SolarCity Bailout Analysis

[Drivin]

Or, like they have done in normal places, *raise the fixed connection charge* while *cutting the per kwh rates*. Which most utilities have done or are doing.

Good that you didn't lump California in as a "normal place"

 

[Perfectlogic]

Exactly! Just like in the water example. Those fixed costs aren't going away, so if more people are going residential solar, they need to raise rates to cover the fixed costs.

Exactly. The CA system really seems weird, which is probably why it is so expensive there. I was just browsing the site of one of the CA utilities yesterday and noticed that you can choose a system of pay where you pay extra during just the mid day hours when the sun is out, but to offer this option hasn't made sense in years. California’s Fowl Problem: 10 Ways to Address the Renewable Duck Curve

You have to go all the way back to 2012 for the mid day hours to be peak demand for the utilities, and why don't you have to pay extra during the evening hour demand peak? This is the largest of the day. It almost seems like residential solar interests have had influence on the regulation as this system happens to be perfect for you if you have solar on your roof, you get to sell power to the utility back to them at an even higher price than you then pay during the rest of the day with your earned credit. Clearly for the utility this system couldn't be worse as the mid day hours are now the part of the day where they have the biggest excess of power themselves. No wonder the electricity rates are shooting up a whopping 7% this year, what a mess.

 

[SBenson]

Ummm... As I expected the merger agreement and docs are coming out pre-2Q ER.

I suspect docs will not have anything related to SCTY related to 2Q, especially the all interesting cash position.

I seriously doubt SCTY will release 2Q ER at all.

In any case, I don't care anymore. I'm happy for the impending short squeeze.

 

[SBenson]

In my view, for SCTY access to (enough) capital is bigger issue than the cost of capital itself.

At a high level, to do 1GW of installs it needs a capital of $3Bil or thereabouts. Even if it keeps it's install rate constant, it needs external financing of $3Bil each year.

So if SCTY chooses to grow the rate of installs, even worse, it needs ever increasing amounts of external capital each year.

For the longest time, Lyndon Rive famously/repeatedly claimed that SCTY will double it's installs each year for foreseeable future. Had he followed through on that, the capital needs from external financing would be something like:

2016: $3B
2017: $6B
2018: $12B
2019: $24B

LOL

Obviously this is unsustainable. For that matter even raising even $3Bil year in and year out is simply unsustainable.

Essentially, the business model was to become Freddie Mac or Fannie Mae of Residential Solar, but with no backing from Treasury or Fed. Another big LOL.

Anyways, coming to the specifics of the financing, some of it comes through asset-backed financing in one form or other but some has to come directly from SCTY. The more that comes in the form of asset-backed debt the better. So that's always the first priority. Second priority is to raise capital through financing against itself. Third is to deplete cash.

When Lyndon Rive or Musk say that SCTY will become cash-flow positive, they are essentially saying that all company operations will be adequately financed through asset-backed financing. Thus, SCTY doesn't need to raise capital against itself or deplete cash.

Over the last few quarters something became very apparent. SCTY effectively ran out of ways to find non-asset financing (second option).

For instance it did a heroic raise in Q4 through the Silver Lake deal, which effectively amounts to avoiding the financial system to borrow from an old friend or brother-in-law.

Period........Cash & Equiv....Change
Q1 2016....361,660,992....-32,194,016
Q4 2015....393,855,008....-24,511,008
Q3 2015....418,366,016....-70,718,976
Q2 2015....489,084,992....-86,764,032
Q1 2015....575,849,024....-66,844,992
Q4 2014....642,694,016....-90,764,992
Q3 2014....733,459,008
Q4 2013....577,080,000
Q3 2013....132,986,000
Q2 2013....159,606,000

For context, even with Q1 ending figure, SCTY is operating with the lowest cash level since Q4 2013. The company operations more than tripled since then (#employees went from 4K to 15K), so it needs lot more cash in the bank to run it's day to day operations.

