Long/Short Investments
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Long/Short Investments in L/S Equity: Valuation and Ideas,

​SolarCity (SCTY): The Problem with “Retained Value”

SolarCity (SCTY) is a company I’m currently short, as I believe it’s a poor business, and have written my rationale as to why I believe so on two other occasions on WhoTrades.

SCTY has a very promotional management team led by, in my opinion, the influence of Elon Musk, its chairman and principal shareholder. Musk, of course, recently stated that he expects his electric-powered automobile venture, Tesla (TSLA), to one day have a $1 trillion market capitalization. He approaches SCTY with a similar promotional mindset, which I believe is best embodied by his creation of the metric “retained value” to assist analysts in helping value the company. Analysts place stock into the measure given the company isn’t profitable, nor does it have positive EBITDA figures, rendering normal multiples unviable. Retained value is essentially the net present value of payments to tax equity investors minus the value of pre-existing solar panel leasing contracts. In plainer terms, it is simply the present value of the cash flows SCTY expects to generate from a solar panel system.

Retained value is deeply flawed and more promotional than anything for a few main reasons stated below.

  1. These cash flows are discounted at 6%, which is way too low if I were to adopt the mindset of a tax equity investor (and, by natural extension, a SCTY shareholder). Tax equity investors would be irrational in demanding only a 6% return on a relatively high-risk, long-duration investment. These cash flows are not collateralized by robust, reliably appreciating assets that would justify a mid-single figure discount rate. They are collateralized by aging solar panels, assets that steadily depreciate over time and run the risk of being entirely devoid of value several years down the line. Therefore, investors’ expected return should not rationally be less than the historical average of U.S. stock returns, but somewhere in the vicinity of the rate of return one would expect for an illiquid, risky security (10% and above). If interests rates rise, the 6% rate will be even more unrealistic.
  2. It assumes that solar lease contracts are automatically renewed after their 20-year leases expire in 90% of the cases. For one, by 2036, solar technology will be different and today’s technology will likely be antiquated by comparison. Therefore, the panel is not going to have much remaining value and SCTY will need to make an expenditure in replacing the pre-existing one.
  3. The necessity of considering a non-zero churn rate is neglected. If customers are financing these panels over the course of 20 years, there will be defaults. A default would result in the reclamation of the used solar system, the value of which is highly uncertain at any given point in the future due to technological innovation, political support for solar subsidies, and so forth.
  4. Retained value understates the fixed costs involved in solar system maintenance and standard selling, general, and administrative fees.
  5. It avoids considerations for income taxes. Many economic models, in general, neglect any mention of taxes, which, the majority of the time, isn’t reflective of reality any time a series of business transactions occur. (Non-speculative) investors who are long SCTY obviously believe that the company will generate positive free cash flow over the long-term. A positive net income over the long-run will create a positive tax bill and would adjust the retained value metric lower.

Standard discounted cash flow is the most reliable means of calculating SCTY’s value and retained value is, in my opinion, a mostly irrelevant promotional distraction.