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RGS Energy: Tempered, Opportunistic Growth

Garvin Jabusch

Kam Mofid has a more long-term vision than most CEOs. His emphasis on the next earnings per share (EPS) report and his obsession with short-term focus are minimal relative to America's typical boss. He's not primarily managing to the next quarter.

His company, RGS Energy (ticker symbol: RGSE), is a solar-module installer, mainly in the residential vertical. RGSE doesn't directly compete with most solar panel manufacturers. Instead, it provides residential rooftop installation distribution for them. It then captures lease payments and revenues from selling excess electrical generation to the grid (in states that allow it). Whereas First Solar (FSLR), Canadian Solar (CSIQ), and Sun Edison (SUNE) are primarily engaged in module manufacturing and commercial and utility-scale installations (although not exclusively -- this is a fast-evolving area), RGS Energy and its larger competitor SolarCity (SCTY) are all about home/residential installations. For now, only three residential installation players have national reach: SCTY, RGSE, and Vivint, Inc. (Vivint is privately held and not discussed here).

RGS Energy Logo

RGS Energy was once the idealistic brainchild of green-oriented consumer -goods firm Gaiam, Inc. (GAIA), and was then known as Real Goods Solar. Mofid joined in 2012, soon after RGSE was spun off from its parent, and quickly moved to modify the makeup of the board, diversify the shareholder base, and "move away from the hippie business mentality," bringing on a number of individuals with practical experience and track records of delivering successful businesses.

Pragmatically, RGS Energy didn't become a true competitor to SolarCity until Mofid joined the company. Not that Kam Mofid and his team are necessarily trying to catch SolarCity in terms of scale or market share. They believe their industry's growth potential will generate enough market share to go around. In Mofid's words, "there's plenty of work to do." Since residential installations don't require any new land development, rooftops are effectively brownfields, and as such represent a great low-impact source of electricity. And Mofid sees many greenfield opportunities in those brownfields.

Whether via smart strategy or just good timing, Mofid and his team have had benefitted from observing SCTY's successes and encounters with pitfalls. SCTY in many ways has paved the way in the residential installation business, and RGSE has had a bird's eye view of the process -- stumbles and all.

As a result, RGSE has chosen not to directly emulate SCTY. In Mofid's opinion, that company is taking on inappropriately high risk. In particular, Mofid thinks SolarCity is banking too heavily on its retained-value-model and being too aggressive in terms of assumed value of solar modules after 20 years of depreciation and continuing technological innovation. Learning from SCTY's success and risks with this model, RGSE will soon no longer rely on tax-equity concepts, reflecting a belief that retained value made sense in the past but no longer applies in "2014 thinking." Already, RGSE has incorporated lower tax value into its growth model as a risk control.

Mofid is not as sanguine as SCTY is about the retained-value-model of valuing solar panels. He also believes that SolarCity is in general too aggressive and too eager for risk -- not only in poor potential realization of retained value of installations but also, and perhaps more importantly, in the "deteriorating policy and subsidy environment in the U.S.," and on a state by state basis.

In any fast-growing industry where the name of the game is to capture as much emerging territory as possible, it's always a struggle to manage between top line growth vs. EPS. Here, RGSE, like SCTY, has chosen to invest in growth at the expense of current EPS, but in a more conservative way than SCTY. As Mofid says, "meaningful GAAP revenue is possible soon with our model."

There is not yet a clear winner between the more and the less aggressive strategies, not that there needs to be. That two of the three largest solar installer companies in the U.S., SCTY and (the much smaller) RGSE, each employ one of these approaches means that a public equity investor can get exposure to both and not have to choose between methods. This is fortunate, because it's possible that both the rapid and the measured growth strategies could turn out to be winners. We like both the high-growth SCTY and the measured-growth RGSE, as each brings interesting and potentially valuable characteristics. Another benefit of investing in both approaches: Not only do RGSE and SCTY employ different approaches to managing growth but they also don't operate in many of the same states. However, for investors who find SCTY's all-out-for-growth approach too aggressive, RGSE may represent a more temperate alternative.

The residential installation market is new and growing fast, so larger players with more access to capital have a major advantage over smaller, locally based firms, both in ability to leverage pricing, engage more projects, and have the flexibility to emphasize growth in states with the most favorable conditions for the solar installation business. This last point is more important than it may seem: Many areas, under the sway of the local public utility commission and the monopoly or near-monopoly of electric utilities, can, or have, or may at some point attempt to stall growth in solar with policies unfavorable to the industry. A national model diversifies and mitigates this risk. Ultimately, as renewable energies cause overall electricity prices to fall, sentiment will cause states and utilities to relent, which will ultimately help solar and wind all along their value chains, but until then, geographic diversity is going to be key. RGSE currently operates in 16 states.