In Q4 the cash drop blow was lowered through Silver Lake deal. In Q1 a remarkable number of asset financing options opened up and SCTY figured out a way to raise cash against old deals (existing pool of leases). So the cash depletion wasn't too bad. But as data indicates they were more of one time in nature than a going forward norm.

You can look at all the press releases here to compare Q2 vs previous quarters in terms of how much funding opened up.

I firmly believe cash depletion this quarter has been rather dramatic.

Lets say the world comes to know that it's cash balance is sub 300Mln end of Q2, what will happen? Will financing partners, business partners and suppliers balk and say they can't do business with SCTY anymore?

That's my suspicion. So Musk was desperate to shore up the capital and all desperate measures were already exhausted. So Musk is trying to make a last ditch attempt to save the firm (by taxing TSLA share holders).

Future Scenarios:

If merger falls appart, SCTY will end up declaring bankruptcy. It cannot possibly gradually scale down. The fixed costs will overwhelm. Even a small squeeze in asset-backed funding will thoroughly destroy it.

If merger happens:

SCTY's biggest problem is the business model. Especially the way it sources financing. It did it this way because it believed leases/PPAs were much more profitable. It deluded itself with gimmicky math and fairy tale assumptions. But with the recent Hancock deal, things became abundantly clear that SCTY is not making much money (in DCF) with this model. This is the first time it sold all of the contracted cash flows. So for the first time it got a realistic appraisal of what the value of the contracts is.

So management finally woke up and said, we will do the sales/installs the traditional way where homeowners directly borrow from banks and will simply be facilitators and we would be just as profitable. Thus we get all cash upfront. No need for all these complicated financing schemes and gimmicks. No liquidity issues.

This is the transition SCTY desperately needs. Which I and a few others have been advocating in the SolarCity thread for a long time.

Once it is merged up SCTY will (or should) very swiftly scale down all these PPA/lease stuff and move into traditional sales model. But SCTY needs time and money for this transition. Tesla will provide that - is the idea.

BUT, once SCTY is folded into Tesla umbrella, if it continues will it's old ways, rest assured it will destroy the mother-ship for sure. Absolutely positive on that.

The reason the deal looks scary is that Musk/Tesla were actually praising SolarCity's creative financing schemes as a strength. If Tesla/Musk really believe that, we might as well run for the hills. I hope that is just sweet talk and they don't really mean it.

The most pertinent piece in my first post was this:

"I firmly believe cash depletion this quarter has been rather dramatic.

Lets say the world comes to know that it's cash balance is sub 300Mln end of Q2, what will happen? Will financing partners, business partners and suppliers balk and say they can't do business with SCTY anymore?"

As it turns out the cash did get depleted heavily. Down to $146 mln (from 362 min).

If not for the merger offer, SolarCity would almost immediately go bankrupt with this disclosure and given the fact that capital markets already closed on it a while back (for non-asset-backed financing).

Elon Musk did a super hero rescue on this one!!

 

[TMSE]

The most pertinent piece in my first post was this:

"I firmly believe cash depletion this quarter has been rather dramatic.

Lets say the world comes to know that it's cash balance is sub 300Mln end of Q2, what will happen? Will financing partners, business partners and suppliers balk and say they can't do business with SCTY anymore?"

As it turns out the cash did get depleted heavily. Down to $146 mln (from 362 min).

If not for the merger offer, SolarCity would almost immediately go bankrupt with this disclosure and given the fact that capital markets already closed on it a while back (for non-asset-backed financing).

Elon Musk did a super hero rescue on this one!!

You can also say Tesla got SolarCity cheap. Everything has a price. I think the deal is fair to shareholders in both companies.

 

[TheTalkingMule]

Having to shutter the Nevada operation was the last nail in the coffin. In a time where they desperately needed to shrink sales cost to survive as a standalone they had to eat the entire operation and skyrocket sales cost from an already insane $.60/W to $.91/W.

You can't sell a product that requires $5,000+ in average sales effort per unit. Not in the long run anyway.

Hoping you'll soon be able to buy an all-in-one PPA at tesla.com with just a click.

