No. of Recommendations: 5

http://www.fool.com/investing/general/2013/09/04/solarcity-i...

I'd be happy to discuss the model or aspects of this company.

Cheers,

Jim

No. of Recommendations: 1

In the article, you state that you would be glad to post your referenced valuation model in this forum. I would like to take you up on that offer and we enjoy giving it consideration. Please post it.

No. of Recommendations: 5

Hi swcaraway,

Sure thing. Please forgive the left-right scroll nature of this. Model first, explanation second (using Excel Column / Row to help).

For this, you'll also need to look at least at the slide deck at http://files.shareholder.com/downloads/AMDA-14LQRE/264987892.... Some of the numbers also came from the Q1 and Q2 2013 releases, I believe.

A B C D E F G H I J K

1 2011 2012 Q1-2013 Q2-2013 2013E 2014E 2015E 2016E 2017E

2 MW installed 287 334 387 557 924 1357 1830 2323

3 Incremental MW 72 157 46 53 270 367 433 472 493

4 YoY 118% 12% 71% 72% 36% 18% 9% 4%

5

6 New customers 9034 30950 8773 8559

7 YoY 243% 65%

8

9 New energy contracts outstanding 7132 26327 7363 8087

10 YoY 269% 72%

11

12 Est. Nominal Pymts Remaining $486 $1,109 $1,222 $1,409

13 Incremental $623 $113 $187 $810 $1,166 $1,455 $1,679 $1,856

14 $$ / incremental MW $3.97 $2.46 $3.53 3.00 3.17 3.36 3.55 3.76

15

16 Retained Value (NPV at 6%)

17 Under Energy Contract $294 $305 $364 $497 $582 $691 $357 $868

18 % of Est. Nominal Pymts Remaining 27% 25% 26% 25% 24% 23% 21% 20%

19 Incremental $11 $59 $203 $277 $327 $357 $371

20 Renewal $246 $264 $298 $416 $497 $575 $302 $732

21 % of Est. Nominal Pymts Remaining 22% 22% 21% 21% 20% 19% 18% 17%

22 % of customers renewing 100% 100% 100% 100% 100%

23 Incremental $18 $34 $170 $233 $277 $302 $316

24 Total $536 $569 $662 $913 $1,079 $1,266 $659 $1,599

25

26

27 RV = NPV of cash flow to shareholders $913 $1,079 $1,266 $659 $1,599

28 assuming company halts growth Mkt cap $2,241 $4,798

29 and installations today and runs P / RV 3.39 3.00

30 out all current contracts + 10-year 19.2% CAGR

31 extensions

• In columns B - E are actual numbers, G - K are projections.

• I first started off with total MW installed (Row 2) and how much additional there was added in each time period (Row 3). Year-over-year (YoY) growth is in Row 4. The company projects 270 MW installed this year (G3).

• For H3 - K3, it takes the prior year's YoY growth and halves it, so it goes from 72% to 4.5% by 2017E (Row 4).

• Rows 6-10 turn out to be just informational.

• Row 12 shows Estimated Nominal Payments Remaining (future cash flows from leases) at the end of each period.

• Row 13 shows additional amounts and Row 14 just divides Row 13 by Row 3 to get $$ per incremental MW installed.

• In G14, I start off at an assumed lower level and then grow it by the 5.5% projected annual savings in costs from there (that's given by the company, and it made a point of saying that it's currently ahead of projections). Actually, I divided by 0.945, which accounts for that 5.5% savings (1 - 0.055). See slide 6 from the deck.

• Row 13 is Row 14 ($$ / Incremental MW) multiplied by the projected added MW (Row 3), and therefore is the incremental addition to the amount of Est. Nom. Pymts. Remaining ("ENPR" going forward).

The rest of this is all about Retained Value (RV). The company knows how much nominal (undiscounted) cash flow is expected to come in each year because it knows the details of all its contracts. It then subtracts nominal estimated expenses for warranty work, inverter replacement, payback of investors (including interest), and various other costs to get nominal cash flows that belong to the company each year. It then discounts each year back by 6% annually and adds them all up (that's "NPV at 6%" in Row 16; NPV = net present value). The total of all this work is RV (slide 10 from the deck).

Aside: RV has two components (also on slide 10): From current leases (Row 17, Under Energy Contract) and from the projection that it will be able to renew those leases for another 10 years. This second part is a significant contributor to total RV and comes from the following argument.

The company is estimating total life of the systems it installs as 30 years, presumably based on industry and supplier data. However, it is selling bonds on only 20 years of the cash flows, the lifetime of the current leases. It assumes that it can sign up its customers again for 10 more years, starting at 90% of the then rate in effect. It no longer has to pay back any investors, so it keeps a much larger portion of these cash flows from years 21 - 30. I addressed this point (briefly) in the article and gave that 100% of customers assumption a pretty severe haircut to see what happened to the projected value.

