Sunnova Energy International Inc.

Sunnova Energy International (“NOVA” or “the Company”) is a residential solar financing business caught in the rising tide of solar energy. In reality, Sunnova is a specialty finance company with undifferentiated offerings that operates in a competitive industry facing secular headwinds. We believe management masks its poor and unsustainable economics with potentially misleading and assumption-based non-GAAP metrics and aggressive accounting. Unlike its solar peers and other financing businesses, Sunnova promotes Adjusted EBITDA, which we believe is the entirely wrong metric to evaluate a business heavily dependent on consumer financing. This is supported by our conversations with a former Sunnova executive, and industry experts who shared our conclusion. Gross contracted customer value is highly dependent on management’s estimates which are based on limited historical data and should not provide investors with confidence. CEO William Berger’s biography omits his previous role at Enron, whose aggressive financial accounting and reporting led to its demise. In addition, CFO Lane obscures his tenure at Madison Williams, a bankrupt broker backed by two investors later charged with fraud. As growth slows and margins deteriorate, the Company’s cash flow profile continues to worsen. We believe the potential misconception of Sunnova as a solar business, as apposed to a financing business, results in sell-side analysts ascribing irrationally high price targets and support its extreme overvaluation. The upcoming catalyst of management’s lockup expiring at the end of September, combined with Energy Capital Partners continuing to liquidate its equity stake, will result in additional downside risk.

Solar Industry Trends Provide Significant Headwinds For Sunnova

  • As solar systems become more affordable, the industry is shifting from 3rd party ownership (leases and PPAs) where Sunnova realizes 96% of its revenue, to 100% customer ownership
  • Purchases with cash and loans allow customers to realize the largest savings. In the long-run, customers should favor the option allowing them to capture the greatest financial benefit
  • New entrants into the loan market, including Loanpal, continue to gain market share, representing 30% of new loans in Q1 2020 and 17% of all solar financing
  • Shifting a larger portion of financings through loans may cannibalize highly profitable solar renewable energy certificate (SREC) revenue
  • Losing the investment tax credit will further hurt the economics of Sunnova’s business. Even if the current 30% level is renewed, industry headwinds look to inhibit the Company’s growth

Undifferentiated Business Model, Ill-Positioned In A Highly Competitive Industry Based On A Porter’s Five Forces Analysis

  • Sunnova is a small player relative to peers. The merger between Sunrun and Vivint Solar creates the largest player in the industry, well-positioned to capture cost savings and compete more aggressively for new customers to achieve greater scale
  • Customer relationships: any solar company offering long-term financing and servicing contracts can claim strong relationships
  • Asset ownership: Sunnova has $1.98bn in solar assets compared to Sunrun’s $4.64bn and Vivint Solar’s $1.85bn
  • Local dealer network: increases counterparty risk; independent salesforce would be expected to direct customer where they are paid the best. We have found several examples of concerning sales practices and other activities by Sunnova and dealer partners
  • Sungevity, another Energy Capital Partner investment, filed bankruptcy after claiming a similar asset-light business model, industry-leading customer acquisition platform and channel partner network

We Believe EBITDA And Contracted Customer Value Metrics Are Completely Meaningless To Evaluate Sunnova

  • Core earnings, which continue to decline, should be the primary metric to measure the performance of a specialty finance business
  • Adjusted EBITDA is a misleading metric to evaluate the financial performance of a financing business
  • EBITDA is not an accurate proxy for free cash flow and does not reflect the Company’s financial performance, as Adjusted EBITDA has grown while operating cash flow and free cash flow has declined
  • Treats interest and depreciation as non-core, while they are core to a financing business, representing over 100% of revenue
  • Depreciation is added back as a result of the large investment in its solar systems and ignores the expense as a negative drain on cash flow
  • SEC Comment Letter shows evidence of aggressive use and calculation of EBITDA
  • Contracted Customer Value (CCV) relies heavily on management assumptions to project 25+ year contracts when the Company only has 7 years of historical data to back its model. Based on Company data, we estimate every 1% change in the discount rate, results in $170 million change in CCV. Auditor PWC has not audited or reviewed Sunnova’s CCV metric
  • With so many variables, including life of service agreements, renewal and cancellation rates, production capacity and performance, hours of sun, required repairs, contracted electricity rates, discount rates, and more, how can this metric be predicted with confidence?

