Solar Bonds Pay Up to 5.75%. What's the Risk?

On Facebook I saw an ad promoting a Solar Bond that paid up to 5.75%. Intrigued, I clicked over to learn the details.

The good news is that the bonds are offered by Solar City, a legitimate, publicly traded company that is a leader in installing solar panels on houses and businesses. The company is publicly traded on the Nasdaq at SCTY. Its chairman is Elon Musk of Tesla and SpaceX fame. Mr. Musk is a bold visionary who exceeds at extracting an enormous amount of capital from investors with Herculean bets on the future. His track record at generating profits at the companies he is associated with is less impressive as neither Tesla or SpaceX are profitable at their core businesses - yet.

Their general model is for the company to pay for the cost of the installation and then lease the equipment back to the homeowner over a twenty-thirty year period. The savings that the homeowner generates on their electricity bill pays for the lease and often leaves some left over, providing an electricity credit to the homeowner. Government subsidies of up to 30% of the installation cost also help to make the installation more affordable for Solar City and the homeowner.

The company is offering several different bond terms. The current terms and their rates are listed below:

1 Year: 2.00%

3 Year: 3.00%

5 Year: 4.00%

10 Year: 5.00%

15 Year: 5.75%

These rates are for bonds purchased directly from the company via an online ordering system. I haven't tried the system so can't vouch for how hard or easy it might be to register and order. Investors can also purchase them through a broker but the rates are slightly lower.

These bonds are not FDIC insured and if the company goes bankrupt, bondholders could lose interest or even principal. Interest is typically paid semi-annually (twice per year) although it may vary according to bond type.

Should You Invest in Solar Bonds?

As of April 15, 2015, the best risk-free rate on an FDIC insured CD according to BestCashCow is close to 2.30% APY. The rate on a five year Treasury Security is 1.31%. The five year muni bond average is a bit worse according to Bloomberg at 1.26%. The ten year yields show a similar spread. Solar City's offering is akin to a high yield bond, otherwise known as a junk bond. Now, the name doesn't mean the bond is junk, but it is risky. An examination of the company's income statement and balance sheet will illustrate the risk.

Solar City's 2014 annual report shows that the company had a net loss of $375 million versus a net loss of $96 million in 2013. Why the loss? The company had an operating profit of $79 million with a 30% operating margin. It's not a great margin but at least they generated an operating profit. Their operating expenses, especially Sales and Marketing were responsible for the widening loss. One way to look at this is that Solar City is in expansion mode and is paying heavily now to get as many panels on customer homes as it can. Once it does this, it will have a recurring revenue stream for the next 30 years, as consumers are not going to rip up the panels. Sounds good. The only problem is that 30 years is a long time. New technology may arrive and make these panels obsolete. Or the utilities may change the way they buy back excess electricity from the homeowner. As a bondholder, you will have to be confident that no matter what the changes, the company will have enough cash over the time period of the bond to pay you interest and also principal.

The balance sheet shows the company has about $700 billion available in cash or cash equivalents to pay the bills. Looking at cash flow, the company used up $1.3 billion in cash last year, the biggest amount being used for payments for solar energy systems that will be leased.

You can see the entire SEC filing here:

http://investors.solarcity.com/secfiling.cfm?filingID=1564590-15-897&CIK=1408356

The company is a bet on whether it can successfully deploy and lease these solar energy systems in a way that generates enough positive cash flowing going forward.

Conclusion

Solar City is a promising company, but it is also a risky one with no history of profits. It could succeed spectacularly or it could also just as spectacularly crash and burn. Whether you invest and how much you invest depends on your risk tolerance.

If you are willing to stomach the potential of losing your investment and want the higher yield, then this might be an investment for you. The shorter term bonds obviously offer less risk.

If you want to be as assured as possible (is there really ever any assurance in life?) that you will receive your interest payments and principal back then this is probably not an investment for you.