Back to the point, now. Because I don't know what all those nominal expenses are -- and certainly not by year -- I can't go year by year and model those out and then play with the discount rate (which is supposed to be the company's cost of capital) and so on. So, the best way I can get from Incremental Nominal Pymts. (Row 13) to Incremental RV (Rows 19 and 23) is to take the ratio between RV and ENPR for the time periods for which I have data.

• Row 18 and Row 21 first calculate what the ratio between RV (each component) and ENPR in Columns C - E. In Columns G - K, I start slightly lower and then drop it steadily from there, and a bit more quickly for the Under Energy Contract part of RV.

It's that decline of RV / ENPR ratio that I use to account for increases to the cost of capital (the discount rate used to generate RV) and increases in cost of components and labor and stuff. Row 14 (starting at a lower $$ / Incremental MW) also does that kind of correction.

• Rows 19 and 23, then, shows the incremental addition to RV for each year (assuming 100% of customers add 10 more years at the end), the subtotals of RV are in Rows 17 and 20, and the total is in Row 24 (and Row 27).

• Cell E28 shows the market cap as of Tuesday's close, and Cell E29 is the P / RV ratio.

• Cell K29 drops that ratio to 3.0 and then the projected 2017 market cap is calculated by multiplying that by the projected 2017 total RV, in cell K28.

• Cell I30 shows the 4.33 year CAGR between that market cap and the recent market cap.

• Finally, I changed the % of customers renewing to 33% (Row 22) which affects Row 23 and cascades to Rows 20 and 24. This resulted in the lower market cap mentioned in the article.

So that's the model and an explanation of what I was trying to do as I built it.

If you have any questions, I'd be happy to answer them.

Cheers,

Jim

No. of Recommendations: 1

*Finally, utilities increase prices at healthy rates. That alone pushes utility electricity to become more expensive than solar electricity systems installed today in just a few years , even accounting for declines in panel efficiency.*

Good Morning, Jim:

While your article makes some sense of a torturous tangle of possibles and unknowables, buried in your analysis is the above nugget. It deserves at least a bit of amplification.

As alternative energy continues to grow outside of established utilities (mostly solar since that is the easiest for the average Joe to instigate), the utilities will sell less of their own generated capacity. At a certain point, that will become a de facto "bad thing" for utilities. They will be required to buy what comes off my rooftop, while they have capital invested in their own generation which demands a return on that invested capital. How will they manage that? They'll most likely have to raise rates on what they generate. Imagine the ensuing dynamic. This will be a true tipping point. I don't know when, but it may come sooner than later, at least in some markets (California and Massachusetts).

Will it happen before 2017? Will something else change or catalyze the dynamic? My Magic 8 Ball says "chances are good."

That said, FSLR as a value stock is likely to benefit just as much. Every book by every wise old geezer will tell you so.

-Randy

No. of Recommendations: 3

Hi Randy,

Good point.

There is so much more to this thesis than I could stuff into a reasonably long article (and at just shy of 1,000 words, even that might have been too long). There's net metering and limits of how much electricity utilities are required to buy from customers; there's the utilities' own solar installations; there's the market share of SolarCity (17% of residential installations); there's the litigation between the federal government and SolarCity about the rebates claimed; there's sequestration and how that arbitrarily dropped the claim amounts, not to mention what might happen in September and beyond when Congress takes up the debt ceiling and budget debates; and so on.

Then there are a whole bunch of unknowns. How will utilities react to disruption of their business model? How much distributed power generation will happen (estimates range from near 0% to near 80%)? What useful information and revenue will SolarCity get from its monitoring of electricity use where its systems are installed? How much PV paneling will be built and sold and how much will China (which is a big proponent of solar) dump on the market? And so on, here, too. :-)

There's a lot going on and a lot that can happen. One resource which I have found of great use is the REN21 Renewables Status Report available at http://www.ren21.net/REN21Activities/GlobalStatusReport.aspx.... That organization has been following renewable energy for many years. BP also puts out the Statistical Review of World Energy: http://www.bp.com/en/global/corporate/about-bp/statistical-r...

Cheers,

Jim

No. of Recommendations: 1

Good article, Jim! And I'm glad your detailed analysis supports my own gut analysis. LOL I own some as well and have been pondering an additional buy, so your affirmation (and data) makes me more confident.

I've mentioned elsewhere on the boards that I suspect SCTY will one day become a Fool recommendation by one (or more ;) services.

Rob

No. of Recommendations: 2

"As alternative energy continues to grow outside of established utilities (mostly solar since that is the easiest for the average Joe to instigate), the utilities will sell less of their own generated capacity. At a certain point, that will become a de facto "bad thing" for utilities. "

Utilities which shift from central & distributed to collecting & storing might do well. An Israeli study shows that at least with smaller cities, the suburbs could collect enough to power the city.

