Image source: Getty Images.
If you need more proof that Tesla Motors' (TSLA 1.52%) offer to buyout SolarCity (SCTY +0.00%) is a bailout, look no further than SolarCity's latest "Solar Bonds" offering. The company just filed to sell $124 million of 18-month solar bonds with a 6.5% interest rate, which is higher than any rate I can remember seeing for SolarCity debt.
Not only is the rate high, demonstrating a long-term trend of rising costs at SolarCity, the rate offered is higher than the discount rate SolarCity uses to report NPV and other figures to investors. If SolarCity were to discount its future cash flows at a more market-appropriate rate like 8%-10%, a very different company would emerge.
The rising cost of SolarCity's debt
When SolarCity started offering Solar Bonds to investors, it was selling them as a great way to invest in solar and a great way to fund projects. SolarCity would pay investors 2% for a one-year term and up to 4% for a seven-year term. What SolarCity didn't publicize was that very few investors were attracted by those yields.
Less than a year later, in August 2015, rates had risen to 4% for a five-year bond and 5% for a 10-year bond. Or, if you were really adventurous, SolarCity offered a 5.75% rate for a 15-year bond. But it seemed like the only investor buying these bonds was Elon Musk. That's right... Elon Musk's SpaceX bought $165 million of the $200 million in solar bonds SolarCity sold!
In August 2016, the terms have gotten even worse for SolarCity. Long-term bonds are gone, and 18-month bonds are now yielding 6.5%.
|
Date |
Term |
Interest Rate |
|---|---|---|
|
October 2014 |
1 year-7 years |
2%-4% |
|
August 2015 |
5 year-10 year |
4%-5% |
|
Today |
18 months |
6.5% |
Source: SolarCity SEC filings.
As I highlighted last year, this is a disturbing trend for SolarCity. Rates on securitizations have been steadily rising, and terms have been getting shorter. SolarCity is signing 20-year contracts to sell energy to customers, and its cost to fund those installations is going up.
Why this matters now
There are a couple of reasons rising interest rates matter now. The first is that SolarCity ended the second quarter of 2016 with just $146 million in cash after burning $216 million that quarter alone. The company needs cash, and if rates are going up, that means future profits are suffering.
Image source: SolarCity.
The second problem is that this messes with future value projections. According to Solarcity's own presentation, the company has $4.04 billion in pre-tax unlevered NPV remaining if we include contract renewals after 20 years and discount all cash flows at a 6% rate. But debt now costs more than 6%, and equity is far more expensive than debt as a funding source. So the discount rate should be at least 8%, if not more like 10%-12%.
If we discount the same cash flows at an 8% rate, the NPV figure falls $822 million to $3.2 billion. And $593 million of that value is in an assumed renewal in 20 years that has no basis in historical evidence. If we assume there's no renewal value, the NPV at an 8% discount rate falls to $2.63 billion.
But that $2.6 billion has been built up with the help of $1,837 million in debt, leaving just $789 million in net NPV. And that's only for the power company, or PowerCo as SolarCity calls it. The development company, or DevCo, has $1,510 million in debt as well. There's only $2,63 billion of value in SolarCity's business and $3,35 billion in debt!
The slippery slope of a debt-filled company
SolarCity's value quickly evaporates and even goes negative if we just discount the company's cash flows at an appropriate discount rate. And I would argue that the assumptions that go into the current NPV calculation are too aggressive, and the 8% discount rate is also too low.
It looks like SolarCity is desperate for cash, and the only way investors are going to give it to them is by raising the cost. That's a slippery slope for any solar company.
This is a growing problem for SolarCity, and will become a problem for Tesla Motors if it acquires the solar installer. Debt is fuel for SolarCity's business, and the cost of fuel is going up big time.
