Why Sunrun Inc. May Go Bankrupt

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The two greatest existential threats to any business are competition and government intrusion. The former can be grappled with via innovation and execution, but the latter can often prove to be an instantaneous death blow.

Sunrun Inc. (NASDAQ:RUN) faces both of these existential challenges. However, government intrusion will be the company’s undoing. While government usually is on the wrong side of the argument when it comes to markets, in the case of Sunrun and solar energy, governmental intrusion is actually correct.

Sunrun’s business model is similar to other companies in the solar installation market, such as Tesla Inc. (TSLA), subsidiary SolarCity, and Vivint Solar (VSLR).

“We install solar energy systems on our customers’ homes and provide them the solar power produced by those systems for a 20-year initial term. In addition, we monitor, maintain and insure the system at no additional cost to our customers during the term of the contract. In exchange, we receive 20 years of predictable cash flows from high credit quality customers and qualify for tax and other benefits

Under our Customer Agreements, customers have the right to use and consume all electricity produced by the solar energy system we construct a solar energy system on a customer’s home which generates electricity at set prices through Customer Agreements which typically have an initial term of 20 years. Rates for both forms of our Customer Agreements can be fixed for the duration of the contract or escalated at a pre-determined percentage annually. Upon installation, a system is interconnected to the local utility gridUnless the solar energy system is connected to a battery, any excess solar energy that is not immediately used by our customers is exported to the utility gridand the customer generally receives a credit for this excess power from their utility to offset future usage of utility-generated energy.”

It is the statements in bold that concern Sunrun’s business model. At first glance, this would seem like a great deal for the consumer and a solid model for Sunrun. That, however, is misleading and a classic example of how investors must investigate a business model beyond a company’s 10-K.

The devil – or Sword of Damocles – is very much in the details of how that energy credit works, for it is where the issue of government involvement and public policy intrude.

In short, residential generated solar power harms the regional public utility monopoly in myriad ways that are ultimately unsustainable and therefore, Sunrun will not be permitted to survive.

Net Metering

Let’s quickly review the economics of public utility providers. They are usually financed by equity IPOs, a substantial amount of debt, and ongoing revenue from customers who use electricity. This revenue is offset by costs, a good deal of which are fixed. Rates are determined by a given municipality’s Public Utilities Commission (PUC).

The general idea is that proposed rates are cross-referenced with how much power was used in a given period, working in cost data, and arriving at a rate. Revenue must be sufficient not only to pay operational costs but especially to pay debt service. A certain amount of free cash flow is then thrown off the shareholders.

As it is, residential solar power is bad for utility economics. Since most solar-equipped homes generate peak electricity during the middle of the day, when households need it least, customers enjoy offloading this excess power onto the grid. The problem is that many states have policies that force the utility to pay for the rooftop solar power at retail rates. Thus, utilities are forced to buy the rooftop solar power at the same rate they sell it to other customers. As we’d expect, such generous reimbursement fuels rooftop solar’s growth. Conversely, wherever such rates are cut, rooftop solar companies flee.

However, forcing utilities to buy rooftop solar power at retail rates puts extraordinary strain on the grid, as these customers are not contributing to the two critical elements of electricity rates: transmission and distribution. Thus, as more and more power is purchased by power companies at retail rates, utilities have to shift more of the grid costs to non-rooftop solar customers. This is known as net metering.

Ratepayers are not going to put up with this for very long. As it is, conservative politicians and the utility lobby oppose it. Without raised rates, the utility must absorb the costs, and if enough revenue is taken away from the utility, it must first cut its dividend. That angers shareholders, and the stock price declines. As both revenue and stock price decline, the debtholders will ultimately demand higher interest rates or pull the credit lines altogether, fearing default. The utility eventually goes bankrupt. As utilities are regional monopolies, that would force government to step in and not only bail out the utility but put it in government-run hands.

