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Regulatory headwinds slow SolarCity’s growth

Two years ago, SolarCity was one of the nation’s hottest growth companies.

Not anymore.

The company, which plans to open the biggest solar panel factory in North America next year in South Buffalo, still is the nation’s leading installer of residential rooftop solar energy systems, with a commanding market share equal to that of its 50 biggest competitors combined.

But SolarCity, over the past year, has stumbled, with its growth slowing to more pedestrian levels, its losses swelling and its financing costs rising. With its growth falling short of expectations, SolarCity earlier this month said it would cut jobs in a move to bring its formerly fast-growing 13,000-person workforce more in line with its more subdued outlook. SolarCity hasn’t said how many jobs it would cut overall, but the reductions include 108 jobs at its San Mateo, Calif., headquarters and its office in San Francisco, according to a filing with California labor officials.

To further save money, CEO Lyndon Rive and his brother, Peter, SolarCity’s chief technology officer, cut their annual salaries to $1.

“We’ve been adjusting our costs to align with the amount of solar we expect to install in the second half of the year,” SolarCity spokeswoman Kady Cooper said in a statement.

The restructuring – which is in addition to an expected $150 million in cost savings that executives expect to result from the proposed $2.6 billion merger between SolarCity and electric vehicle maker Tesla Motors – is the latest sign of the dramatic change in SolarCity’s outlook since it became a centerpiece of Gov. Andrew M. Cuomo’s Buffalo Billion economic development initiative.

The solar industry won a major victory last year when the federal government agreed to extend a key tax credit that reduced the cost of new residential solar installations by 30 percent. But that victory has been tempered by changes in regulatory policies in some states that have reduced other subsidies and made solar power less economical. A policy change in Nevada – one of the nation’s top solar markets – prompted SolarCity and some other installers to pull out of the state entirely.

The company’s headwinds also had an impact on its proposed merger with Tesla, run by Elon Musk, the Rives’ cousin and SolarCity’s chairman. When the deal was first proposed, Tesla was offering to pay SolarCity shareholders with Tesla stock worth $26.14 to $28.30 per share, based on a Tesla share price of $216. But when the deal was finalized last month, the purchase price dropped to $23.76.

The new headwinds SolarCity faces aren’t threatening to put the company out of business or even jeopardize its commanding market share. But they highlight the new challenges confronting the company as its transitions from an all-out growth mode to an approach that puts more emphasis on conserving cash in a market where constantly changing regulatory policies aren’t as friendly to solar power as they once were.

Installation slowdown

SolarCity’s installations, which never grew by less than 63 percent during any year from 2009 to 2015, are expected to slow to around 9 percent this year, mainly because of a 39 percent slump in new bookings during the first half of this year.

The scaled-back growth forecast “could serve as a source of concern,” said analyst Philip Shen of investment firm Roth Capital. “It may suggest the health of SolarCity’s near-term business may be challenged.”

SolarCity, which initially had expected to install more than 1,200 megawatts of solar generating capacity this year, now predicts that its installations will range between 900 and 1,000 megawatts this year. The company scaled back its growth plans late last year in a bid to improve its cash flow, but bookings early this year were even slower than expected because of the regulatory changes.

SolarCity isn’t alone in paring its growth forecasts. SolarCity competitors First Solar and SunPower both have lowered their guidance, with SunPower announcing plans to cut 1,200 jobs.

Lyndon Rive, however, said there are signs that SolarCity is moving beyond its first half weakness. The company’s order bookings during the second quarter were 42 percent higher than they were during the first three months of the year, although they were well below last year’s accelerated pace, as consumers rushed to go solar out of fear that a 30 percent federal tax credit – since extended – would be allowed to expire this year.

And the company hopes to tap into an entirely new part of the solar market by launching a new roofing product next year that will have solar generating capacity built in. Musk has said the solar roofing product, to be built at its Buffalo factory, could make solar power a viable option for the 5 million U.S. homeowners who have to replace their roofs each year. Most rooftop solar today is sold to consumers with relatively new roofs that are less likely to need repairs or replacement during the 20-plus years that a solar energy system is expected to last.

“This does sound like it could be a very differentiated product – one that addresses concerns on aesthetics and the challenges of the sale process to customers with old roofs,” Credit Suisse analyst Patrick Jobin wrote in a report.

