A Terrible Way to Invest in Solar Energy

By Markets Fool.com

Image source: SolarCity.

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Solar energy has been a difficult business to break into over the past decade, particularly for companies that don't have a direct interaction with customers. The latest to hit trouble is Enphase Energy, producer of microinverters and once a high-flying initial public offering in the solar space. The company recently said it will lay off 11% of its workforce in an effort to save $20 million to stay float.

Enphase follows financial trouble for Power-One, eventually acquired by ABB (NYSE: ABB), and even weakening performance from SolarEdge Technologies (NASDAQ: SEDG). And the struggles for inverter, optimizer, and other equipment suppliers won't end here.

Building a business from a position of weakness

The core problem with solar equipment suppliers is that they're beholden to their customers for demand. In the residential space, SolarCity (NASDAQ: SCTY) and Vivint Solar (NYSE: VSLR) are the two big players, and as their preferences have changed, so have the fortunes of suppliers.

When the residential solar industry was young, string inverters from Power-One were the winner in the market. Then Enphase Energy took the market by storm with microinverters. And more recently, SolarEdge power optimizers have gained market share, particularly as SolarCity has grown. What's common is that customers drove the adoption of each company's products, only to see customer preferences change.

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Manufacturers have known that customer preference can change, so they've tried to expand their product lines. Energy storage was seen by Enphase Energy as a product it could sell in the future and SolarEdge has partnered with Tesla Motors' (NASDAQ: TSLA) Powerwall to add new capabilities to power optimizers and inverters. But they're still relying on customers to need their products, which may not always be the case.

The problem with customers driving your business

Part of the drive for Tesla buying SolarCity (NASDAQ: SCTY) is that Elon Musk wants to bring all of the energy business under one roof. And there's already talk of the companies developing an inverter to include with Powerwall, which could be announced as early as October. And with SolarCity already building its own solar manufacturing plant in Buffalo, New York, power optimizers may not be needed by the company, either.

In other words, end customers are developing their own products to squeeze suppliers out.No matter how hard inverter and power optimizer manufacturers try to improve their products, they'll always be fighting the possibility of customers developing their own products. When you don't own the end-customer relationship, as SolarCity and Vivint Solar do, you can't guarantee demand going forward. And when customers find a better option, the rug can be pulled out quickly.

A bad way to play solar energy

Investors have gotten caught up in the idea that Power-One, Enphase Energy, and SolarEdge could be big winners in solar, driven by high growth rates at their IPOs. But there's also a big risk that demand will dry up quickly as customer preferences change, leaving these companies out in the cold, which is something each company has faced. Without the ability to own the end-customer relationship, solar equipment suppliers simply aren't worth investing in.

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Travis Hoium has no position in any stocks mentioned. The Motley Fool owns shares of and recommends SolarCity and Tesla Motors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.