Back in early September, we wrote about SolarCity's (SCTY, Financial) precarious business model. Since then, shares have plummeted, falling 40% since the publication of the article warning of massive downside.
While the company is traditionally known for disrupting the century-old energy industry by providing renewable electricity directly to homeowners, we argued that the firm operates more like a bank. Essentially, its business can be broken down as borrowing at a low rate and lending at a higher one. If that was indeed the case, SolarCity would be indefinitely reliant on further sources of funding to continue growing. Because banks can accept deposits and access the Fed, they typically have a reliable source of funds. SolarCity's business model doesn't have that luxury.
On Oct. 30, the company announced that is was significantly cutting back expansion plans, stemming from its finite access to the traditional capital markets.
"Going forward we are focusing our strategy on cost reductions and cash flow. Though we expect our deployments to grow in 2016, we are not targeting the same growth rates that have gotten us to our current scale going forward."
Just this summer, SolarCity created a new fund in collaboration “with a large financial institution” to finance $400 million in solar projects. In total, SolarCity has financed over $9 billion worth of U.S. solar projects. To continue its rate of growth, the company would need to tap the capital markets at increasingly onerous rates. Lately, this is increasingly impossible.
Meanwhile, the company would like you to believe that the financing situation is less than troublesome:
"The current dislocations in the solar financing markets have had limited impacts on SolarCity's funding due to our differentiated assets and financing structure. Though the risk-free rate will inevitably rise, we expect distributed solar's risk premiums to continue to compress and secure a balanced cost of capital."
Still, it looks like the expected growth rate for the company has been permanently impaired for a few reasons.
First, the appetite for funding solar financing has clearly deteriorated. Leading the charge has been the unexpected downfall of SunEdision (SUNE, Financial), down over 70% from its high on the year. Shares in so-called "yieldco's", essentially solar utilities, have also performed incredibly poorly. Stock in Terraform Power (TERP, Financial) and Terraform Global (GLBL, Financial) have fallen by almost half on the year. Because, as we argue, SolarCity's business model is entirely dependent on an unending flow of capital, loss of investor appetite for funding such companies is a life-killer.
As such, the premium that investors had been assigning the company for rapid top-line growth has fallen dramatically. The reduction in share price over the past 12 months has stemmed almost exclusively from multiple compression.
The latest plunge has hopefully shown investors what SolarCity's true operating model is. While most are myopically focused on the long-term potential of solar energy, few are looking at the inherent contraints of funding such a roll-out. While the company can still be very successful and hopefully turn cash flow positive next year, investors need to heavily discount their previous growth assumptions.
