Shares of SolarCity (SCTY), which have already seen an astronomical rise over the past year and a half, surged upward earlier this summer on news that the company agreed to purchase Silevo Inc., a maker of solar panels with ambitious plans, for $350 million.
SolarCity provides solar energy solutions for homeowners, businesses, education facilities, and government entities in the United States. Its goal is to reach an installed cost per watt that makes it the lowest in the world, and is competitive with conventional energy without government incentives.
The company’s strategy for its initial growth phase has been to eliminate middle men by vertically integrating as much of the process of setting up customers with solar energy as possible. SolarCity started by insourcing its sales and marketing, then went on to vertically integrate installations, then financing, reducing costs at each step along the way.
Furthermore, the company has revolutionized the way solar energy is financed. In the past, households that wanted to convert to solar-powered energy consumption had to make large upfront payments to buy the panels and have them installed and serviced. Consumers had to wait many years to recoup their money through cost savings, and bore much of the risk in between. This created an extremely unattractive barrier. SolarCity pioneered the practice of allowing residential customers to lease, rather than purchase, solar equipment. While customers are usually held to a long-term lease agreement (often 20 years), the model has been very attractive to consumers, who quickly benefit from cost savings.
The Silevo deal will integrate the hardware component of the business, namely the production of solar panels, as well. The company believes that this will lead to considerably more cost savings. Elon Musk, the chairman of SolarCity’s board of directors, has gained credibility in the field of energy technology through his leadership of Tesla (TSLA), which has become a staggering success in the electric-vehicle market. Mr. Musk commented that the acquisition will provide SolarCity with access to the best technology available in the solar-energy field, specifically in terms of low-cost, high-efficiency solar panels. He also believes that the addition will allow SolarCity to lead the industry in economies of scale. Indeed, Silevo has already announced ambitious plans to build one of the largest solar-panel manufacturing plants in the world in New York.
Some critics have pointed out that SolarCity appears to be entering the solar panel business at a time when the market is already oversupplied. Indeed, many leading solar panel producers, such as SunPower (SPWR), have experienced major earnings disappointments in recent years due to a flood of inexpensive solar panels, many imported from China. Chairman Musk has replied that while there is still a glut in the market for relatively low-efficiency solar panels, the high-efficiency model that will be produced by Silevo will be in high demand in the coming years.
High-efficiency solar panels require less surface area to provide the same amount of electricity, which will lead to vital cost savings because most of the non-panel costs, such as labor, installation, wiring, etc. are largely proportional to the surface area of the installed panels. In order to lower the total system cost, higher efficiency solar panels will be key in the coming years. Furthermore, Mr. Musk believes the struggles of the solar panel industry in recent years have actually knocked out some potential competitors by discouraging investment in higher efficiency models, thus leaving SolarCity with a unique opportunity to lead the field in terms of both efficiency and volume.
While the company concedes that solar energy’s cost per kilowatt hour of energy is not currently competitive with fossil fuels, its spokespeople argue that the proper measure of the competitiveness of solar energy should be based on what adaptations will have to be made to the world’s energy mix going forward. Indeed, the world would need hundreds of gigawatts of new capacity each year to meet often-cited international targets for renewable energy, and solar energy may become cost competitive among renewables. As scale is ramped up to help meet those targets, per-unit costs should, according to the company, reach a level that is competitive with fossil fuels and thus could lead to even more dramatic growth for the industry.
For the time being, however, the share price is rising likely in response to the company’s future prospects, not its current profitability. Indeed, while the Silevo purchase significantly expands the scope of the company’s ambitions, SolarCity remains in the initial growth phase of its business model, and we believe it will take a number of years still before investors should expect any profits. Thus, most value-minded investors will want to steer clear of these shares for now.