However, most people just keep on with their old patterns until too late.

No. of Recommendations: 3

Hi everyone,

Please refer to the model outlined here: http://boards.fool.com/hi-swcaraway-sure-thing-please-forgiv...

I had a conversation with Travis Hoium yesterday. He's a writer/analyst for Fool.com and has followed solar energy for quite a while. Anyway, he and I discussed the model and he raised what I think were a couple of good points and (important!) he found a significant error in part of the calculation.

First, the error. In rows 18 and 21, columns H - K, where I'm supposed to be putting the total Retained Value each year by adding the previous year's total and the new incremental amount, I wasn't. In G18, for instance, I added 2013's incremental Under Energy Contract RV (G20) to 2012's RV (C18). That was correct. But then I copied that formula over to H18 - K18, which meant that I was using the wrong previous year number. Similar situation for row 21. The correct formula for H18 should have been H20 + G18 (instead of D18, which it was). Before it was $277 + $305 (from D18) = $582. The correct amount should have been $277 + $497 (from G18) = $773.

Changing to the correct formula gives $773, to $1,101, $1,458, and $1,829 for H18 - K18 and to $649, $926, $1,228, and $1,543 for H21 - K21. That, of course, raises the RV at end of 2017E to $3,372 (K25 and K28).

Second, a couple of points Travis made.

First, he argued against increasing the $$ / incrmemental MW amount in calculating incremental Est. Nominal Pymts Remaining. Recall that it is the $$ / incremental MW installed (row 15) * incremental MW installed (row 4) that leads into the RV calculations further down the spreadsheet (rows 20 and 24).

I started this at $3 / MW (all dollars in millions) and grew that as the company saved on costs. Travis argued that SolarCity would have to lower its selling prices in order to remain competitive as solar components continue to fall in price. Competition would come from utilities and from homeowners deciding to just install the things themselves. This argument seems reasonable, while a climbing $$ / MW implies increasing margins at the company. So, keeping this at $3 / MW for all years lowers K25 to $3,038 at this point. Dropping it by 5% a year lowers K25 to $2,780.

Second, he argued that the 3x multiple I assigned at the end (lower than the 3.5x it was trading for at the time and the 4.24x it's trading at today) didn't make sense. Why should the market assign a multiple like that?

You can value a company however you like, but the valuation needs to make economic sense. RV is future cash flow to the company after expenses, discounted back at 6%, and is what the company would receive over the next 30 years if it stopped growing. It's not FCF (the company would still owe taxes on it) and it doesn't take G&A expenses into account. Companies often trade at P / FCF multiples in the single digits (which anticipates some growth). A more appropriate multiple might be 1.5 x or 2x. At 1.5x, market cap would be $4.17 B (using the 5% decline to $$ / MW version) instead of the $4.8 B from the earlier version of the model.

So, more conservative assumptions lower the valuation by about 13%. I can live with that.

Cheers,

Jim

No. of Recommendations: 7

Jim,

There's plenty of analyst/writer/talking head types out there that would have just forgot that conversation ever happened.

It's a testament both to you and the Fool that you came back and not only talked about how there were potential "flaws" in your valuation model, but gave us specific data and "why."

Another reason why I'm glad to be called a Fool!

Thanks,

Jason H

No. of Recommendations: 0

Thanks for the update Jim, and I echo Jason's sentiment.

John

No. of Recommendations: 0

Hi Jim, thanks for sharing your model!

A few questions/comments:

- As I understand, RV doesn't include income taxes, selling&marketing, general&admin and CapEx. Why don't you adjust RV downward to account for those items?

- RV also doesn't include the revenue generated by the purchase&installation of the solarpower system for customers who didn't choose the $0 upfront-cost-though-higher-fixed-lease-payments. Or does it? That extra revenue should increase the fair value.

- Would it you deem it too preposterous to try to model the gross expenses? Based on the $1409M value of ENPR, if you assume that they are evenly distributed throughout the next 20 years as an annuity, you get a PV(@6%) of $808M. Contrast it to the NoRenewal RV value of $364M and you would get something akin to a gross margin of 45%. This of course ignores the timing of the cashflows (specifically, the purchase of expensive solar power systems in the begining), so we can't model them as annuities. I'm thinking that maybe we can roughly solve this issue by comparing RV changes relative to SolarPowerSys Purchases investing outflows and figure out a way to model gross expenses.

- Why use a 6% discount rate? How did the company come up with that figure? Why don't you use a higher figure, and how would you go about doing that?

Will

No. of Recommendations: 0

Hi Will,

Great questions and thanks for taking the time to think through the model and what's happening.

*- As I understand, RV doesn't include income taxes, selling&marketing, general&admin and CapEx. Why don't you adjust RV downward to account for those items?*

- RV also doesn't include the revenue generated by the purchase&installation of the solarpower system for customers who didn't choose the $0 upfront-cost-though-higher-fixed-lease-payments. Or does it? That extra revenue should increase the fair value.

