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SolarCity IPO Review: Is Solar Power The Next Subprime Crisis?

In early October, I wrote: “The time to invest in solar stocks is not now.”

Well, it’s still not time. And I say that based on the technicals and the fundamentals.

The Bloomberg Global Large Solar Index (BISOLAR) continues to trade sideways, after plummeting more than 60% from its early February high.

And solar power’s still way too expensive. Even if we factor in steep government subsidies and falling panel costs.

Nevertheless, solar power startup, SolarCity (SCTY) is determined to test the IPO waters this week. Is it a smart move and, more important, a smart investment?

Not according to this guy. And over the next two days, I’m going to share why. So let’s get to it…

The Trend is Not Our Friend

When it comes to any investment, and particularly IPOs, the trend is supposed to be our friend. But in this case, it’s not.

Countless cleantech companies have already postponed or withdrawn IPO plans, as Greentech Media’s Senior Analyst, Eric Wesoff, points out. Like BrightSource Energy, Elevance Renewable Sciences, Genomatica, Fallbrook Technologies and the now defunct Solyndra.

Plus, as I shared before, the price performance for solar companies hardly smacks of a trend worth embracing in 2012, either. Major solar power companies First Solar (FSLR) and SunPower Corp. (SPWR) are still down by more than 20% this year. And China-based LDK Solar (LDK) and Yingli Green Energy (YGE) are off by more than 55%.

We can’t even use recent IPO performance for cleantech companies to build optimism…

Enphase Energy (ENPH), which makes microinverter systems for residential and commercial solar system owners, is down 59% since its IPO in March. And biofuel companies KIOR Inc. (KIOR) and Gevo Inc. (GEVO) are off 57.4% and 90.6%, respectively, since their IPOs last year.

Like I said, the trend is not our friend. And SolarCity’s underwriters must be smarting from all the negativity, too.

When the company originally filed for an IPO, it planned to raise $201 million. Based on the current pricing range of $13 to $15 per share, though, the maximum raise is down to $151 million. That’s a decline of 24.8%.

The only hope for SolarCity’s IPO to buck the trend is for it to boast stellar fundamentals. But based on my proven screening system for Hot IPOs – which helped us avoid Facebook (FB), Groupon (GRPN), Zipcar (ZIP) and Zynga (ZNGA) – that’s hardly the case.

Zero Hallmarks of a Hot IPO

As I’ve spelled out before, the best IPOs boast an operating history of at least five years, trailing 12-month revenue of more than $50 million, increasing profitability and, of course, an attractive valuation.

Founded in the summer of 2006, SolarCity barely passes muster on our age requirement. Or does it? If we actually evaluate the company based on when it secured its first paying customers under a solar power operating lease, which accounts for 90% of its business, the company’s only four years old. (Strike 1.)

In terms of revenue, the company reported total sales of $59 million in 2011 and about $103 million in the first nine months of 2012. That’s great, until we dig into how the company recognizes revenue. And if we focus on revenue from its core business – operating leases, not sales of solar power systems – SolarCity might (just barely) cross the $50 million threshold this year. (Strike 2.)

Moving on to our profitability and valuation requirements, SolarCity doesn’t even come close.

Losses keep increasing. In fact, for the first nine months of 2012, the company’s already reported $4 million more in losses than it did for all of last year. (Strike 3.)

And even if we assume that its IPO prices at the low end of the range, shares come to market at a price-to-sales (P/S) ratio of about 8.5. By comparison, the average stock in the S&P 500 Index trades at a P/S ratio of 1.5. And the best-performing IPOs of 2012, Michael Kors Holdings (KORS) and Guidewire Software (GWRE), only trade at a P/S ratio of about 6.5. (Strike 4.)

Another Financial Crisis in the Making?

Despite possessing zero hallmarks of a hot IPO, investors are bound to be interested in the deal, simply because of the popularity and religious-like fervor for all things related to alternative energy.

Don’t be similarly misguided.

The truth is, SolarCity isn’t really an alternative energy company. It’s more of a financing company. It sells solar panel systems to residential customers for no money down. In return, the customers sign a 20-year lease. And then SolarCity packages these future cash flows with other contracts to sell to investors seeking tax-advantaged and above-average income.

Such a business model should sound vaguely familiar…

In its simplest form, it’s how we got into the subprime mortgage mess. Expected cash flows on long-term real estate contracts, in many cases with no money down, were packaged into collateralized debt obligations (CDOs) to sell to investors searching for higher yields.

So what could possibly go wrong with a business model that resembles the one employed by Wall Street to market CDOs? Gee, I don’t know. Maybe another massive implosion?

Tomorrow, we’ll take a closer look at why that (and more) is exactly the risk that investors face with SolarCity’s IPO. So stay tuned.

Ahead of the tape,

Louis Basenese