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Alexander Valtsev

SolarCity: How Are You Doing, Jim Chanos?

Jim Chanos of Kynikos Associates said he is still betting on a huge decline in the shares of SolarCity Corp, which he has called a "subprime financing company," and said he wishes he could borrow more stock to short its shares. 

"I wish I could borrow more," Chanos told CNBC in October.

This is what happened next:

(Source: Google Finance)

Not only the stock surged by about 50% since then but it also actually posted a gain of 7.5% on a year-over-year basis. I bet short-sellers are crying now, while option holders just made a killing. Checkmate, Jim Chanos? Not so soon.

Fundamentally, I agree with Mr. Chanos: the company is constantly losing money and its revenues are difficult from a recognition point of view:

"Chanos asserts that SolarCity, a provider of solar energy systems, is burning $500 million per quarter. SolarCity sells most of its solar panel systems via lease deals. Chanos has said that the lease system is akin to taking out a second mortgage on a home". (Source: Reuters)

The only difference between me and Chanos is that I am not going short on solar stocks. They are way too risky for that. A recent example of SunEdison Inc.'s rally is just one example of that. In fact, if you want to short, the best deal for you is to buy put option. This way, you can never lose more than 100% of your investment. And, moreover, it is generally cheaper to do derivatives that the actual shares.

The best part of the "solar stocks' mania" is that everybody knows that: (1) they are dependent on external financing, (2) they rely on tax credits and (3) the price of fossil fuels is going down (including the "clean" option of natural gas). But in the short-term, fundamentals do not drive the prices: it is the psychology that does it.

It seems to me than most solar stocks' owners are not planning to own them forever. In fact, they probably check the stocks a few times a day just to make sure they are not underwater. I used to be like that, and it made me some money here and there. What I eventually realized is that it is not for me. The more I learned about corporate finance and accounting at university and on my job, the more I found out that I wanted to be a long-term investor - somebody, who "grows" with the business, gets to know finer details and business processes, talks to the management team, and listens to earnings calls. Moreover, a long-term investor cares most of all about the company's financials and cash flow generating abilities. SolarCity's investors clearly do not care about that, let alone the dilution effects of the company's continual equity sales:

(Source: Google Finance)

Positive findings:

- Revenues are growing - not only an annual basis but also on a quarterly basis. There seems to be little seasonality involved;

- The company manages to raise external financing without a problem (mostly through debt, as debt ratios show).

Negative findings:

- The more company sells, the more it loses in operating income, as historical data show. There is not even a hint of a positive net income;

- SolarCity constantly generates negative cash flows from operations (CFOs). It is okay to generate negative free cash flows. It is also okay to generate negative CFOs now and then or as a result of investments in net working capital. However, it is not okay to lose real cash every single quarter in operations (and, as it looks like, increasingly)!

- As the company's equity erodes with quarterly losses and debt mounts with new funding, the key ratios become more and more alarming: we can see that the debt-to-equity ratio went from 2.0x to 3.0x in just a year, while the equity's concentration slipped from 17.5% of assets to low double-digits. I am not even talking about leverage ratios or liquidity ratios - they are meaningless in this case.

So here is my question to SolarCity's investors: why would you want to own this stock for more than a day? This is a ticking time bomb. Anything can happen to the market's perception about solar companies. Most of them will go bust within a year, if the ability to raise external funding is pulled away.

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