Editors' Note: This article covers a stock trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.
Over the past couple of years, we have seen several industries, which had been left for dead, and many stocks for that matter, have a renaissance of epic proportions. Nowhere has this been more evident than in the solar industry where stocks such as Canadian Solar (CSIQ) (2 to 33), First Solar (FSLR) (12 to 65), SunPower (SPWR) (4 to 35) and JinkoSolar (JKS) (4-35) have had tremendous runs. A combination of shrinking subsidies, overleveraged balance sheets, and overbuilt capacity made for a backdrop, which would take many formerly high flying promising companies into bankruptcies and several within a whisker of their financial lives.
It would appear that many newer technologies experience this similar pattern, which we observe time and again. I would characterize this pattern as having 3 phases. Phase 1 being defined as the hype where the market gets overly enthusiastic about the prospects of a company or industry. Phase 2 being defined as the hangover digestion phase where investors come to grip with the reality that the stock prices and market capitalizations of the hyped stocks don't have the near-term earnings potential that the hype phase overlooks. This phase 2 "shakeout" often times leads to many bankruptcies and fewer players. Phase 3 is the re-emergence of the strongest players with the best business models and often times make even higher highs than experienced during the hype faze (think Amazon (AMZN), Tesla (TSLA), Regeneron (REGN)).
I believe the solar industry as a whole is in the process of entering phase 3 (many parts of the value chain are already up big as referenced above). Although it would have been better to see more panel makers (particularly the least efficient ones) go bust during the digestion phase, the industry is emerging stronger and with fewer/better players. On the production side, costs for modules have come down from $6/watt to $.55/watt and poly prices have come down from $250/kg to $18/kg. Most of the better panel and poly makers have clear roadmaps to reduce costs and raise efficiencies even further. The result has been a country by country emergence of topographies, which have pierced grid parity in comparison to the legacy infrastructure on a non-subsidized basis. Places like Spain, Italy, Japan, Chile, Hawaii, and Puerto Rico can produce solar electricity cheaper than the current alternatives (storage, infrastructure to build out, and bureaucratic red tape being excluded).
The downstream situation and opportunity.
Over the past couple of years, I've read various articles talking about the disparity of German installation costs for solar being roughly half the costs of their U.S. counterparts. Everything from scale, red tape, and subsidy games have been cited as reasons for the disparity. Rather than focus on the reasons for this, I find it more useful to focus on the real trend, which is: The accelerating reduction in costs as the United States gains scale and efficiency with a little "time on the vine." We need to understand that the US solar industry was slower to adopt solar friendly policies than our German friends did.
Why is this important and where does it leave us?
Unlike the upstream poly, wafer, panel, and module producers (which have many players in each part of the value chain) there are relatively few ways to play the downstream space in the public markets. Many of the players are smaller or private companies with the exception of 2; SolarCity (SCTY) and Real Goods Solar (RSOL).
As many of you know SCTY has had a tremendous run along with other solar players. Some have focused on its largest investor (Elon Musk) while others have looked to the liquidity pools SCTY has obtained to drive adoption. Those with a longer vision can see a business model in SCTY where it can afford to be company/technology agnostic and source the cheapest, most highly efficient solutions for its customers and take out the individual technology risk the typical panel/module/poly producer has.
In the case of RSOL, the company was basically left for dead. A combination of a bad acquisition, the challenges to the industry, and poor execution by the previous management team left the company, much like the banks post the housing collapse, in a zombie like position. Fortunately, the company was given a second wind with the reflation of the solar space and in particular their downstream competitor SCTY. People took note of the similar $100 million sales number for 2012 for RSOL (105 for '13 and 144 for '14 street consensus) and the $128 million for SCTY (160 for '13 and 257 for '14 street consensus) and thought to themselves something has to give. Further, RSOL is set to turn profitable this quarter or next while SCTY is not set to do so as far as the eye can see. Either RSOL or SCTY had to be radically mispriced one a $70 million market capitalization and the other a $4.2 billion market capitalization, or a combination of the two. After all, they do the same things don't they? Well they did until SCTY went out and started getting a bit more creative with how it was going to grow its business. By attracting the likes of Goldman Sachs to offer them liquidity pools to overcome the upfront problem of a large cash outlay, SCTY was able to go out and drive adoption and make money in doing so. By offering lease like financing where customers could avoid large capex expenditures SCTY was able to profit on the entire value chain (from the selling of the panels, to the installation, to the financing access/enablement).
Where does this leave us?
RSOL has done some heavy lifting and has cleaned up its balance sheet wiping out all of its debt, eliminating the concentration of its previous largest shareholder Gaiam, and after the Mercury acquisition will have roughly $20 million in cash with a business that is on the cusp of returning to profitability in a space, which is exploding. From conversations with investor relations and management I have concluded that the SCTY business model approach and the resulting valuation differential the market has assigned to the two companies has not been lost on them. Given the success of the SCTY approach and the only barrier to entry for a company with the scale and cost structure of RSOL being that of obtaining the right capital partner, I believe it is a matter of when not if RSOL transitions into the SCTY approach. When they do, I expect fireworks.
A 10-fold increase in the share price of RSOL would still yield a sub $1 billion market capitalization or less than 25% of the value of SCTY. At $2-3$ per share RSOL is a combination of perhaps one of the greatest opportunities to unlock value and strategic dislocations I have seen in my career. Understandably, the company had to "right the ship" prior to making this move but now that the heavy lifting is nearly complete I would encourage those with the capacity to take risk to do your own due diligence here as the transition to the SCTY approach could yield an epic ride.
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