I didn't include those for one reason. I used a market multiple valuation at the end based solely on RV and compared it to the current market multiple assigned to current RV. Going that route I necessarily had to not include additional expenses like SG&A and income taxes. (CapEx wouldn't be included because RV is not a cash flow, this isn't a DCF model.)

Same for additional revenue from selling the installations outright to the homeowner (your second question).

Basically the model says "Here's what the market is saying the value is based on today's RV. Here's an estimate of what the market will say in 2017 based on a projected 2017 value for RV." All the extra expenses and revenue sources are baked in to the market multiple.

*- Would it you deem it too preposterous to try to model the gross expenses?*

No, just very, very difficult. I try to keep my models pretty simple because I know how much any assumption can affect the outcome. The fewer assumptions I make, the less chance there is for error (and there's already plenty of chance).

Here's an illustration of that difficulty:

*Based on the $1409M value of ENPR, if you assume that they are evenly distributed throughout the next 20 years as an annuity*

That's not a valid assumption. A friend of mine was kind enough to give me the exact contract he had just recently signed with SolarCity for the installation on his house. From that it is plain that the output of the panels goes down by some amount each year which means the guaranteed delivered power output goes down. At the same time, his cost per kWh increases by a certain percentage each year.

I know what the increase in price is because it's stated very clearly on the contract and I can calculate an average decline in panel output efficiency. However, that's just one contract. I have no idea if the same changes would apply to all contracts and extrapolating from a single contract to thousands over the course of 4+ years is a very big assumption. How will the technology of the panels improve over time? What if SolarCity applies different price increases for different customers based on how much each customer's regular utility bill has increased in the past? And so on. That's the revenue side.

On the cost side, there are historical prices on panel costs, but I don't know how those will play out in the future nor what the company is actually paying today. Similarly with labor costs, maintenance costs, and so on. What if the company finds that it's maintenance costs come in higher than currently projected, based on more years of data over more system installations? I can't reliably model that.

The biggest lever in the model I built is the growth rate of MW installed. I think I was pretty harsh here, cutting it in half for each of four consecutive years. This covers a multitude of sins, to steal a phrase. Among these are changing gross margins (e.g. increases in panel costs that cannot be passed along to customers), failure to increase revenue by selling systems outright, pushback competition from utilities that cuts into the business, and so on. I have no idea how each of those might affect my numbers, so I lump them all into a single spot and try to be conservative there.

In the follow up post, Travis had pointed out where I might have been too optimistic by letting nominal $$ / MW grow, so I cut further, not letting the company grow it like they've been doing. My friend's contract was $3.60 / MW on a nominal basis (higher than the $3.00 I gave the company). But, the model needs to be more conservative than the contract because using the contract's number as the base case is too big an assumption.

Aside: I took a two-day course on modeling valuation of banks. What the analyst taught was to basically build future versions of the financial statements. The number of assumptions in doing so easily numbered in the dozens as you had to set assumed growth rates for just about everything and had to say whether or not various margins applied on various line items. Frankly, that scares me to death because I *know* how bad humans are at predicting the future, how many behavioral biases affect those judgments (e.g. overconfidence, anchoring, and recency), and how a mistake in one assumption can have compounding effects by the time you get to the final number, today's value per share.

I want to keep my models as simple as possible while still capturing what I have to think is the essence of how the company works.

Long answer to that question. :-)

*Contrast it to the NoRenewal RV value of $364M and you would get something akin to a gross margin of 45%*

Not really, as the RV also includes future estimated maintenance costs and payments to the investors.

*- Why use a 6% discount rate? How did the company come up with that figure? Why don't you use a higher figure, and how would you go about doing that?*

Because I had to. I have no idea what the yearly cash flows are in whatever model they're using (cash inflows vs. outflows) and I can't back engineer it with any reliability. This means I can't model it on a year-by-year basis which would give me the ability to change the discount rate.

I am assuming that this is their cost of capital, but that is a pretty big assumption. On the one hand, it's based on the fact that companies are *supposed* to use their cost of capital when discounting to find the NPV of projects. On the other hand, there's the temptation to use a lower discount rate to boost NPV, justified by factors X, Y, and Z.

What this implies is that this is the interest rate they're required to pay their investors on what are, essentially, bonds. When they start floating bonds funded by the leases themselves instead of the tax credits (and they're working toward that), I'd expect them to change the discount rate used to calculate RV, assuming the bonds have a higher (or lower) interest rate. If I knew what the interest rates actually were (and they might be available and I just haven't found them), I'd be able to make a judgment and adjust my model to account for any differences.

Good questions, as I wrote, and I hope my answers adequately addressed them.

