Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.
When Array Technologies (NASDAQ:ARRY) stock IPO’ed in mid-October, shares immediately rocketed to $30. ARRY stock eventually peaked at $44 as mom-and-pop investors marveled at the company’s supposed 145% growth rate.
With climate change at the forefront of many people’s minds, investors have madly rushed into the solar industry. Array Technologies, the #2 maker of solar panel ground-mounting systems, looks like a logical bet.
But behind the company’s seemingly hyper-fast growth hides both a stagnating technology and gross accounting deception.
With former star CEO Ron Corio now taking a backseat to a newly installed management team, its innovation pipeline has slowed. The company’s accountants have temporarily hidden this fact. But unless something changes, it’s only a matter of time before investors realize they’re getting hoodwinked by a perfectly timed IPO.
ARRY Stock: Running on Past Success
Array Technologies makes ground-mounted tracking systems for solar panels: the brackets that turn solar panels towards the sun at any given time of day. The seemingly hum-drum business has rocketed in popularity in recent years. Solar panels on trackers can generate up to 25% more energy than stationary ones, and brackets’ cost is minimal. Some 70% of all solar panels now use some tracker technology.
Investors can thank Corio for the company’s success. He patented the first solar tracking system in 1993 and still holds the patent for Array’s only significant product: a tracking system that turns multiple solar panel rows with a single motor. Put another way, while competitors need a new engine for every row of solar panels, Array Technologies can use a single one to drive entire systems.
The innovation has rewarded the company handsomely. Sales more than doubled through H1 2020, while gross margins grew to 25%. Management was quick to reward themselves, splitting 22 million Class B shares between their ranks.
Array’s (Unintentional?) Accounting Trickery
Array’s massive growth, however, has more to do with short-term federal regulations and accounting rules. According to Wood Mackenzie, an energy research firm, the U.S. saw tracker market shipments double in 2019 “as a result of companies safe-harboring equipment to achieve eligibility for the federal Investment Tax Credit.” ARRY’s balance sheet reflects the one-time boost: last year, the company recorded a massive $308 million jump in deferred revenue as customers rushed to close deals before the Dec. 31, 2019 deadline.
Deferred revenue is the accounting equivalent of a meat processing plant that can’t process the entire slaughter at once. Prepaid cash (or unprocessed cow carcasses) gets stored as a liability on the balance sheet. It’s only when cash is “earned” does it move back onto the income sheet as revenue.
So, when Array opened the release valve in H1 2020, the same $308 million got re-recorded as revenue. And by adding that amount to their “real” H1 income, Array made it appear as if their business had doubled overnight — just in time for their IPO.
Releasing deferred revenue to boost sales by $308 million, just in time for an IPO
In reality, once investors remove the one-time boost, it turns out Array’s H1 2020 sales grew only 9%.
Was the misdirection intentional? The SEC might have a hard time deciding. On the one hand, the company did follow accounting norms; deferred revenue is a normal part of any business with long-term contracts. On the other hand, many will reasonably argue that the company failed to adequately warn investors of the risk, given the tax credit’s gross one-time distortion right before its September IPO.
But one thing is understood: if ARRY stock keeps dropping, expect lawsuits from angry shareholders to appear.
Array’s Lack of Innovation
Has the company kept up with innovation beyond its accounting department? ARRY stock bulls will point to the firm’s SmarTrack, “machine learning” software that boosts energy output by up to 5%. But as a high-growth tech investor, I see this corporate hogwash all the time. Every major solar tracking company has developed similar software; Array’s sole differentiating factor is Corio’s invention that allows a single motor to drive multiple rows of solar panels.
And even that hasn’t helped Array’s new management gain market share. A rising tide lifts all boats, and the solar tracking firm has only bobbed along with 12% market share, despite the U.S. federal government giving the company a home-court advantage. Meanwhile, international players have been catching up. Mexico’s Arctech Solar, and Spain’s PV Hardware, Soltec, and Nclave grew their combined market share from 22% in 2017 to 32% in 2019.
Array is running out of time to innovate before low-cost producers catch up. Former CEO Corio has long shared his dreams about battery storage for solar farms, a potentially massive growth area for Array. But under today’s management, R&D counts for so little that it doesn’t even appear as a line-item on the firm’s income statement.
What’s ARRY Stock Worth?
If Array can somehow maintain market share without introducing new products, its topline growth will still converge with the overall solar market’s. According to the EIA, that means a slowdown for Array from 28% growth in 2021 to just 11% by 2024. And by 2030, growth would plateau at 3.8% as solar installations saturate the energy market.
That’s terrible news for ARRY stock. Using a two-stage DCF model with the following calculations:
- Assume ARRY’s free cash flow tracks the overall solar market
- Account for $308 million of deferred revenue
- 9% discount rate
- 3% growth after 2050
That suggests that the company is worth just $2.56 billion, or $20 per share. That’s the same amount that the company’s bookrunners calculated pre-IPO.
What Should Investors Do About ARRY Stock?
Array’s accounting practices have clearly fooled many investors; the company has a market capitalization of $4.68 billion.
Put that in context by considering the #1 solar tracker player, NEXTracker. The company, owned by multinational Flex Ltd. (NASDAQ:FLEX), has a 30% market share, or over 2.5 times that of Array. You would imagine the U.S.-Singapore parent company, which also counts three other industrial segments, to have far greater value than Array. After all, its 2019 revenues were 35 times larger.
But what’s Flex Ltd. worth? Just $2.41 billion more than Array Technologies.
In other words, buyers of Flex stock will receive a solar tracking subsidiary that’s 2.5 times the size of ARRY for just $7 billion. And they can throw in another $22 billion of revenue-generating businesses for free. Investors might also consider Valmont Industries (NYSE:VMI), owner of #7 player Convert Italia. The industrial stalwart trades for a far more reasonable 10.6x EV-to-EBITDA, compared to ARRY’s 27.3x.
In either case, don’t let Array’s accounting tricks fool you. They’re a valuable company. But without technological innovation, share prices will eventually sink back to $20.
On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.