Burying a Dead Horse

In August, Barron’s approached us and expressed interest in doing a piece on SolarCity’s business model.

Unfortunately, at the time, we were in the middle of a securities offering process, and SEC regulations prevented us from commenting or answering any questions for the piece. When the article appeared on August 31, with the sensational headline “Dark Clouds over SolarCity”, it included a number of inaccuracies about SolarCity and the Section 1603 Grant program. The same quiet period rules prevented us from correcting those mistakes once the article was published.

We completed our securities offering two months later, the quiet period ended, and we moved on. However, those same misstatements were repeated this week in a Barron’s blog post dated November 18. It’s difficult to fault Barron’s for the piece. The inaccuracies are understandable, given the complexity of the issues, and the fact that we had not addressed them. Yesterday we walked through the specific inaccuracies with the author on the phone, and we appreciated that opportunity. We would also like to take the opportunity to correct them publicly, here.

Many of the false assertions and inferences in Barron’s August 31 article can be traced to a misinterpretation of the concept of “fair market value.” The article states:

“The government asks solar-system owners to estimate the cost, or ‘fair market value’ of their systems, on which tax credits are based. SolarCity appears to use a more complex measurement than some other solar installers. While analysts estimate that SolarCity’s costs are about $4 per watt, the company’s reported fair market value often exceeds $6. The higher the ‘fair value,’ the larger the tax credit.”

As anyone who follows the solar industry knows, solar project owners are eligible to claim a 30% investment tax credit, or ITC, on the cost to acquire their systems. Under the Section 1603 program, the owners could choose to get a cash grant for the same 30% of the value, instead of the tax credit. These credits and grants are not based on the “cost” of a solar system, as the article implies, they are based on the price paid to acquire that system, whether the buyer is a homeowner or an institutional investor. Businesses as a general rule set prices higher than their costs. The price that a willing buyer pays a willing seller is the “fair market value,” of the system.

Contrary to what the Barron’s article states, SolarCity does not use a “more complex” method than similar installers in valuing solar projects, and solar companies cannot “estimate” the fair market value in applying for grants under Section 1603. That fair market value – which of course is the price the buyer actually paid for the system – must also be determined by an independent appraiser. The IRS provides guidelines for appraisal methods for establishing the fair market value of assets. These approaches have been in place for decades and are used across a broad range of asset classes, including housing, research and development, and oil & gas. All of SolarCity’s solar power systems have been appraised by third parties, using Uniform Standards of Professional Appraisal Practice (USPAP) standards, and following IRS guidelines. The entire energy industry uses the same methodology that is stipulated by the IRS. SolarCity does not use a different methodology than other providers to determine fair market value. Appraiser Cohn Resnick’s paper on the valuation of solar assets details this process. Moreover, for large projects, Treasury requires that applicants also provide a “cost certification” from yet another expert, an independent auditor, which confirms the accuracy of the independent appraiser’s valuation. Finally, beginning in June 2011, Treasury began publishing fair market value guidance for solar projects, and SolarCity’s appraised fair market values have been at or below all the guidance that has been provided.

Following its misinterpretation of fair market value, the other primary inaccuracy in the August 31st article involves a flawed analysis of solar project databases. From the article:

“Barron’s recently reviewed a database listing 153,628 solar contracts in Arizona and California, and found that SolarCity’s reported values are significantly higher than those of similar companies. In Arizona, its values exceeded rivals’ by 35% in 2011; 15% in 2012; and 20% this year, through mid-August. In California, the company reported higher market values than the industry from 2008 through 2011, and again in 2013.”

The California database in question is the California Solar Initiative (CSI), and if you read the CSI website you can see how clearly different SolarCity is from companies Barron’s describes as ‘similar’. From the CSI’s FAQ:

The current $/watt data available for California Solar Initiative projects present difficulties when comparing host customer-owned and third-party-owned systems (e.g. leases or power purchase agreements (PPAs)). The reported costs for host customer-owned systems are simple, as they reflect the purchase price inclusive of parts, labor, permitting fees, overhead, and profit. Third-party-owned systems, on the other hand, are reported in a variety of ways, and may also capture costs for additional services.”

Click here to read further for CSI’s explanation of these differences.