Cheers,

Jim

No. of Recommendations: 0

*The biggest lever in the model I built is the growth rate of MW installed. I think I was pretty harsh here, cutting it in half for each of four consecutive years. This covers a multitude of sins, to steal a phrase. Among these are changing gross margins (e.g. increases in panel costs that cannot be passed along to customers), failure to increase revenue by selling systems outright, pushback competition from utilities that cuts into the business, and so on. I have no idea how each of those might affect my numbers, so I lump them all into a single spot and try to be conservative there. *

Hi Jim,

If it isn't too much work, how does reducing the "harshness" of this assumption impact the conclusions? What if it's only reduced by 1/3 per year, or 1/4? Does that have a material impact on the model's conclusion?

This is a really interesting conversation and company, by the way. I've thoroughly enjoyed this discussion.

Fletch

No. of Recommendations: 0

*If it isn't too much work, how does reducing the "harshness" of this assumption impact the conclusions? What if it's only reduced by 1/3 per year, or 1/4? Does that have a material impact on the model's conclusion?*

Hi Fletch,

Oh certainly it does. I don't have the model in front of me, but the whole thing depends on the amount of incremental MW installed each year. If the drop in growth rate each year is less than 50% (33% or 25% drop a year, as you proposed), then more incremental MW of systems would be installed each year than currently modeled. That ultimately means more RV growth and a higher total in 2017 (the last year of the model). And that means a higher projected share price a few years down the road, assuming the rest of the model stays constant.

When building a model, I'd rather be too pessimistic and therefore pleasantly surprised by actual results, than be too lax (thinking I might be more "realistic") and be disappointed. But then, given our human propensity to overconfidence, even being "harsh" I'm probably not conservative enough. :-)

Cheers,

Jim

No. of Recommendations: 0

I totally get it. Thanks Jim. I'm pretty excited about this company and am enjoying learning everything I can.

Thanks for sharing all of your hard work on this.

Fletch

No. of Recommendations: 0

Hi All,

I just run into this board by chance. Your discussion of SolarCity has interested me. Would you please help me to understand what is 'Real money stock Picks board' and what is 'Messed-Up Expectation Portfolio'? It seems this board doesn't belong to any of the services such as SA, RB, etc. Thanks.

Afai

No. of Recommendations: 0

*Would you please help me to understand what is 'Real money stock Picks board' and what is 'Messed-Up Expectation Portfolio'?*

Hi Afai,

Happy to! And glad that you found this board. :-)

In Nov. 2010, the Fool launched a set of small portfolios ($5,000 each, and contributing $1,000 each month) that are run by several of the in-house analysts at the company. It was originally called "Rising Stars" but the name was later changed to "Real-Money Stock Picks." A real improvement, huh? :-) Here's the overall page: http://www.fool.com/specials/realmoneyports/real-money-portf...

Each of us presented to the organizers an outline of what type of investing we would do and I chose an idea that had intrigued me that I read first in a book by Michael Mauboussin, chief investment strategist at Legg Mason (and who's spoken at TMF), called *Expectations Investing*.

In that, he pointed out how hard it is to value a company given that there are dozens, if not hundreds, of assumptions built into any model. Instead, he wrote, turn the DCF model exercise on its head and see what the current price has to say about the growth assumptions currently baked into the price. Then compare those to what the company has done and is likely to do in the future. Buy when expectations are low and sell when they're too high.

Thus the Messed-Up Expectations portfolio. http://www.fool.com/specials/realmoneyports/real-money-portf...

More details on this, at least how I started with my thinking, can be found near the beginning of this board.

Since then, I've added a couple of other criteria, the biggest of which is looking for a catalyst that the company could use to correct the market's misconception.

For SolarCity, I think the messed-up expectations come from the confusing business model, the uncertainty of being able to operate successfully with that model, and the negative connotations all things "solar" still labor under, even thought there is a very big push worldwide toward this type (and other types) of non-fossil fuel energy.

Feel free to poke around and ask questions.

Cheers,

Jim

No. of Recommendations: 0

Hi Jim,

Thank you for explaining it to me. I really like Solarcity for the way it helps the home owners to obtain solar energy without having the home owners to put up so much money at the front. If I remember correctly, it seemed SCTY had made couple deals with Viridianwill and Direct Energy to install solar panels for their customers. I hope that SA or RB would recommend SCTY in the near future.

Thanks.

Afai

No. of Recommendations: 0

Jim,

Thanks so much for such a thorough reply!

Wouldn’t a growing annuity solve the issue of forecasting the lease payment revenue? I too wanna be wary of making too detailed projections (doesn’t improve understanding, makes us overconfident). However a 20 year fixed payment, growing at the inflation rate or so, doesn’t seem too far fetched. And we can project that future lease payments coming from incremental contracts decrease over time to account for competition. According to *anecdotal evidence I gathered over the internet*: there are some solar-energy installers in America offering comparable one-stop-shop services whose undiscounted lease payments per customer are about $5K lower than SCTY’s cost– a considerable sum for most households our there. I think SCTY can achieve a reputation for quality and justify higher prices than the competition, but i doubt they can manage to increase price on an absolute/nominal basis. I agree with your projection of falling $$/MW in the future.