Mofid has a goal of becoming and remaining at least the third-largest installer nationally. His understanding of the scope and depth of the solar installation market in the U.S. shows strongly here: He is content to capture 1/10th of that rapidly growing business.

So RGSE is now beginning to take steps to accelerate growth. Primarily, this is taking the form of a financing joint venture called RGS Energy Asset Management, owned with Altus Power America Management. Goldman Sachs (GS) has agreed to provide capital access for the JV, but Mofid didn't address the terms or scale of its involvement. (Goldman evidently likes installation diversification as much as we do: They are also major capital providers to SCTY.)

RGSE has a couple of other sources of and access to capital. First, the firm currently has no long-term debt, only a revolving line of credit with Silicon Valley Bank that it pays down to zero at the end of each quarter. Long-term debt financing does appear to be in the cards going forward, though. As Mofid says, with respect to expansion, "there will be a debt aspect". Second, they have a $200 million mixed shelf filing reserved to fire growth (acquisitions and capital) when they perceive an opportunity.

Near-term, Mofid feels the industry has now and will continue to have access to state and federal incentives at least until 2016. After that, incentives most likely won't go away, but may drop by some meaningful percentage. So Mofid projects the solar installation industry will have record growth through 2016, then slow a bit, which concurs with our own view of the situation.

When asked what RGSE's key risks involve, Mofid gets more macro. Utilities present a patchwork, he says: "some good, some quite bad" (he says RGSE's home state of Colorado, for example, is currently a tough environment), so, again, a national model is key to offset that risk. As a result, the residential installation industry will likely experience both consolidation and failures of local installer firms, providing growth-by-acquisition opportunities for all three major, multistate players.

Regarding tariff risk involved with buying modules from Chinese manufacturers, Mofid sees the additional costs as "very low" relative to his business at $0.02 to $0.05 per watt (I note here that this actually presents meaningful inflation for utility scale plant developers that depend on Chinese prices, but that's a different discussion). Moreover, RGSE buys from multiple panel manufacturers, and most of these are positioning themselves to make and ship from plants outside of China (via possible additional manufacturing capacity in Mexico, for instance).

Manageable as Mofid sees them for now, there are definite political risks involved with being a solar installation business in the U.S., including states' regulations, utilities' intransigence, and national tariffs. Investors should consider their view of national and local policymaker sentiment toward renewables when assessing risks associated with an investment.

And perhaps those risks explain RGSE's recent lackluster share performance and high short interest of late. On the latter, RGSE has recently hired a professional short interest monitoring service to report violations of shorting rules (such as naked short selling) to FINRA. This may have the effect of dissuading unscrupulous shorters, but I doubt it. I'd rather see RGSE spend capital growing, and silence the critics that way.

There's also been bad press regarding RGSE's recent Hawaiian acquisition, Sunetric. And not without reason -- Hawaii presents other risks and opportunities. The business pipeline there is mostly comprised of commercial demand, so residential firms may face declining business and ultimately attrition, potentially including RGSE. But this may also mean larger firms with geographic diversity away from the islands and some staying power may be able to consolidate market share. It's too soon to tell.

That said, the Hawaii deal reveals some RGSE strengths. Mofid and team were willing and able to move nimbly from a cash/equity deal to an all-equity deal as the situation with Sunetric evolved. The Sunetric acquisition is interesting for another reason. Mofid says RGSE is, again, like SCTY, becoming active in the solar-to-storage space, and he thinks they can use isolated, contained-grid environment and expensive-utility bill center Hawaii as an ideal proving ground for perfecting a business model that can work. And the two residential installation firms aren't the only ones who think the panel-to-storage model will work. As Barron's recently reported, "Barclays this week downgrades the entire electric sector of the U.S. high-grade corporate bond market to underweight, saying it sees long-term challenges to electric utilities from solar energy… and recommends investors who can do so should underweight the electric sector versus the broader U.S. Corporate index, and rotate out of bonds issued by utilities in areas 'where solar + storage is closer to competitiveness.'" RGSE is looking at both Hawaii and California markets for the solar+storage model, and they will look to "innovate into those services as technology comes on line."

SCTY has a major advantage over RGSE in the storage race due to its sisterhood with Tesla Motors (TSLA) and its forthcoming Gigafactories, which may produce high-quality batteries for as little as 60 percent of the cost of other manufacturers. But this doesn't mean RGSE can't make significant progress with the same model, especially in states where SCTY is not present.

Similarly, RGSE plans to keep expanding within its existing markets. Where there is no strong local player, RGSE can establish its brand and presence de novo; where there is a local brand that is already valued by the community, there could be opportunities to acquire installers with their infrastructure, employees, trucks, and sales pipelines. Mofid mentioned twice that the residential solar installation space is still in its "constantly evolving," "Wild West" stage, and that keeping a war chest (no debt yet, shelf filing) ready for his "best opportunities" is his approach. It's hard to disagree with this, and yet we can't help but wonder whether he shouldn't be deploying his war chest a little faster; sometimes the largest risk is the one you don't take, and residential solar installation won't be an immature market forever.