 

[EV-lutioin]

Solar roofing! Nuf said...

 

[SBenson]

Some people seem to have a false hope that SCTY's retained value in existing projects offer an opportunity for monetisation, which could help with TSLA/SCTY combined company's immediate cash flow.

Keep in mind, excluding renewal portion, which can not be monetised, the NPV is $1.258 Bil.

But here is the rub, all the ABS deals done are done in such a way that the residual cach flow of the out years are prohibited from monetisation. They are offered as "buffer" against defaults. Effectively any project that is part of any ABS deal is done with monetisation.

My hunch is that all projects that could be monetised are already monetised. There is not much left. If at all at most a few hundred million dollars. On the other hand the Cash balance of SCTY is so low that it will be forced to cease operations if it doesn't restore it's bank accounts quickly. So any monetisiation done through emptying the portfolio will barely keep SCTY alive for a few quarters. In reality this scenario might have already passed (or else the company wouldn't have let the cash position get so low).

In a nut shell. It's a false hope to expect SCTY to somehow help out with TSLA cash flow.

 

[TheTalkingMule]

My hunch is that all projects that could be monetised are already monetised. There is not much left. If at all at most a few hundred million dollars. On the other hand the Cash balance of SCTY is so low that it will be forced to cease operations if it doesn't restore it's bank accounts quickly. So any monetisiation done through emptying the portfolio will barely keep SCTY alive for a few quarters. In reality this scenario might have already passed (or else the company wouldn't have let the cash position get so low).

In a nut shell. It's a false hope to expect SCTY to somehow help out with TSLA cash flow.

There are people that think SCTY will HELP with cash flow at Tesla? That's a bit rosy even for me.

Why your concern about their ability to pull in cash? They just secured nearly $1B in fresh deals. Isn't this about the largest/easiest string of bank deals we've ever seen out of SCTY?

 

[SBenson]

There are people that think SCTY will HELP with cash flow at Tesla? That's a bit rosy even for me.

Why your concern about their ability to pull in cash? They just secured nearly $1B in fresh deals. Isn't this about the largest/easiest string of bank deals we've ever seen out of SCTY?

Only the $305mln of Cash Equity financing is of real value.

The other two are credit/tax-equity facilities for future projects. They don't add to the cash flow. There is an earlier deal which is also tax equity facility announced during the quarter.

To give perspective, net of tax-equity, SC spent $400mln+ in Q2 over 200MW installs. In Q3 they are planning to do less install less at 170MWs. So it will barely be cash flow neutral for Q3, if at all.

However this is not repeatable. SC is trying to sell everything from the kitchen sink. It will have to be profitable to be sustainable. It is far from it as I have shown in the other thread.

In any case I believe the merger will happen due to Elon's mighty will. Then there will be massive restructuring behind the scenes. We will all live happily ever after. Nothing to worry.

Cheers!!

 

[Ulmo]

Or, like they have done in normal places, *raise the fixed connection charge* while *cutting the per kwh rates*. Which most utilities have done or are doing.

I'd like more accurate accounting: charge for each sub-aspect of the service more accurately. For instance, charge for grid transit, which gets broken up into pieces:

• Fixed capital costs for that level of grid connection
• Variable costs for that grid connection, e.g., transformer overheating. This should still have an economic disincentive programmed in for the utility to not under-provision. This could be either done by regulation (ugh) or competition (also ugh, but possible in places that do undergrounding projects much more easily).

Then, charge for electrical use:

• Electricity that is bought (and sold) and accounted for in the utility's bill (utility provided)
• competitive electricity that is bought (and sold) across the utility by other entities (per agreement, whether regulated or not)

The utility can break down time of use, quality of source, cost of source, etc., according to the various elements above, or better elements. Just make all the accounting more accurate.