My issue is mainly about the cost structure, and how opaque the company is regarding the cost assumptions in the RV calculation. If I had to model that, I guess I would apply a growing annuity + a big lumpy initial payment (to account for the solar system purchase). I care about this cuz I surmise that solar energy installers such as SCTY are benefiting from excess supply and solar equipment dumping on behalf of Chinese exporters selling at a loss. I would like to figure out how this would look like if the industry became more rational and starting selling equipments at higher prices – and its effect on solar-energy-installers. As you well pointed out, doing this is incredibly hard at this point, we just have too little information and there are too many variables.

In any case, I agree with you that one shouldn’t over-model stuff we know little about. That is clearly the case with SolarCity given the opacity of the cost structure (and RV assumptions regarding projected costs). I realize that all valuation methodologies are relative (even DCF); but I still feel a heck of a lot more confident buying the stock of a company I think is undervalued based on a DCF estimated fair value, than buying the stock of a company whose valuation is limited to the projection of sales and other (non FCF) metrics such as RV, and applying an exit multiple. That said, I think your model is the best next thing given the information we currently have.

I consider myself to be a novice investor, and I think that studying other investors’ valuation models is the best education one can get (that is, after thoroughly studying everything Buffet ever said). Again, thanks a bunch for sharing your insights!

-Will

No. of Recommendations: 0

Jim:

I just wanted to let you (and others) know that my Solar City system finally went live last Friday, so it's been generating electrons for four days now. Unfortunately for some reason, the output is not being reported to the on-line monitoring system yet. Solar City has an open trouble ticket on it and expect a resolution in the next two days.

John

No. of Recommendations: 2

"I just wanted to let you (and others) know that my Solar City system finally went live last Friday, so it's been generating electrons"

Living in North Dakota, an evacuated tube heat collector with just enough PV to run the circulating pump would be more interesting. For those who don't know, evacuated tubes are so efficient they are using them at the south pole base where it is about 40 below in mid summer. Here we could use it in the winter for DHW and space heat, and in the summer use the space heat part to warm the ground under the house.

We got our attic > ground heat storage system running in late April. Water returning from the buried tube is 13 degF warmer than when first measured, so we are storing heat in the ground. The attic runs notably cooler, as much as 20 degF on a hot sunny afternoon. Given enough spare time, plans are to rig a hot water preheat and run the warmed water through that first, then through the buried tubes.

Douglas Hvistendahl

Dumb mistakes are irritating.

Smart mistakes go on forever,

unless you test your assumptions!

No. of Recommendations: 0

**SolarCity Soars On Installment Expectations For 2014**

*SolarCity (SCTY) stock soared Friday to a five-month high after the company announced it will significantly expand its solar energy installations in 2014.*

The company, whose chairman is Tesla Motors (TSLA) CEO and founder Elon Musk, expects to achieve 278 megawatts of solar energy power deployed this year, increasing that to between 475 and 525 megawatts next year. At the midrange, that would be an increase of 80%.

http://news.investors.com/101113-674760-solarcity-solar-pane...

John

No. of Recommendations: 0

Hi Jim,

I'm wondering how SCTY's recent announcement regarding 2014 production impacts your model?

Thanks,

Fletch

No. of Recommendations: 0

*I'm wondering how SCTY's recent announcement regarding 2014 production impacts your model?*

Hi Fletch,

Sorry not to respond sooner, but I've been on vacation (flying home today) and just read this. Seems like good news and the stock jumped, so it is probably good for the model, but no details from the model as yet. More later when I have a chance to catch up on 2 weeks of stuff (by which time I'll need another vacation).

Cheers,

Jim

No. of Recommendations: 0

Hi Jim,

Do think SCTY is still a good buy at this price or is it a hold?

No. of Recommendations: 0

*Quite surprising that this has never been a RuleBreaker recommendation.*

Frank:

I think it's just a matter of time. We'll be glad to have been frontrunners.

John

No. of Recommendations: 0

$62.58 - I literally had to force my fingers to press the computer keys at that price to purchase.

We will see where it takes us.

Frank

No. of Recommendations: 1

*I'm wondering how SCTY's recent announcement regarding 2014 production impacts your model?*

Hi Fletch,

OK, if I put in 278 MW installed for 2013 (instead of 270, which I had previously) and increase 2014 estimates from 385 MW (which would have been 1/2 the growth 2013 sees) to 450 MW installed for 2014 (still below the 475 - 525 MW range the company gives) -- which means 66% growth over 2013, keeping all else the same (cutting growth in half each year going forward) and not fiddling with any other parameters, I get a projected market cap of $5,244 MM at the end of 2017. That's only 8% higher than its current $4,857 MM market cap today.

