SCTY Stock: Why Jim Chanos is Short on SolarCity Corp

SCTY StockBillionaire Jim Chanos Shorting SolarCity Corp

SolarCity Corp (NASDAQ:SCTY) is among several popular companies that share a powerful enemy: Jim Chanos. The billionaire investment fund manager is betting heavily that SCTY stock is going to crash.

Chanos is the anti-Warren Buffett. Rather than finding underpriced investments, Chanos searches for overpriced assets. He looks for companies that are way too expensive, and then bets their stock prices will fall.

This strategy made him a rich man. He’s a genius at sniffing out rotten stocks that investors are propping up with optimism. Naturally, his talent has drawn a cult following of traders who mimic his every move.

You can hardly blame companies for getting worried when Chanos puts them in his crosshairs. History has not been kind to the companies he goes after.

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Chanos gave an interview on Wednesday in which he named his latest targets. A lot of really popular companies made his list, including Alibaba Group Holding Inc (NYSE:BABA), Valeant Pharmaceuticals Intl Inc (NYSE:VRX), Tesla Motors Inc (NASDAQ:TSLA), and…SolarCity Corp. (Source: “Jim Chanos Speaks with CNBC’s ‘Fast Money Halftime Report’,” CNBC, May 4, 2016.)

One of those companies (ahem, Valeant) is under investigation by regulators. It has lost a tremendous amount of value in the last year, so it’s no surprise that Chanos is going short. Here’s what he had to say about the downtrodden healthcare stock:

“They don’t develop their own drugs. They buy them. The life on their drugs are anywhere from two years to 20 years. The most a drug can have is a 20-year patent. If we take a look at the fact that they’ve bought $40.0 billion worth of companies and we use a 20-year life on those purchased companies, which is generous, that’s $2.0 billion a year they ought to set aside for in effect rolling off drugs. You take that number out of the $3.5 billion, interest of one and a half, $2.0 billion to amortize, there’s nothing for the shareholders.” (Source: Ibid.)

That should give you a sense of how Chanos thinks. He’s a ruthlessly intelligent guy with tons of experience at peeling away the layers of optimism that usually surround popular tickers. I wouldn’t want him as an enemy.

So should SolarCity stockholders be worried? To be entirely honest, seeing Jim Chanos target a stock is enough to make me go back and take a look. It doesn’t mean he’s always right, but his opposition does warrant a second look.

Here’s his beef with SCTY stock:

“In the last quarter, Solar City had lease revenues of $75.0 million. If we assume no expenses, one person at headquarters to basically take the lease payments to the bank, no depreciation, no interest, whatever, they have $6.0 billion of capital employed in the business. $300.0 million divided by $6.0 billion is a five percent return on the solar leases. We think that John Hancock was using something like an eight percent discount rate. So the problem with Solar City is they’re losing money on every installation and making it up on volume. And that’s a problem when you have a levered balance sheet. I think Solar City gets into financial trouble in 2016.” (Source: Ibid.)

While Chanos makes some solid points about SolarCity’s business model, he’s using a snapshot analysis. He’s looking at what the business is right now without any regard for what the future holds. Solar energy is an industry on the rise.

He also discounts the new securitization methods that SolarCity is using to finance its expansion. Those ideas are more than just a novelty; they could help limit the risk caused by SolarCity’s levered balance sheet.

I was a little surprised he didn’t mention that in the interview. But then again, this seems to be a pattern with Chanos when he’s talking about firms owned by Elon Musk.

When he’d first taken a short position in SolarCity last year, he raised concerns about customers defaulting on their commitments to the company. SolarCity’s CEO, Lyndon Rive, had the perfect comeback:

“I just don’t think he got his facts straight,” Rive said. “We sell them energy at a lower rate than they can buy from the utility today, so the likelihood they are going to default on us is extremely low,” noting that the default rate for customers was around a half percent over the last eight years.

The takeaway is that Chanos is a really talented money manager, but he might be one step behind Elon Musk (who is the chairman of SolarCity). He also went short on Tesla, but his reasoning for doing so was kind of shaky:

“One of our historical sign posts of a company in trouble is when numbers of senior people leave over a short period of time. Tesla fits that bill. We have a chart that we’ve had—I guess we’re going to have to update it this afternoon—of senior executives leaving Tesla. It is a flood of people leaving in the past few years. And that is not a good sign and this is a company that can’t forecast its deliveries one quarter out. And yet everybody is confident about what they’re going to make in 2020 or 2025. I want to see them make the Model 3 and sell it profitably. I don’t think they can do it.” (Source: Ibid.)

Chanos is making investment decisions based on a few staff members? That seems pretty vague compared to his analysis of Valeant.

In any case, it seems like investors are facing a clear choice: would you bet on Jim Chanos or Elon Musk?