With the shutdown of NRG’s Home Solar division, David Crane’s bold foray into the residential solar market was abandoned, and the recent bankruptcy of Sungevity has similarly emphasized distress within residential rooftop solar. Yet as the US solar market doubled in the year 2016, it is clear residential solar is not going away anytime soon. Given the failure of some entrants to gain traction and the challenges even of those who are succeeding, what lessons and conclusions can we draw so far from the space?
The first conclusion is that customer acquisition is destiny. For larger players, this means obtaining market share, while smaller players will rely on local relationships and knowledge which is no less critical for building projects.
Major players like SolarCity, Sunrun, Vivint and NRG all focused on spending tremendous amounts on customer acquisition technologies and streamlining processes for getting a customer from interest to closing. SolarCity gained a critical technology edge when it purchased Paramount Solar for $120 million, a company described as a “closing machine”. SolarCity spent roughly $0.71 per Watt of electricity generated on customer acquisition in 2016. This is well-above the industry-wide figure of $0.49 per Watt, reflective of the critical importance industry leaders place on raising a company’s profile and obtaining market share early. NRG also made significant investments in customer acquisition technology, with its purchase of Pure Energies Group in 2014, right after SolarCity purchased Paramount. Sunrun purchased REC’s residential solar unit. Yet these technology innovations were also paired with operations that could cheaply and efficiently install the solar systems. In contrast, now-bankrupt Sungevity spent a considerable sum on its web platform, but paid margin to outside installers to put systems in place, effectively losing some of the benefit of its superior customer-acquisition technology. Overall, ability to plow cash back into the acquisition process and grab more market share has been key for these large players and should be a priority for anyone hoping to rival them at their level of scale.
The second conclusion is that the form and structure of financing in the capital markets is also pivotal, although the form this will take is unclear.
Securitization has so far been the goal of larger players in the residential solar space, and that will fundamentally affect how their equity is valued. “Securitization” is essentially the process by which multiple streams of payments are bundled into a security for purchase by asset managers, most famously in the mortgage space. With mortgages, part of what makes the security attractive is that the underlying cash flows are coming from a diversified pool of mortgages (e.g. some in Kansas, California, New York), bundling all the small income streams into a single, large stream with consistent payments and underlying sound metrics (credit profiles, common terms of the mortgages, etc.). The originators of mortgages are in turn able to free up their balance sheets by securitizing these cash flows. This technique has been used for everything from home alarms to motorcycle loans.
With residential solar, asset managers similarly appreciate that the underlying solar lease or power purchase agreement (“PPA”) produces a steady stream of long-term cash flows for securitization. Yet few players have reached the volume of assets needed for securitization, although the market’s appetite for the products is growing. SolarCity has produced 6 successful securitizations, while Mosaic, Sunrun and Spruce Finance have produced 1 each. NRG Home Solar, by contrast, did not tap into the solar securitization markets, and ultimately ended its existence by originating leads for Sunrun and Spruce Finance, who have successfully accessed these markets. According to a white paper by Marathon Capital, Vivint, SunPower and Sunnova are all close to the market share desirable for securitization. Securitizations have allowed these companies to free up their balance sheets and put more money into growing market share, potentially lowering their customer acquisition costs but also producing dividends for shareholders.
While asset managers have eagerly grabbed securitized residential solar products, they have shunned the stocks of their originators. As of writing, Sunrun is currently trading around $4.94, off its high of $13.74. SolarCity similarly was not a darling of stock analysts before its merger with Tesla. Given that the cash inflows to the companies selling securitized products are not regularized or consistent, one can appreciate how traditional energy investors might find uneven cashflows distasteful, even when they are profitable. This would seemingly suggest that analysts have still yet to become fully comfortable with solar as an equity position even if the debt markets have been eager for the exposure. SunPower and First Solar’s share prices further confirm a general market bias against solar, even though both companies are more profitable than their share prices would suggest.
The securitization process is also transaction-fee intensive and other players have found success pursuing straight bank financing. Banks like CIT, Investec and Keybank have been willing and eager lenders in the residential solar space. And savvy sponsors like Sunlight Financial have also sourced additional financing sources with low fees. With the increased desire of investors for exposure to debt products secured by residential solar contracts, innovative structuring will carry a premium, particularly for first-movers.
Conclusion—It’s too early to tell
When asked about the effects of the French Revolution, Mao Tse Tung famously quipped “it’s too early to tell.” The residential solar space is in its infancy and working through several challenges. Yet it’s clear from the tea leaves that the winners will be those whose strategy gives them the flexibility to reinvest in grabbing market share—either locally or nationally—and to fund their products in the capital markets, with the preferred structure to be decided. Companies answering to shareholders hungry for cash flows to be directed to them rather than back into growth will face challenges against players willing to plow all their earnings back into growth and sales. Also, anyone who can shrink the customer acquisition costs will win. But the winning formula is still up for grabs.