Podcast Audio | Posted by Phil Leigh on December 18, 2012
Solar City (Ticker: SCTY) is in the news at least partly because last week Goldman Sachs was forced to price the initial public offering (IPO) at $8 per share which was about forty percent below the $13 – $15 price indicated in the original Securities Exchange Commission filing. Since Goldman is the most powerful securities underwriter the IPO price is a major concession.
Although based in Silicon Valley, Solar City does not manufacture electronic components. Instead, it installs photovoltaic panels much like thousands of local electrical contractors around the country. Goldman would have been no more likely to accept Solar City as a client than any such contractor but for two exceptions.
First, Solar’s “financial engineering” is the investment banking equivalent of OxyContin. Ultimately it is every bit as addictive and equally destructive. Specifically, SCTY vigorously promotes lease financing that (1) enables homeowners to avoid a down payment and (2) is structured in a manner to optimize tax and rebate incentives for investors providing the financing. For example, earlier this year Morgan Stanley sold investors $300 million in a fund used to provide such financing. For starters, investors get a 30% Federal tax credit as well as applicable utility rebates authorized by various state and local governments. The conventional interest rate return implicit in any lease is icing on the cake.
Second, Solar City is well connected in Silicon Valley. Elon Musk who was the founder of PayPal and current CEO at Tesla Motors is the Board Chairman. Draper, Fisher leads a group of venture capitalists who invested almost $500 million before the IPO.
Since an installed solar panel array can cost $25,000 – $50,000 the “nothing down” option tempts consumers seeking to immediately lower their monthly electric bills. Yet typically the lease obligates them to a 15 – 20 year monthly payment that increases about 3.5% annually. Moreover, since the leased rooftop array is owned by the investors instead of the resident, home resale can get snagged if buyers don’t not want the array, or desire to repair or upgrade an aged roof.
In short, Solar City may be the first of a wave of companies that casual investors falsely assume to be technological leaders but are actually little more than finance companies. They shall resemble the computer-leasing craze of the 1960s. During that era companies such as Leasco Data Processing, Dearborn Computer, Randolph Computer, Data Processing & Financial General, Computer Investors Group, and Continental Computer sometimes reached triple digit stock prices merely by purchasing IBM mainframes and leasing them to the end users at moderately lower rates.
Their principal method of reporting profits was the use of 7 – 10 year depreciation schedules as opposed to the 5 years that IBM applied to identical models in their own customer rental base. In the present day of ubiquitous personal computers, readers can readily perceive the absurdity of an assumed 7 – 10 year useful life for any equipment subject to Moore’s Law of semiconductor progress and implied equipment obsolescence. As a corollary, Solar City’s leased panels are typically depreciated over 30 years even though leases are only 15 – 20, and photovoltaic technology over the next 30 years is difficult to predict.
Nonetheless, in the 1960s computer leasing stocks were temporarily all the rage. While still under the age of thirty, Leasco’s CEO used company stock to acquire Reliance Insurance, which was a prominent old-line Philadelphia company. Such a development galvanized Wall Street pushing Leasco’s stock to $140 per share when the CEO attempted to acquire Chemical Bank in a share exchange transaction. Such audacity sobered the established financial community with the result that the nascent industry found it hard to access new capital. The stocks lost popularity and were typically taken private a decade or so later at values only a small fraction of their late 1960’s stock prices.
As Will Rogers put it eighty years ago, “You can’t have a picnic if the party carrying the basket doesn’t show up.” If the Federal budget crisis is genuine, perhaps the Government will stop bringing the basket for Solar City.