SolarCity Corp (NASDAQ: SCTY)’s Integration Plans May Fall Short Of Expectations

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By Martin Foley on July 12, 2014 Company, Energy & Solar

SolarCity Corp (NASDAQ: SCTY) bought Silevo, a small solar panel manufacturer, three weeks ago. By acquiring the United States based manufacturer, SolarCity hopes to vertically integrate its business from the manufacture of its solar panels to the installation process for clients.

SolarCity’s attempt at vertical integration is similar to the moves by Elon Musk, CEO of SpaceX, a space transport services company, and Tesla Motors (NASDAQ: TSLA), an electric car company. For SpaceX, the young CEO assembled all the materials needed to build a space rocket. In the case of Tesla, Musk announced his Gigafactory plans to integrate the electric car company with battery manufacturing to reduce its costs.

Musk’s efforts for vertical integration seem to have a bright future due to the fact that there are few rocket manufacturers in the world for SpaceX, and the few battery manufacturing plants that exist for Tesla as well.

However, SolarCity’s plans for vertical integration may not attain the same success that SpaceX and Tesla are on track to achieve.

The first reason is that SolarCity’s technology is primitive.

Silevo’s target efficiency in cells is 24%, but their current efficiency is only 21%. This value is not that much higher than current technologies, such as Trina Solar (TSL) or SunPower (SPWR)’s production efficiency, which is targeting 25% efficiency cell. In this alternative energy space, it is apparent that SolarCity is not producing any new technology with its recent Silevo acquisition.

SolarCity must choose between supporting either American workers or the economy.

The key difference between Elon Musk and SolarCity shareholders is that Mr. Musk built his companies on the basis of creating jobs in the United States, while SolarCity takes the more economical route.

SolarCity, as well as other companies in the solar energy field, outsource their manufacturing to other parts of the world. SunPower, one of the leading solar companies in the world and the maker of the most efficient solar panel cells, bases its production in Mexico, France, the Philippines, and Malaysia.

The decision to outsource its production makes sense economically. Taking into account land and labor costs, infrastructure costs, nearness to suppliers, and other factors, basing production in these countries reduces the company’s costs significantly.

SolarCity is not the first vertically integrated solar energy company.

JinkoSolar (JKS), a manufacturer based in China, was integrated far before SolarCity merged with Silevo. It is also far more integrated that SolarCity will ever be, and operates on a much bigger scale – two times that of SolarCity. JinkoSolar builds and owns solar projects on a utility scale (not residential) and is integrated all the way to polysilicon manufacturing.

It may not be beneficial for SolarCity to go big.

At the end of 2013, the company employed just over 4,300 workers. In order to start the new facility for manufacturing, SolarCity must hire roughly 3,300 new employees. This means that it will increase its workforce by nearly 70%.

By comparison, the world’s cost leader has roughly 7,000 production workers, and produces 2.1 GW of modules each year.

Starting with a smaller operation would be a better way to determine whether the benefits are worth the costs of manufacturing its own solar panels.

The risks could be greater than the rewards.

If SolarCity succeeds in its attempt at integration, the rewards can be massive for shareholders. Efficiency is not a problem, and by the time the solar energy company’s facility is online, Chinese competitors will most likely offer high-efficiency modules for purchase.

In terms of monetary risks, it is important to consider cost per watt. SolarCity purchase its solar modules at roughly $0.70/watt. If the company succeeds in its production scales, they will ideally reach a production cost of $0.55/watt. The company is expected to install roughly 1 GW of solar systems by the end of this year. Thus, the company will have saved $150 million thanks to its production scaling.

The risks the company faces include not being able to reach a competitive cost, underutilizing the facility, and bear substantial costs.

SolarCity’s Future.

If SolarCity’s production facility actually reaches favorable costs, the company will have a new type of advantage. Producing solar panels domestically in the United States allows SolarCity to enter the utility-scale market, and is a great business opportunity.