SolarCity also launched a new loan product this year that allows its customers to own the solar panels that are installed on their roofs, rather than lease them. About 20 percent of SolarCity’s customers during the second quarter either bought their solar systems outright with cash or took out a loan – a trend that Rive expects to grow in the coming months. He also thinks it could expand SolarCity’s customer base by providing an alternative for consumers who would rather own than lease their panels.

While SolarCity hasn’t released details of its roofing product, Jobin raised concerns that it could be expensive and he noted that other solar roofing products, made by companies that include Dow Chemical, have failed to build a big market.

“This concept of building integrated photovoltaics is not new,” he said.

Financial drain

SolarCity’s losses have been getting bigger, mainly because it hasn’t been able to reduce its costs as quickly as its executives hoped. Analysts expect the company, which had losses that averaged $59 million during each of the last four years, to increase its losses this year by about 25 percent and to continue reporting losses at a slightly slower pace in 2017.

Despite a strategy change last year aimed at making SolarCity’s operations generate more cash than they consumed by the end of 2016, the company’s costs actually have increased by about 12 percent since hitting a record low last fall, said Andrew Bischof, a Morningstar Inc. analyst who expects the company to keep missing its cost-reduction goals.

A big reason for that is an uptick in the cost of finding and signing up new customers – a trend that SolarCity executives hope to reverse through the Tesla merger, which will allow it to sell rooftop solar systems at the electric vehicle maker’s stores.

SolarCity’s costs for every watt of generating capacity it installs dropped fairly consistently throughout 2014 and 2015, with the expectation that those expenses would keep dropping this year as the company’s growth produced more economies of scale. The company also counts on the high-efficiency solar panels that it plans to make at its South Buffalo factory next year to further reduce its installation costs and push solar energy prices closer to the point where they no longer need to depend on subsidies to make financial sense.

But the spike in customer acquisition costs this year has derailed that trend – at least temporarily. Its cost per watt, which got as low as $2.71 during the fourth quarter of last year, jumped to $3.18 per watt during the first quarter before falling to $3.05 per watt this spring as installation and sales costs grew. Rive said during a conference call earlier this month that he expects SolarCity’s customer acquisition costs to fall further during the current quarter.

The company also counts on its Buffalo factory, being built by the state with $750 million in taxpayer funds, to help it reduce its costs, since the high-efficiency panels it will produce will allow SolarCity to use fewer panels and less associated equipment to generate the same amount of electricity as one of today’s conventional systems.

Borrowing costs rise

SolarCity – a company that constantly needs to raise money from investors to pay for the rooftop solar systems that most of its customers purchase through no-money-down lease deals – has seen its borrowing costs increase.

That’s important because higher financing expenses make it harder for SolarCity – which has $3.25 billion in debt – to make progress toward its ultimate goal of having its solar energy systems be affordable enough that they make economic sense even without subsidies.

The latest evidence of SolarCity’s rising financing costs came this month, when the company offered $124 million in “solar bonds.” The 18-month bonds offered investors an interest rate of 6.5 percent – far higher than the yield on less risky fixed-income investments. It was the highest interest rate SolarCity has offered on its solar bonds, which have struggled to find widespread interest among investors. SolarCity Chairman Elon Musk and his SpaceX business have bought most of the solar bonds that the company has sold so far.

The latest offering isn’t any different. Musk said in a regulatory filing last week that he will buy $65 million in bonds through the latest offering, while Lyndon and Peter Rive each will buy $17.5 million of the debt.

But the 6.5 percent yield, over an 18-month term, is a sign that SolarCity is being forced to pay higher interest rates to attract the financing it needs, especially on debt that isn’t backed by payments from its rooftop solar installations.

When the company first issued solar bonds, which are attractive to the company because they avoid costly banking fees, they carried interest rates of between 2 percent and 4 percent, with terms ranging from one year to seven years.

“SolarCity’s business model requires access to low-cost financing to fund installations, strong customer renewal rates and the ability to maintain market share,” Bischof said.

That’s where SolarCity’s new loan offering can help the company in another way: It reduces the business’ financing needs, since the customer is taking out a loan to pay for the panels upfront, rather than relying on SolarCity to borrow money for a lease arrangement that takes 20 years to repay.

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