Tesla Is Grossly Overvaluing SolarCity

More than three months after Tesla (NASDAQ: TSLA) announced its intention to acquire SolarCity (NASDAQ: SCTY), CEO Elon Musk hasn’t answered the single most important question for investors yet, which is what return they should expect from such an investment.

When analyst Colin Rusch from Oppenheimer & Co. asked for “some sort of scope of return on capital” on the conference call after the acquisition announcement, Mr. Musk acknowledged the relevance of the question, saying “we will certainly have all that done for you, but the reason it’s not just all in a neat package is because this is a sort of an odd case where we have to tell you at the start of the process, before we have all the answers.”

Three months later Mr. Musk is running behind on his promise. The S-4 that has since been published, hasn’t been helpful either. It heavily relies on the dubious metrics that SolarCity has been using for years without presenting a new and serious look at what the business is actually worth.

Analysts and media seem a bit shy too to delve into the numbers. Those who are in favor of the deal generally stick to explanations like “If you don’t believe in Elon, why are you buying these stocks in the first place?” - an insight presented by equity analyst David Whiston (link).

As some of the Tesla bulls repeatedly say, it is easy to criticize Mr. Musk from the sidelines, while he is working hard to build his business empire. So let’s take a positive attitude here and offer some help. While Mr. Musk is engineering the first rocket which performance bar is larger than the vehicle itself - you can’t make this stuff up, can you - we’ll delve into SolarCity’s numbers to work out an actual fair value for the company.

More Than Money at Stake in Tesla’s SolarCity Deal

The vote on Tesla Motors’ proposed merger with SolarCity is drawing nearer. That means Tesla shareholders have quite a dilemma to sort out.

Though Elon Musk, Tesla and SolarCity’s chairman and largest shareholder, has termed the proposal a “no-brainer,” the reality, at least for Tesla shareholders, is far more complex.

From a strictly financial perspective, the deal is something Tesla shareholderscan do without. Tesla, of course, has significant ongoing cash needs without the additional burden from SolarCity. Though Tesla showed $3.2 billion in cash on its balance sheet as of June 30, that money is expected to burn quickly as Tesla prepares to bring the Model 3 sedan into production. Capital expenditures alone are expected to total $1.75 billion for the second half of the year.

Adding the struggling solar-panel developer to the mix would make this problem worse. SolarCity spent $766 million on operating expenses last year, nearly twice as much as its total revenue. Through June of this year its expenses hit $265 million, 42% more than its revenue in the first two quarters. Worse still, SolarCity has more than $3 billion in long-term debt on its books. Tesla has said it would need to raise fresh capital before the year is out, despite raising nearly $2 billion in equity financing in May.

Avoiding that burden would give Tesla more financial flexibility to launch the Model 3 on time and on budget. A successful Model 3 launch is essential for Tesla to justify its valuation, and that task becomes more urgent as legacy auto makers roll out new competition for the Model 3.

Tesla-SolarCity Merger Would Make Tesla’s Business Model Worse, Not Better

Tesla shareholders would be better off voting down the company’s merger with SolarCity, in part because combining the two companies would likely cause Tesla’s expenditures to explode.

The merger looks like a loser from a Tesla shareholder’s perspective, mostly because the addition of SolarCity would wear on Tesla’s financial well-being, as the company’s capital expenditures alone are expected to balloon to $1.75 billion by the second half of the year.

Adding the hulking, money-bleeding solar-panel developer to the mix would inevitably compound this problem.

SolarCity spent nearly $800 million on operating expenses in 2015, the Wall Street Journal reported Monday, essentially dwarfing its total revenue by more than half. The solar panel maker is an albatross on shareholders’ necks: It currently has more than $3 billion in long-term debt on its books; and its expenses hit $265 million by June.

SolarCity Is Being Sued for Intellectual Property Theft

In a lawsuit filed in San Francisco on Monday, the parties accused SolarCity of gaining undue advantage of Cogenra’s Shingling technology that helps in manufacturing high-efficiency commercially viable solarpanels.

SolarCity and its subsidiary Silevo misappropriated Cogenra’s trade secrets, manufacturing processes, and other intellectual property to give themselves a competitive advantage and head start in developing shingled-cell solar modules, Cogenra said in the lawsuit.

WHY TESLA’S SOLARCITY BID WILL FAIL

Gigafactory, Model 3 Implications

Tesla’s blog notes its Gigafactory-produced Powerwall home battery system dovetails with SolarCity-produced solar panels. But Goldfarb objects to “the hypothetical connection in that solar can charge a home battery during the day, and this then can be used by the electric vehicle at night — or both batteries could be used to sell back to the grid.” But solar generally doesn’t produce enough to power a home, he says. “And you can’t store power in your car battery during the day because the car is usually not there.”

Goldfarb also says the $4 billion Gigafactory in Nevada has been “a huge bet” and has experienced delays. “It is hard to see how its battery model will be profitable,” he says.

