Sunrun (NASDAQ: RUN) Investment Thesis - Part 3
Sunrun's unit economics and IRR
Part 3 - Sunrun's unit economics
Unit economics and IRR
To assess whether a business is a good long-term investment, it's important to consider factors such as its return on equity and unit economics. However, GAAP accounting may not give a complete picture of a company's true earnings power. For Sunrun, more than half of its sales and marketing costs are expensed in the first year, while the contracted customer relationship lasts for 20 years or more. This creates a mismatch between recurring revenue and front-loaded expenses, which can make it difficult to accurately assess the company's financials using GAAP net income. Instead, it's more informative to look at metrics such as unlevered IRR and levered IRR, as well as net cash inflow generated per customer.
Based on these metrics, Sunrun demonstrates strong unit economics. The company has an unlevered IRR of around 10% and a levered IRR of over 20%. With an advance rate of 80% in solar ABS, Sunrun generates $3,000 in cash inflow for each customer assuming a standard $7.2KW solar system without battery or any other supplemental revenue stream. Assuming a financing cost of 7%, Sunrun will experience cash outflow from year 2 to year 5 before seeing positive cash flow until the end of the contract. On a net/net basis, the levered cash IRR is over 20%.
We can further analyze Sunrun's business model by looking at its lifetime value (LTV) to customer acquisition cost (CAC) ratio. Based on an $8k CAC per customer (sales & marketing) and an LTV of $20k (net of system cost), the ratio could be as high as 2.5x.
Overall, Sunrun's unit economics look strong even without considering renewal value or any up-selling opportunities. For a more detailed breakdown of the analysis, please see the appendix.
Unit economics
To gain a comprehensive understanding of Sunrun's unit economics, it is helpful to examine the impact of acquiring a specific customer on GAAP earnings and cash flow. This analysis can provide insight into where Sunrun can add value for its shareholders.
S&M $8.5k, G&A $1k: Sunrun spends an average of $8,500 on sales and marketing to acquire one customer, which has increased by $3,000 over the past five years due to rising wages and the acquisition of Vivint, a company with a more direct-sales approach. Sunrun nearly tripled its headcount within three years by acquiring Vivint, resulting in higher sales and marketing expenses. In addition, Sunrun spends $1,000 on general and administrative expenses at its headquarters.
Solar system $21k, total creation costs $30k: To install a solar system for a typical customer, Sunrun purchases a 7.2KW system for $14,000 ($2 per watt) and spends an additional $7,000 on installation and labor costs. The total cost of the solar system is $21,000, which, combined with sales and marketing and general and administrative expenses, brings the total creation cost to around $30,000 as of 2022.
Gross contracted value $40k: On the subscriber value side, the contracted subscriber value is around $40,000, which is calculated using a discounted cash flow method at a rate of 6%. This value is derived from the expected payments from customers, the net proceeds from tax equity finance partners, payments from utility incentives, projected future cash flows from solar renewable energy credit sales (SRECs), and the estimated operating and maintenance costs to service the systems and replace equipment.
Gross proceeds of $33k - $13k from tax equity, $20k from debt: Assuming a conservative advance rate of 85% (with a management range of 80-90%), Sunrun estimates proceeds from financing to be around $33,000, of which $13,000 comes from tax equity investors and the remaining $20,000 comes from debt financing (either a warehouse facility or solar ABS).
Net cash inflow $3k: Overall, Sunrun generates a net cash inflow of $3,000 per customer, which equals the proceeds of $33,000 minus the creation cost of $30,000.
This analysis demonstrates the unit economics of Sunrun's business and highlights how the company generates value for its shareholders. Now we move on to GAAP earnings:
Revenue $11.2k in Year 1: The company generates GAAP earnings from each customer through various revenue streams. In Year 1, the company generates $1,600 in revenue from each customer through a PPA agreement, which is calculated as 1,500 hours x 7.2KW x $0.15 per KWh. In addition, there is $200 in revenue from incentives, with the most important one being SRECs. Utilities in different states need to buy renewable credit from the marketplace to meet renewable portfolio standards (RPS), creating a demand for SRECs. Another significant revenue stream is generated from the 30% ITC received from the partnership flip, amounting to $9,400 ($1.3 per watt) in Year 1. Although it doesn't show up in revenue from the GAAP perspective, it is recorded as a gain from non-controlling interest. Total Year 1 revenue per customer is $11.2k.
COG $4k, S&M $4.5k, G&A $1k, Op Income $700: The cost of installing the system is $21,000, but only $4,000 is recorded as cost of sales. The remaining amount is capitalized and depreciated over 35 years. For sales and marketing, out of the total $8,500, $4,500 is expensed in Year 1, and the rest is capitalized as the sales and marketing efforts are spent to acquire a 20- / 25-year contract. General and administrative expenses amount to $1,000, and there is an additional $1,000 in stock comp expense. The total cost of goods sold is $4k, sales and marketing expenses are $4.5k, and general and administrative expenses and stock comp expenses amount to $1k each. The company's operating income is $700.
GAAP net loss $500: The company has $20,000 in debt that incurs 6% interest, costing $1,200 in interest expenses. As a result, the company incurs a GAAP net loss of $500.
Sunrun's true earnings power cannot be fully reflected in GAAP accounting in early years since most of the sales and marketing expenses and part of the system cost are expensed upfront, while the contract lasts for more than 20 years. From Year 4 onward, especially with the escalating factor of 3%, Sunrun would turn a net profit for each customer.
Revenue $2.7k in Year 4, net income of $100: Based on simple math, the revenue in Year 4 would be $2,700, including an additional $700 from the tax equity investor. Maintenance cost is estimated to be $180, and G&A would be $600, reflecting economies of scale. Depreciation and amortization are estimated to be $600, and interest expenses are expected to be $1,200. The net income would be $100.
Revenue $2.4k in Year 10, net income $300: From Year 10 onward, Sunrun would record significant profits as interest expenses reduce due to the amortizing loan, and G&A costs decrease further due to economies of scale. Based on simple math, the revenue in Year 10 would be $2,400, maintenance cost is estimated to be $180, G&A would be $500, depreciation and amortization would be $600, and interest expenses would be $800. The net income would be $300.
Total cumulative earnings $4k + upfront cash inflow $3k: Over the lifetime of the contract, total cumulative earnings are expected to be around $4,000, discounted at 6%. The total net contracted value for each new customer is $7,000, including the $3,000 upfront cash inflow.