Almost everyone looking at this agrees, except for one problem: making the accounting more accurate exposes all of the income shifting going on. Today, there's a lot of hidden welfare for people that vote for big government, big welfare, etc.. A lot of it is class-biased (even race-guilt-biased), environmental, etc.. (As an environmentalist, I don't like being grouped up with the super-classists (and racists, when that exists).) Unhiding that welfare does a bunch of things: it puts into question the good welfare, the bad welfare, the good environmental incentives, the bad environmental incentives, etc. But, I say, let's question it, and come up with a new charging paradigm. Since most utilities are heavily regulated, this puts the onus on the politicians. Unfortunately, they generally act dumb (whether they are or not), and the utilities similarly act special too, so change in this area can be tooth-pulling in nature. But, there is ample opportunity to deliver better progress, product, and outcome in this area, and I truly hope visionaries at the utilities and government step up, at least enough to get the balls rolling on this. I think they will be forced to by the changing economic landscape of energy, and already are taking some of the steps along this path.

I feel like while this is all happening, we're kind of stuck in a wind storm of changing events, and we're trying to point out this and that while it's all flying about. We can do it, but often, it looks self-contradictory, whether it is or not. For instance, when the Nevada PUC didn't grandfather the existing solar contracts, it was grid costs vs. return on investment for clean energy, and boiled down to "whether or not to grandfather", before which, a lot of contradictory accusations went flying around, and it took a good looking at by all parties to really see clearly. I blame everyone, some parties more than others (look in their intents), but also I think everyone did well by their end, some parties more than others (ditto their intents). (I'm already on record as bashing certain "evil parties" on this, so I don't feel like I have to keep declaring that loudly. Luckily, we see the Casinos having to disclose some more of these issues, so it is being explained by others for us.)

Ultimately, the solutions involve all these parties. We will continue to see some of the evidence of whirlwinds of activities that go on in these "wind storms" (my analogy). This is the marketplace hobbling along toward the future, in its own way. We all know that, I think. We will see more of this. The overall trend is similar: more clean energy.

 

[neroden]

Almost everyone looking at this agrees, except for one problem: making the accounting more accurate exposes all of the income shifting going on. Today, there's a lot of hidden welfare for people that vote for big government, big welfare, etc.

Actually, most of the hidden welfare is for rural people, who then go out and yell about how they want to vote for small government. If they actually get small government it tends to be a rude awakening for them and they start demanding big government again. I really cannot stand the hypocrisy involved in that...

Electricity is a very good example: rural grid electricity is very expensive to provide and is heavily subsidized by urban dwellers, but the average rural person doesn't realize that *he's* the one getting the welfare and the urban dweller is the one paying for it. :sigh: (To be fair, *some* rural voters do understand that they are huge welfare recipients.)

 

[jesselivenomore]

I'm curious to continue this discussion now that some time has passed. I have not followed SCTY as long as some of you, so please correct me if I am wrong about any of my observations.

SCTY is essentially a financing company. It takes loans out against itself to lease out equipment. As long as the lease payments are greater than the interest payments, the company is profitable in the long run. There isn't some fundamental flaw here with the model which prevents it from working.

The problem is that access to capital is dependent on many factors, including overall business climate, so the level of interest payments is not set in stone. When there is an industry downturn like we've had, capital gets tight, and all of a sudden the math doesn't add up anymore. However, that doesn't necessarily mean that the business model is broken. When oil prices were crashing, many oil companies reported losses. When the financial crisis hit, banks were on the verge of insolvency. But that doesn't mean those businesses had a broken model under nominal conditions.

From what I understand, SCTY along with many in the industry were staffed and prepared for a demand spike leading up to the ITC being phased out. When the ITC got extended, while good for the industry in the long run, it meant much of the expected demand did not materialize. This resulted in high costs from overstaffing. This was exacerbated when the Nevada PUC mess happened right afterward, leading many potential customers to hold off until they saw how the situation played out. All of this contributed to the turmoil in the industry(not just SCTY), the higher than expected costs and losses, and thus higher costs to capital. Now perhaps management could have done a better job anticipating all this, but management missteps do not equate to a broken business model.

Sunrun and VSLR have the same business model as SCTY, and aren't as well capitalized as SCTY. Neither are bankrupt, infact VSLR just closed $303M in financing.