Killing Net Metering

For all of these reasons and a few others, PUCs are getting involved and spiking the benefits of net metering to solar owners. The most notable decision was in Nevada – a devastating decision against the solar industry, which was mostly rescinded. However, this is exactly the threat facing the solar industry and Sunrun.

In Nevada’s original decision:

Solar owners receive energy credits at the wholesale rate, not the retail rate. Fixed monthly charges increase. Time of use pricing. Solar power costs will no longer be fixed for 20 years, and this is retroactive.

This would have made solar installations far less attractive, and therefore, Sunrun has fewer customers. Indeed, Sunrun itself announced at the time that it was leaving the Nevada market, as did SolarCity and Vivint Solar.

This decision also highlighted numerous other potential long-term problems. Existing customers who got a solar system thinking their costs would be fixed for 20 years are going to be angry. Guess who they sue? Sunrun. Hello, class action lawsuit.

Or maybe they don’t sue at all. Maybe they simply don’t pay, leading to cascading defaults.

What happens when the solar owner sells his house? Who wants to buy a house with a legacy solar lease that’s a lousy deal? The homeowner will have to eat that cost.

It wasn’t just Nevada that made changes. Hawaii, Wisconsin, Arizona, Louisiana, Mississippi, Georgia, Indiana, and Maine have all acted. Wisconsin’s didn’t stick, and so far, neither has Louisiana’s. Yet consider the fact that Indiana is not exactly a high sunshine state. If they killed net metering, who is next?

It is only a matter of time before government realizes that it cannot have its cake and eat it, too. Politicians cannot call for enhanced residential solar reliability on the one hand and bankrupt utilities on the other.

It is unsustainable. So naturally, all the solar players are running to California. So far, the state remains resolutely misguided in most of its public policy, but should the PUC ever get its head on straight, and cripple net metering, solar everywhere is toast.

Make no mistake, the utility lobby is all over this, and for good reason.

How Sunrun Implodes

Eventually, net metering will blow up and Sunrun with it. They even acknowledge it in their 10-K (page 12).

Sunrun faces even bigger financial problems.

Sunrun and its peers must deal with the eventual gutting of the Solar Investment Tax Credit. The 30% credit remains in place until 2020, when it drops to 26% and then to 22% in 2021. A permanent 10% credit for commercial project, not residential, remains thereafter.

Sunrun has traditionally generated about 8.5% to 11% of its revenues from incentives. Once those tax incentives vanish, that money is subtracted from the bottom line.

Yet investors seem to be missing the most obvious reason to get out of Sunrun: the disaster that is both SolarCity and entire solar installation sector.

As of December of 2014 – more than three years ago – 112 solar companies have either gone bankrupt or acquired for pennies on the dollar. Five more went under in 2015. There’s plenty of reasons why.

One might think that SolarCity was a great solar installation company. It offered the product through multiple sales channel, of which, door-to-door sales were a big part of its strategy.

Yet despite the hype, SolarCity was a complete disaster, and Elon Musk had to bail the company out. In fact, the only reason he did this was because of the spider web of interest conflicts. According to FastCompany:

“Six of Tesla’s seven directors have clear ties to SolarCity. Tesla’s board includes SolarCity’s former CFO, a SolarCity director, and two VCs whose firms also have seats on SolarCity’s board, along with Musk’s brother, Kimbal. Musk chairs both companies and is SolarCity’s largest shareholder. He has taken out $475 million in personal credit lines to buy more shares in SolarCity and Tesla when advantageous. SpaceX, his aerospace company, has purchased $165 million in bonds issued by SolarCity. “

The curious part of this whole deal is that SolarCity subsequently halted all door-to-door sales. Its business fell to pieces so badly that – because it was the leading solar installer – total solar installations are expected to decline 13% in 2018. The reason installations rose 19% in 2016 was because SolarCity was responsible for a quarter of those installs.

It’s obvious that Tesla and Musk see that SolarCity is a failing business and has pulled its sales force from door-to-door routes. If he’s doing this, why would anyone expect Sunrun to do any better?

Sunrun is headed for bankruptcy. It’s only a matter of time.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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