Saturday, July 09, 2011

Solar Energy - Where's the Platform Play?

After my last blog post on investing in solar energy, a friend introduced me to Kerim Baran, cofounder of CivicSolar, an online distributor of solar equipment. Kerim gave me a little more data to chew on. Thus, here are some more thoughts on the space.

What does Solar on Your Roof Cost?
Installation costs right now are $5/Watt, which breaks down as follows: $2 for panels, $0.5 for inverters, $1.50 for balance of system (racks, wires, connectors, etc.), and $1 for installation. The average US residential solar installation costs around $20k.

Service companies like Solar City that plan and install solar panels on your roof typically make 30% margin on the installation of the job, and will provide financing costing an additional 10-15% which is backed by banks. So if you don't pay cash, and don't arrange the installation yourself, you're looking at $7 per installed Watt of solar capacity.

The price breakdown above also illustrates how the industry of getting photovoltaic (PV) cells on your roof is structured:

PV equipment manufacturers like Mayer and Burger, and GT Solar make equipment for a huge field of commodity PV manufacturers. Racking, cabling, and inverters are made by a different set of companies. Offline and online distributors like Kerim's CivicSolar get the wares to installers, which are often local contractors (although SolarCity also does its own installations). The local contractors often are electricians or construction companies that need third-party services like software to plan out the installation on your roof, and training on how to install the cells in the first place. These contractors are also hired by full-service firms like SunRun and Sungevity that present packaged deals of installation and financing to consumers who want solar on their roof.

Falling Costs
Don't mind the $7/Watt cost though - the US Department of Energy wants solar installations to go down to $1/Watt by 2020.

Right now, just installing the panels costs that much. Panel prices will fall, racking might become easier (think solar cells that you drape over your house like a carpet), and inverters could become cheaper (inverterless panels seem possible) or unnecessary (most devices in the average household require DC, not AC, so the extra conversion could be avoided).

The goal of $1/Watt is far away, but it illustrates just how far prices could drop.

Temporary Low
At the moment, PV manufacturers valuations are depressed because government solar subsidies are ending - Germany is one example of a country that's phasing them out. Some of the PV manufacturers' stocks are trading at 5 P/E, despite 10% profit margins and solid growth. Yet demand has declined and panel manufacturers are sitting on extra manufacturing capacity and stockpiled solar panels.

Despite this, betting against solar right now is like betting against Microchips in the late 70's: yes, demand temporarily fell, but given how much dormant demand there is, it would be stupid to bet that the solar industry will shrink long-term. Just think about all those big mansions in the Sun Belt of the US that want to reduce their $400 air conditioning bills.

Platform Plays
In the computer industry, platform plays always pay best: Build your own proprietary system that's an significantly better than the status quo and allow others to build on top of it. Think Android, Chrome, Windows, iOS, Macs, and so on - all of these are highly successful platform plays. I think it's reasonable to assume that the most powerful solar investment strategy would be in a platform play.

Where to Invest?
But what's the platform play in solar energy? All the hardware - PV cells, inverters, racking - is commodified as far as the eye can see. Photovoltaic technology is actually pretty simple, low tech stuff. What's improving is the PV manufacturing process. Yet betting on the PV equipment manufacturers feels wrong - you're betting on the second derivative here, because in order for these companies to grow, the PV manufacturers need to increase their rate of growth, not maintain it.

It's the installers like Solar City, SunRun and Sungevity that might end up becoming the platform. Homeowners can call them up and have them take care of installation, just like consumers can build their own computer out of individual parts, but prefer to buy one from Dell. If you will, these installers are building a service platform on commoditized hardware.

The problem is that it's hard to invest in these companies as an individual investor. None of them are public, and even when Google[*] put $200 million into Solar City, my understanding is that Google didn't get equity. The Sequoia Capitals of the world that invested in the early stages will reap the benefits.

[*] Yes, I work at Google but I don't do investments, nor am I speaking here on Google's behalf.

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