With all that said, I do now believe the SCTY acquisition was a bailout, and without it SCTY would have gone bankrupt. Not because of its business model, but because of the weight of the Buffalo factory. Capex was $1.8B in 2015 and $1.3B in the first three quarters of 2016. In an already extremely challenging business environment, the capital needs of building and ramping the factory would have been too much to overcome IMO. Also, I speculate that the Buffalo Billion bribery scandal which halted funding also contributed. The factory was supposed to go online at the end of 2016, but got delayed. The scandal happened I believe mid June, and almost immediately a few weeks later TSLA announced the acquisition - which promptly brought in Panasonic to bail the factory out. SUNE went bankrupt for the same reason, it was trying to ramp a 3gigawatt factory that it sunk all its money into.

If this is correct then what's important for Tesla is that it did not waste shareholder value by bailing out a broken business model just to save Elon's ass or keep Spacex's solar bonds solvent. It bailed out a company that got overextended in an extremely challenging industry environment, who's business is viable and can produce long term value once the industry stabilizes.

I'd especially like to hear SBenson's take on what I'm missing here, since I know you have a very bearish view on this and you've been following it from the start.

 

[MitchJi]

With all that said, I do now believe the SCTY acquisition was a bailout, and without it SCTY would have gone bankrupt. Not because of its business model, but because of the weight of the Buffalo factory. Capex was $1.8B in 2015 and $1.3B in the first three quarters of 2016. In an already extremely challenging business environment, the capital needs of building and ramping the factory would have been too much to overcome IMO. Also, I speculate that the Buffalo Billion bribery scandal which halted funding also contributed. The factory was supposed to go online at the end of 2016, but got delayed. The scandal happened I believe mid June, and almost immediately a few weeks later TSLA announced the acquisition - which promptly brought in Panasonic to bail the factory out. SUNE went bankrupt for the same reason, it was trying to ramp a 3 gigawatt factory that it sunk all its money into.

I thought that the funds for building and equipping the factory are being paid by NY State. Isn't that correct?

 

[jesselivenomore]

I thought that the funds for building and equipping the factory are being paid by NY State. Isn't that correct?

Hm, you're right. But during a funding halt who foots the bill?

 

[MitchJi]

Hm, you're right. But during a funding halt who foots the bill?

I assumed that the project is just paused.

 

[dc_h]

I assumed that the project is just paused.

Ny state is paying. After Panasonic agreement, Panasonic pays for the equipment. Without merger scty probably doesn't outsource the mfg and probably can't close the factory. The merger was risk absorbing, but Elon has derisked everything created an annuity of the existing assets and a low investment business from what is normally a capital intensive business.

 

[RobStark]

New York State is responsible for up to $750M including equipment.

Any over runs are Solar City responsibility. Solar City budgeted $150M for overruns but have not heard of any yet.

Panasonic wants to add specific equipment so Panasonic is paying for that.

Once SCTY( now Tesla Inc) meets targets for hiring, revenue, and tax payments it can trigger a clause in the original agreement to double the size of the Buffalo Gigafactory at New York State taxpayer expense.

 

[WarpedOne]

So, this makes the bailout interpretation void.

 

[TheTalkingMule]

Not really. If SCTY had kept up business as usual in that environment, they may have run into trouble getting financing and run out of money. That's just the nature of building an 80% growth end-to-end machine that requires full financing, those factors kept them on the financial tightrope in perpetuity.

What people forget is that they had(have) options. If they wanted to, SCTY could have very easily scrapped their PPA offering in new markets and just done straight profitable sales in an market outside of the most mature(profitable) ones. They could very easily coast along on that forever, that's simply not part of the vision.

I imagine we'll see a slimmed down offering from Elon very shortly with little internal sales cost but huge customer referrals(like as high as a Model S). Eliminating the current sales model is the key to not only Tesla's success, but the entire residential marketplace. Elon can drive that change industry-wide simply because they're the biggest player.