SolarCity is unusual in that it finances, develops and installs the majority of its solar projects. Most of SolarCity’s competitors in the lease and power purchase agreement category don’t build the systems themselves, but rather acquire them from third-party contractors. When SolarCity’s competitors report for the project database, they report the amount they paid the third-party contractor. That is a lower number than the price they sell the system for, but the price is the value the grant or tax credit is based on. In short, Barron’s mistakenly assumed that the system costs reported in published databases like CSI are the same as the fair market values that Section 1603 applicants are allowed to claim. They are not. This misinterpretation contributed to a flawed analysis that appeared to show a much greater difference in price (and by implication, grant or tax credit) than actually exists.

Barron’s also misrepresents SolarCity’s liability to investors. The August 31 article states thatif its obligations to those partners aren’t met—because of a decrease in government aid, defaults on lease payments, or other hiccups—the company might need to raise additional funds. These and other concerns suggest that SolarCity’s outlook could be considerably cloudier than its market value implies.”

SolarCity doesn’t indemnify project investors for a decrease in aid, lease defaults or other hiccups. The company merely stands behind the fair market value of our systems. SolarCity and its financing partners are owners of the systems and both take ownership risk as part of the transactions.

Barron’s also makes statements about SolarCity’s business model and financial health that we find to be misleading, namely:

“Like other renewable-energy companies, SolarCity is dependent on government subsidies to make a profit.”

This statement implies that renewable energy companies are subsidized in a way that carbon-based fuels are not. It’s no secret that all forms of energy are incentivized. The incentives that the solar industry receives are a tiny fraction of the overall subsidies that have been provided to nuclear, oil & gas and coal over the years. However, solar systems also generate direct returns to the taxpayer that aren’t just measured in cleaner energy or jobs. Solar lease payments are taxable as income, and the federal government recovers the cost of incentives paid for financed solar systems over time by collecting income taxes on the lease payments. In 2012 the U.S. Partnership for Renewable Energy Finance published a study titled “Paid in Full” that found that a leased residential solar system can provide a 10% nominal rate of return to the federal government on the initial tax credit paid over the expected life of the solar asset.

Like many young companies at our stage, SolarCity is focused on growth, and we reinvest the majority of our revenue into growing operations, building projects and hiring. Because we recognize most of the costs to acquire customers upfront, but recognize the majority of our revenue over twenty year periods, we are not currently profitable on a GAAP (Generally Accepted Accounting Principles) basis. Nevertheless, we were cash flow positive in the second fiscal quarter of 2013, and we expect to be cash flow positive in the fourth quarter of 2013, and on a go-forward basis thereafter.

SolarCity currently employs more than 4,000 full-time workers. Every single one of those jobs is in the United States, and many were created during the deepest recession of our lifetimes. We are currently hiring an average of more than 15 new employees each workday. SolarCity has built projects with local workforces in more than 2,500 different American cities and towns. We are providing services to more than 82,000 customers, including the U.S. Army, Air Force, Marines and Navy, a number of the Fortune 500, and more than 300 schools and universities. We have raised funds sufficient to finance more than $3 billion in solar projects. We are privately financing a series of solar installations for military families across the country that is expected to be the largest residential solar project in American history when completed.

Returning to Barron’s, the final element of the article worth noting is the discussion of the fact that Treasury Department’s Section 1603 Grant Program is undergoing a broad review, and that the review includes SolarCity. That’s not news: SolarCity first reported in October 2012, over a year ago, that we had received a request for documents from Treasury, and we have since discussed Treasury’s inquiry and its progress in more than two dozen public filings. The issue in the inquiry is the fair market value of solar assets. We are absolutely certain that we have followed the 1603 Program’s rules and guidance. As we explained above, in applying for Section 1603 grants, we have relied on independent appraisers using well established IRS guidelines, and all of our projects were valued at or below the guidance that Treasury itself had published for the industry beginning in June 2011.

Every few months, a news outlet reports on this issue as if discovering it for the first time. The Barron’s articles are only the latest example, but felt we owe it to our customers, partners, employees, and shareholders to set the record straight. The inaccuracies in these articles obscure the tremendous progress the entire solar industry has made to reduce costs and expand adoption. Fair market values have fallen significantly in the past few years, and incentives per system have decreased dramatically at the state and federal level. In the states where solar is most popular, such as Arizona and California, the industry no longer relies on state deployment incentives in many locations. Nationwide polls show support for solar across the political spectrum. These trends will only continue, regardless of who bets against them.

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