I'm a few days late to this party, but finally took a look at the SolarCity S-1 yesterday. A few things have already been written about the business, so I won't redundantly go into all the discussion of operations, risks, etc. (Even better, read it for yourself.) But here are a few items I'll add in that caught my eye.
First of all, for a business model like this, discussions about cashflow and margins aren't straightforward. Much has been written about this being a high cash burn model -- but you have to look under the hood on that, and then really pay attention to the IRRs of their projects, which is the heart of the business. That's not spelled out in the S-1, of course, but this Woodlawn Associates analysis does a very good job of teasing that out. I'll echo what they say, namely, that SolarCity appears to be getting pretty industry-standard IRRs, from what I've seen in the market. A good data point, but it also suggests there's no magic returns advantage to the company, other than benefits of scale to attract the lower-cost capital.
Secondly, the company really is growing impressively. It's basically been doubling installations every year since 2009. Again, I think that's not that unusual for this market -- solar financing is simply exploding right now. Part of that is simply the power of this type of financing model to unlock consumer buying decisions; part is the significant drop in solar panel and other costs, but a relatively unnoticed factor is the drop in the cost of customer acquisition over time.
You would expect there to be an inflection point in any small but fast-growing market where customer acquisition costs go down over time simply because customer awareness breaks through some kind of threshold and then customers need less education, etc., to want to make a purchasing decision. Interestingly, however, for SolarCity, there are indications that from 2009-2011 the cost of customer acquisition stayed flat. A simple calculation of sales and marketing spend per MW booked stays pretty constant during that period, coming in at between $250-$300 per. This is a curious lack of advantage from scale at the company, and if these figures are indicative of the industry as a whole, it is even more curious.
But I'm seeing a pretty important shift in the marketplace over the past 18 months or so, to really focus on reducing the cost of customer acquisition. Lots of innovative approaches either via technology (remote assessments) or economies of scope (turning to roofers, energy auditors, etc. as lead generators). I think we'll continue to see these costs driven down over time as better data mining and direct marketing capabilities are introduced to the market. And that's more important than you might think -- as Woodlawn Associates points out, SG&A costs per Wp for SolarCity averaged $0.48 over the past few years, with sales and marketing being something close to two-thirds of that spend. When we're all enamored of solar panel prices falling below a dollar per peak watt, reducing the implied $0.30 per Wp in sales and marketing costs would be important for continuing to accelerate the growth of this market.
It's an under-appreciated aspect of the solar market for sure -- I recently was told by an insider about how frustrated even Secretary Chu got a couple years back, when he started learning about how important installation, etc., costs were to solar power competitiveness, and that simply reducing the costs of panels wouldn't be sufficient.
But in light of all that, it's striking to see that in the first half of this year, SolarCity's sales and marketing per MW booked dropped by something like a third, to under $200 per. And it's not because the projects got bigger -- a similar drop is seen on a per-customer basis (from $5,356 per new customer in 2011 to $2,399 per new customer in 1H12). Is that a sudden materialization of the market shift I describe above? Or is it the result of SolarCity's "SolarStrong" program with the military, and similar aggregated sales that might require less effort per home booked? If the former, that's great news. If the latter, you have to wonder if it's a bit of an aberration, at least for SolarCity. The truth may lie in the middle somewhere.
Finally, the company's recent venture financing history is pretty fascinating. At least to me.
At first blush, the company's $81M Series G raise earlier this year was at a shocking valuation. The implied valuation appears to have been something in the neighborhood of $1.9B (fully diluted).
But before all you solar entrepreneurs get stars in your eyes all over again, note the fine print on the bottom of page 137:
"Each share of Series G preferred stock is initially convertible at the option of the holder into one share of our common stock. Pursuant to the terms of our amended and restated certificate of incorporation, upon the closing of this offering, each share of Series G preferred stock will automatically convert into a number of shares of common stock equal to the quotient obtained by dividing (A) the original issue price of $23.92 per share by (B) the product of (i) the public offering price in this offering (before deducting underwriting discounts and commissions), multiplied by (ii) 0.6. However, in no event will one share of Series G preferred stock convert into more than approximately 2.47 shares or less than one share of common stock as a result of this conversion adjustment mechanism. As a result, the outstanding shares of Series G preferred stock will convert into no more than 8,372,072 shares and no fewer than 3,386,986 shares of common stock."
So the valuation was high on paper, but there's a pretty significant ratchet attached to it. And by my simple calculations, this implies that down to a post-IPO price of $16 per share (note: much lower than the $23.92 per share paid by the Series G), they lock in a 67% return -- as long as the price remains that high at the point where any lockup expires. That's not a bad return, and locking it in with this ratchet makes the high Series G valuation much less relevant than it might appear. Indeed, the share price would have to fall back down below the Series F price of $9.86 per share before Series G starts losing money on an investment where they purchased shares at more than double that.
Venture capital terms like this always fascinate me, and it may be a good lesson for other late-stage investors in the sector, if they're not already deploying this kind of strategy. It's a good lesson in how to give a high valuation and still get a good chance at a decent return.
But it's not a panacea, and I'll note one important implication of this kind of arrangement: It adds pressure for this to be the last round of financing into the company before an IPO (barring possibly just re-opening the Series G if needed), and it puts the company into an "IPO or bust" situation, as far as some very important investors are concerned.
I really want SolarCity's IPO to go well -- we all have a lot riding on its visible success at this point. But I note how the incentives around the table would be for the company to IPO as soon as possible. And that the company's current cash position suggests they may need additional financing relatively soon. Knowing the caliber of the investors in this company, I trust them to not send this company out to the market before they feel it's really ready for prime time, and as discussed above, there's a lot to like about the story (while also some points of concern, as many have noted). But more generally, we've seen too many cleantech IPOs that clearly went out too early. And it's hurt us on Wall Street, and thus hurt our returns as a sector.
Fingers are crossed this time around. Not only do we as a sector need a win badly, SolarCity also looks a lot more like the kinds of companies I've been espousing (and investing in). So I'll be cheering them on. And if they keep growing like they have been, there's a lot to cheer for.