When we asked whether sitting on the "war chest" of unused shelf offering and zero debt is itself a risk, Mofid sidestepped. While he did affirm their forward guidance, he gave little insight on a concrete path toward achieving this guidance, offering only, "we're gonna keep doing what we're doing." What we can glean from regulatory filings and conference call transcripts reveals only a bit more clarity. Important components for RGSE's roadmap include establishing new funding vehicles for project financing (that may or may not be part of the current JV), which must be an essential aspect of the plan to move away from relying on tax equity in financing and bankrolling ongoing business operations.

Mofid clearly passionately feels that the industry is compressing, and small installers will be pushed out, leaving space for companies like RGSE to move in with their larger bankrolls and resources to capitalize on the vacuum. For now, RGSE is estimating 50-55MW installed capacity in 2014, but it's not clear if this includes the acquisition of smaller private solar firms.

In any event, "what we're doing," for now, also seems to include expanding installation capacity via acquisitions. The last four of the company's buys were paid for primarily with RGSE shares; so far, Mofid seems to be taking a bet on dilution over debt. And it appears that RGSE is about as petal-to-the-metal as it can realistically be at this point: Mofid noted that the company's final acquisition in 2013 slowed its plans down significantly as it dragged on through the first quarter of 2014. It seems that RGSE has capacity to take deals one at a time, but not faster. And evidently, this suits their temperate growth model fine.

We asked Mofid if the confluence of new efforts to grow, emphasizing states where SCTY is not already present, and having not yet taken on any debt means RGSE is beginning to position itself as a possible acquisition target. Mofid says they have no current focus on becoming part of a larger peer such as SCTY or any other potential bidder. Further, since Mofid claims "there will be a debt aspect to our growth plan," it seems the zero debt balance sheet will at some point give way to the desire to expand. Still, while not currently courting suitors, Mofid admits that "everything is for sale."

Between now and 2016, both SCTY and RGSE are likely to accumulate small local installers within a chaotic environment of consolidation, regulatory changes and price fluctuations. It may well be that some panel manufacturers and utility-scale players such as SunEdison (SUNE) and SunPower (SPWR) are waiting for the residential space to sort itself out before deciding to make offers for firms like RGSE, which could then act as verticals to get their panels into the U.S. residential market.

Acquisition target or not, we see no reason why RGSE should not realize market capitalization growth to about eight to 10 percent of that of SCTY. As of the time of this writing, that implies a 300 to 400 percent upside for the stock, not counting 2015/2016 growth. Thus, we feel comfortable placing a $10.00 2015 price target on RGSE. And considering the rapid growth of the industry, higher valuations than that going forward from there are Mofid's to lose.

Background notes on Kam Mofid:

  • Canadian-born, from the Niagara Falls area
  • Undergraduate degree from University of Waterloo
  • Was a fellow at GM Canada, sent to
  • Georgia Tech for his masters
  • Strong engineering and primarily automotive background
  • 29 year old exec at UTC
  • First non-founding president at REC Solar
  • In 2011, brought over to MEMC (SUNE), just in time for the solar market crash
  • In July 2012, RGSE called Kam with CEO opportunity
  • RGSE at that time was controlled by GIAM, and had very low trading volume. Mofid turned over the board and diversified the shareholder base, now 17% owned by a Boston PE firm via several rounds of share issuance
  • He hasn't sold a single share of his holdings yet
  • Has little professed regard for analyst/commentators who write negative things about companies he leads -- he feels most focus too much on short-term results at the expense of long-term shareholder benefits

RGSE Suppliers:

  • Panels: CSIQ, STP, and several others. RGSE does not utilize long-term purchase requirements
  • Inverters: Fronius and several others (no share with question)
  • Racking: Uni-rack

– HQ Visit, May 22, 2014

Jeremy Deems, Robert Muir and Jake Raden contributed research for this post.

Disclosure: Green Alpha® Advisors has current positions in RGSE, SCTY, SPWR, FSLR, CSIQ, SUNE, and TSLA. Green Alpha has no holdings in or near-term intention to buy any other company mentioned in this post.

Garvin Jabusch is cofounder and chief investment officer of Green Alpha ® Advisors, LLC. He is co-manager of the Shelton Green Alpha Fund (NEXTX), of the Green Alpha ® Next Economy Index, and of the Sierra Club Green Alpha Portfolio. He also authors the Sierra Club’s green economics blog, "Green Alpha's Next Economy."



was posted on AltEnergyStocks.com.


       

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