Today, it's trading at 7.3x Retained Value (using end Q2 2013 RV numbers), while the 2017 projected market cap uses a 1.5x multiple on $3,496 MM in RV. The recent rapid rise in price has really put a crimp on returns from today, assuming the model is accurate. Note, though, that the model is not accurate, as I originally had 385 MW installed in 2014, not the 500 MW the company is projecting now, and I don't expect it to be accurate.

Cheers,

Jim

No. of Recommendations: 2

*Do think SCTY is still a good buy at this price or is it a hold? *

Hi chad,

I'm hesitant to answer a question like that because I don't know you or your circumstances. For me, I think it's a speculative buy today, with the price possibly a bit ahead of itself. The company's not earnings positive yet and not even cash flow positive quite yet (though it's supposed to be the latter beginning Q4 2013).

The market's a game of expectations, however, and given the 80% year-over-year growth (at midpoint) the 2014 MW installed guidance has, the market is certainly expecting good things from the company. Can it grow installations that much every year (77% this year expected, 80% next year)? I doubt it, which is why my model cuts MW installed growth so quickly over the next few years. But that's possibly too conservative, who knows? My initial projection of 385 MW installed for 2014 based on 1/2 of 2013's growth rate is likely to turn out to be way low, which affects the valuation tremendously. That's why I said speculative. There just isn't enough history with the company yet to have a feeling for how well they can live up to their own expectations and guidance.

I'm investing in the company both personally and via the MUE port with a multiyear horizon and I hope you would, as well. Given the rapid rise in price recently, though, a fair amount of good results is now expected. If it doesn't meet expectations, then it will likely get whacked, but I have no idea if that will happen or not. Another reason why I wrote "speculative buy."

I think the future is good for the company, but it could go either way. That's a third reason. :-)

Anyway, take it for what it's worth and not as telling you what to do. In other words, if you decide to invest, do it with eyes wide open.

Cheers,

Jim

No. of Recommendations: 0

Thanks Jim. SCTY is a little over a double for me at this point, and I can't figure out if I should sell an overvalued hot stock, or buy more of an incredible company at the very beginning of its growth story! Haha, I'll likely add to the position if I do anything as I've been transitioning to the "nearly never sell" Stock Advisor mentality over the last couple of years and it's been working out very well.

If the market gives the "Elon Musk" premium to SCTY that it arguably gives to TSLA, the 1.5x multiple on RV could be pretty conservative. Or not. SCTY might have a wider range of potential outcomes than just about any other company I follow right now. Should be an interesting ride.

Fletch

No. of Recommendations: 23

Hi John,

http://seekingalpha.com/article/1969331-solarcity-the-most-e... by CDM Capital

An interesting article. It raises some good points, ones I've raised myself, but it also has some assumptions that I'm not sure I agree with.

**Author is short:**

It's good that this is disclosed. Take the bias that raises into account when reading the article.

**Investment banking and ratings:**

This is indeed a concern and a possible source of conflict of interest. I haven't read the reports by the various sell-side analysts, but they should include the disclosure that the firms they work for have an investment banking relationship.

I don't think CDM Capital quoted any analysis by those who did *not* have a banking relationship with SolarCity. If that's correct, it could be for a couple of reasons. First, there isn't any (which I'd be surprised if it were the case). Second, it all agrees with what he is calling out, so he doesn't feel it strengthens his case. If this other research didn't agree, I'd feel he probably would have called it out as further proof of the bias of the ones he is talking about.

**Discount rate / cost of capital:**

This is a legitimate issue. The discount rate one should use is the firm's cost of capital, which is a weighted sum of the cost of debt and the cost of equity (abbreviated as WACC, weighted average cost of capital).

Cost of debt is straight forward, being the interest charged on the company's debt, less the tax savings on interest paid. I haven't done a lot of digging so I don't know for sure if SolarCity discloses this. It could indeed be 6%, the discount rate SolarCity uses for the retained value calculation.

Cost of equity is much harder to determine and the best one can do is estimate it. If you already know this stuff, please skip ahead. One way to figure it out, especially for non-dividend paying companies (like SolarCity), is the risk free rate plus the product of the company's risk premium and the stock's beta. (That's the Capital Asset Pricing Model way of doing it, which has some assumption problems of its own, but is used because it can actually be calculated.) Risk free rate is the Treasury rate for the period of investment, currently around 2% to 3% for a 10-year note. The risk premium is how much extra an investor requires to choose to invest in the company rather than the Treasury and, historically, has averaged between 3% and 7% or so. Beta, of course, is how much the stock's price moves relative to moves in some comparable index, usually the S&P 500.

You can see that cost of equity is always going to be higher than cost of debt.

