the cash flows generated from the portfolio of 201MW of residential and commercial solar project cash flows to JHF over the next 20 years, (c) SCTY is receiving $227mn in upfront cash equity, (d) including tax equity investments and upfront rebates/prepayments, this transaction will raise $3.00/W in total financing, or roughly $603mn, (e) this transaction reflects a blend of $2.35/W for commercial projects and $3.24/W for residential projects, (f) the internal rate of return (“IRR”) on the portfolio is approximately 8.2%, (g) the majority of the installations were completed in 2015 (suggesting little risk of cherry-picked projects), (h) the projects are spread over 18 states, with no single state comprising over 35% of the portfolio (meaning California, or the highest margin state, was not the majority of the portfolio), and (i) the average FICO score for the residential customers is 744 (in line with the average score for SCTY’s aggregate portfolio of projects).
Yet, and addressing among the key bear points emboldening many of the shorts in this stock, this deal suggests, at face value, SCTY has resolved the inability to raise capital, through third-party cash-equity and tax-equity financing, in excess of its current cost (i.e., $3.00/W in total capital raised versus its current cost/W of $2.71). Stated differently, this implies SCTY has a clear path to generating free-cash-flow to fund growth.
The Bad – a Fundamental Flaw in the Anecdotal Thesis; and Why We Feel the PowerCo is Far Less Valuable than Previously Assumed. While many of our peers are raving about the $3.00/W in third-party capital this deal was able to garner, compared to SCTY’s most recent cost structure of $2.71/W, we find two major flaws with this argument. More specifically: (1) we contend the approximately $346mn in cash tax-equity associated with this deal is not available to fund growth, or retire debt, as this cash has already largely been spent to offset the CAPEX of the systems themselves (we believe this represents a general misunderstanding of how solar tax-equity works versus upfront cash equity injections), and (2) SCTY’s $2.71/W in reported C4Q15 cost is likely artificially low due to SG&A that was delayed into C1Q16 – we remind our readers that SCTY originally guided C4Q15 GAAP OPEX to $245mn to $260mn (or $252.5mn at the mid-point), but ultimately reported $227mn, with S&M well below our estimates (Exhibit 1); while we contend this optically helped their cost structure look good in C4Q15, we believe the company is now having to reverse these cuts, likely pushing costs the wrong way in C1Q16.
Valuing the PowerCo. To value the PowerCo, using the JHF as the basis, we note the following assumptions (in no particular order) – see Exhibit 6 below for buildout:
- SCTY has virtually no net-operating-loss-carryforwards (“NOLs”), implying the need to factor in some tax liability (in Exhibit 6 below, we show the impact with a 35% tax rate and without);
- 101mn in shares are outstanding;
- There are up to $150mn in Silevo earn-out payments due;
- The residential/commercial split is