Financial Performance Continues To Decline As Growth Slows And Margins Erode; Highly Aggressive Inventory Accounting

  • As industry headwinds intensify, topline growth is slowing and reported margins have declined
  • Reported gross margin excludes core interest expense required to fund its specialty finance business
  • We calculate gross margin, which is extremely volatile and sometimes negative, significantly below reported margin (~60-70%)
  • Gross margins also inflated relative to peers by two highly unusual industry practices
  • Prepaid Inventory: NOVA’s prepaid inventory purchases at year end 2019 were 3x peers. We believe the tax benefit associated with these pre-purchases will artificially benefit margins and be a major headwind into 2021
  • Inventory Accounting Method: NOVA uses the weighted average method vs. FIFO for peers. With input prices deflationary in nature, FIFO is the more conservative approach. NOVA’s method allows it to report higher margins than peers, all else equal
  • Operating and free cash flow continue to decline as the business grows. We believe NOVA’s “Adjusted Operating Cash Flow” makes use of numerous aggressive and unsupported addbacks. They portray it as a positive result, but we believe it is deeply negative
  • Sunnova relies on access to capital markets to support its unprofitable underlying business. As the balance sheet continues to grow, the economics of the business are stripped out by debt holders and tax equity investors, leaving equity shareholders with an overleveraged business dependent on management assumptions that will likely never generate cash flow for equity holders

Corporate Governance Concerns And Insider Activity Should Worry Investors

  • Largest shareholder Energy Capital Partners (ECP) continues to liquidate its position, reducing by ~13% in July and ~24% in August.
  • ECP exited its investment in Sungevity, another residential solar company, three months before the Company filed bankruptcy
  • As the lockup expires, we believe insiders will follow ECP’s lead and be anxious to reduce their positions at today’s inflated valuation
  • CEO Berger omits his experience at Enron, where he worked for 5 years, from his biography. The Enron scandal involved booking mark-to-market earnings upfront on opaque financial models with assumptions that later proved inaccurate. This became known as mark-to-model accounting. We worry Sunnova’s non-GAAP metrics employ similarly aggressive interpretations
  • CFO Robert Lane and VP of Finance Christian Hettick previously were executives at Spark Energy (SPKE), another energy company with a poor business model promoting high growth, which ended up collapsing
  • CFO Lane also obscures his tenure from 2009-2011 at Madison Williams, a now bankrupt energy broker-dealer that was backed by Pan Asia China Commerce Corp (PAC3) and Fletcher International. Fletcher collapsed in 2012. The bankruptcy trustee said “in many ways, the fraud here has many of the characteristics of a Ponzi scheme”. The SEC later charged PAC3 with securities fraud in a film financing deal
  • On September 25, 2020 Audit Chairman C. Park Shaper disclosed a 10b5-1 stock sale program effective August 24th
  • Mr. Shaper came from Kinder Morgan, a Company formed by ex-Enron executives and has been criticized by some as a “house of cards”. During Mr. Shaper’s tenure as CFO of Kinder Morgan Energy Partners, it received an informal SEC probe into its acquisition accounting for Tejas Gas. Spruce Point observes that Tejas cost investors 18% more than initially proposed, resulting in goodwill ballooning from $0 to $152m
  • Kinder Morgan paid $27.5m to settle a lawsuit that it misclassified expenses to inflate payouts during periods Mr. Shaper was Kinder’s President
  • Executive compensation is not aligned with performance and metrics do not reflect those used by peers
  • Compensation metrics include Adjusted EBITDA, adjusted operating cash flow and gross contracted value
  • Sunnova’s peer group does not fairly represent its business by excluding specialty finance companies
  • NOVA’s audit partner is an energy specialist, and not a financing specialist better suited for specialty finance companies

Significant Downside Risk As Market Perception Reevaluates Sunnova As A Specialty Finance Business

  • Spruce Point arrives at our price target of $5.00 – $8.00 per share through a combination of a book value multiple reflecting the declining fundamentals of Sunnova’s business and a value per customer in line with solar peers
  • Sunnova trades 16% below sell-side brokers’ consensus price target of $31 per share
  • We believe these targets are overly optimistic as a result of using EBITDA and contracted customer value multiple methods
  • Coverage by solar and energy analysts does not reflect the nature of Sunnova’s business. We believe coverage should be assigned to specialty finance analysts as is the case with leasing companies such as AerCap and Air Lease.
  • Sunrun’s acquisition of Vivint Solar provides a key data point to assess valuations in the industry. Sunnova trades at a premium to both peers on a revenue and customer basis, despite generating less revenue per customer and having a less diversified business
  • We believe there is limited probability of an acquisition by Tesla/SolarCity as Tesla’s market share of the installation and financing market has declined since the acquisition

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