All else equal, a lower discount rate makes the discounted total higher than when calculated with a higher discount rate. I agree with CDM Capital's point that the discount rate used for Retained Value is almost certainly too low, but in order to use a higher one (e.g. the 9% WACC CDM Capital estimates), one needs to know the annual cash flows for the period modeled, and SolarCity doesn't disclose those, as far as I know.

**Cost of capital estimate:**

Hmm, let's see what I can come up with. According to the latest balance sheet (9/30/13) capital = $316.4 MM debt + $306.1 MM equity = . Beta (Y! Finance) is not available (I believe Y! uses a 5-year, monthly number, which obviously isn't there). It's easily enough calculated, though, from historical prices. It's the slope of the linear regression line fitting the data of the stock's price changes vs. the S&P 500's price changes. Usually this is monthly, but SCTY has been trading for just over a year, so let's use weekly, Friday closes. For SCTY, the weekly, 1+ year beta is 3.68 (and that value is statistically significant at a quite low p-value of 0.00055, meaning the chance that it's no different than zero is only 0.055%; in other words, use it).

The 10-year T-note rate is 2.75% according to Y!. It's a fairly risky company, so let's give it a risk premium of 7%.

Cost of equity, Ke = 2.75% + 3.68 x 7% = 28.51%

Let's assume cost of debt, Kd = 6% since that's what the company is using for its retained value calculation and I haven't tried to dig out what it's paying on its debt. Let's further assume that it will eventually pay 35% in taxes. Here's the calculation for WACC:

WACC = (316.4/622.5)(6%)(1-0.35) + (306.1/622.5)(28.5%) = 16.0%

For a company that's perceived to be as risky as SolarCity, that's not an unreasonable WACC.

**Which discount rate?**

So the best handle we have on present value of the company is the retained value, which is the present value of the cash flows to the company from its future lease payments after paying off the debt holders, discounted back to the present. What discount rate should the company use?

To see why this is so important, look at the present value of an annuity, which is an unending stream of regular cash flows. The present value is the annual cash flow divided by the discount rate. Assume $1000 per year. With a discount rate of 6%, PV = $16,667. Bump it up to 10% and PV = $10,000. Bump it further up to 16%, what I got above, and PV = $6,250, some 63% lower than the 6% PV level.

I'd really like to see how CDM Capital calculated a drop in retained value with its higher 9% discount rate. The model they built to do that would tell us a lot of how they're thinking of the company and give us a chance to assess the validity or reasonableness of the assumptions.

Even more, though, what I'd really like from SolarCity is an explanation of why it uses 6% as the discount rate when calculating retained value, so that I can judge the reasonableness of the assumptions and reasoning.

Failing that, I'd be more comfortable if the company discounted at a higher rate than 6%. That it doesn't is one of the dings against it. But unless I build a model of projected annual cash flows, for which I believe not enough information is available to make it nothing more than a WAG, I cannot use my higher 16% discount rate.

So, I tried to approach this issue in a different way in my valuation model, by underestimating how many MW of power the company is likely to install. Let the company use it's inflationary 6% discount rate, just give it less to inflate. See my original model upstream in this thread for how I tried to do that.

**100% renewal assumption:**

This is another good point raised by CDM Capital. The original leases are 20 years long. It's pretty aggressive to assume 100% of those customers will renew for an additional 10 years (where all the cash flow belongs to the company). That's another ding against the company.

I addressed this the same way that CDM Capital did, by whacking it back quite a bit. CDM cut it by 50%; I went further and dropped it down to 33%.

**Price to sales:**

Focusing on this, I think, is a mistake. The company reports squat for sales because it isn't selling the equipment, it's leasing the equipment. This will always be inflated. Similar for P/E ratios at this early stage of the company's development (though the author didn't touch upon those). And looking at gross margins is also incorrect (which the author does do). It's a lease model, not a sales model, business.

**Government investigation:**

This is a known issue. Drawing a causal linkage between the government's investigation of how SolarCity valued the installations for the tax benefit payments and lower gross margins is, in my opinion, spurious. Criticizing the company for not more vigorously defending itself against Forbes is also silly because it ignores the fact that it's stupid for a company to comment publicly on an ongoing investigation. Anything it says can probably be fed into the investigation, so it's prudent to stay silent. The argument that if it has nothing to hide it should be blabbing all over the place is ridiculous. Any corporate lawyer would advise management to stay mum while being investigated, regardless of the "guilt level" of the company. Doing otherwise could only make things worse.

**In conclusion:**

There are some good points raised about the company, ones that I've tried to address in my thinking about it and rough valuation of it. There are also some points which I consider are either based on a misunderstanding of the company's business model or not enough thinking on why the company might be doing things a particular way.

In summary I agree with several of the points raised by CDM Capital. However, I don't necessarily agree that it is "egregiously overvalued."

Better than most articles by short holders, but doesn't really raise anything new.

Cheers,

Jim