Musk says, according to Vox, that a SolarCity deal will not affect Tesla’s plan to sell its $35,000 Model 3 starting in 2017. But Goldfarb says the margins in this part of the market will be very tight. “General Motors has been promising a late-2016 launch of a 200-mile range Chevrolet Bolt EV, electric car,” he says. “Moreover, the electric car market is crowded in the midprice range. Nissan, Ford, BMW, VW, Fiat, Mercedes, Kia, Mitsubishi and Smart all produce cars in the segment.”

Not Mass-Market Suited

Given the above-noted factors, Goldfarb says Tesla’s mass-market and SolarCity-takeover ambitions appear out of line with Musk’s track record as a master and visionary. For example he’s been out in front of the self-driving revolution (though the self-driving car “is really just a toy right now, and this market is very crowded, too,” Goldfarb says). Tesla can and should focus on what it does best: high-end electric cars, Goldfarb says. “Tesla owners love their cars,” he says. “They should. These are wonderful automobiles.”

Shareholders Go After Elon Musk’s SolarCity Bailout Plan

Tesla shareholders are suing the company because of its proposed merger with SolarCity, thus creating a challenge for Elon Musk to save the troubled solar energy company.

Tesla Motors Inc. (TSLA:NASDAQ) announced on Sept. 19 four shareholders filed lawsuits alleging that the Tesla board members “breached their fiduciary duties in connection with the proposed merger.” The shareholders also accuse both companies of unjustly enriching certain individuals through the deal.

“The lawsuits could prevent or delay completion of the merger and result in substantial costs to Tesla and SolarCity,” stated Tesla in a regulatory filing.

The lawsuits were filed by two pension funds (City of Riviera Beach Police Pension Fund and Arkansas Teacher Retirement System) and two individual shareholders (Ellen Prasinos and P. Evan Stephens), according to the filing.

“Other potential plaintiffs may also file additional lawsuits challenging the proposed merger. The outcome of any such litigation is uncertain,” Tesla stated.

In June, Tesla announced its plan to acquire SolarCity Corp. (SCTY:NASDAQ) in an all-stock deal, which valued SolarCity at $2.6 billion as of Aug 1. The merger is controversial, as Elon Musk is the chairman and largest shareholder of both companies and Lyndon Rive, the CEO of SolarCity, is a cousin of Elon Musk.

According to some analysts, the merger doesn’t make financial sense.

“Investors are likely to view this transaction as a bailout for SolarCity and a distraction to Tesla’s production hurdles,” stated Oppenheimer’s analyst Colin Rusch in his report after the merger announcement.

Based in San Mateo, California, SolarCity designs and installs solar panels at residences across the United States. The company sells long-term contracts and it is the market leader.

The company has frequently fallen short of its installation goals. Its operating expenses increased by 55 percent, causing the company to lose $533 million in the first half of 2016.

Musk’s vision at stake in Tesla shareholders’ vote on SolarCity merger

SolarCity’s fate now lies squarely in the hands of Tesla Motors and its shareholders.

A 45-day window in which SolarCity could consider other offers beyond Tesla’s $2.3 billion merger bid closed on Wednesday night, and no other investor or company put a proposal on the table.

That wasn’t entirely surprising. After all, 15 potential buyers or investors looked at SolarCity earlier this summer, while the solar energy company was hammering out the terms of Tesla’s merger offer and trying to see if anyone else would top the electric vehicle maker’s bid.

None did.

Now the big question is whether Tesla’s shareholders buy into CEO Elon Musk’s vision for creating a renewable energy juggernaut that combines electric vehicles with solar energy and battery storage.

Shareholders from both companies still have to vote on the proposed merger. The date of the votes haven’t been set, but it could be as early as October.

Most analysts think the deal will go through. They say many Tesla investors support Musk’s renewable energy vision and are likely to go along with his strategy.

They also tend to downplay the concerns that arose from the regulatory filing about the cash crunch that both companies are facing. Tesla needs to pay $422 million to some of its bond holders by the end of the month, and both companies need to raise billions in new funding to finance their ambitious plans.

The news recently has been better on the financing front. Tesla, which had $3.25 billion in cash on its books at the end of June, reached an agreement this month to borrow up to $300 million from Deutsche Bank to fund its vehicle leasing program.

SolarCity earlier this week raised $305 million in a deal with five institutional investors and an investment fund advised by George Soros.

That fundraising will cover only a portion of the companies’ financing needs, but it shows that their ability to raise funds remains viable.

Still, the worries persist on Wall Street. Since the deal was finalized on Aug. 1, Tesla’s stock is down by 13 percent. SolarCity shares have tumbled by 34 percent.

As a result, a deal that was worth $2.6 billion when it was announced now is worth about $350 million less.

In the deal, SolarCity shareholders will receive Tesla stock worth $22.59 at today’s prices. But because of the liquidity concerns and uncertainty over shareholder approval, SolarCity’s shares are trading at $17.50 – a steep 23 percent discount to the value the Tesla offer places on the shares.

Normally, the discount would be just a few percentage points.

One of the more skeptical analysts following the deal, Gordon Johnson of investment firm Axiom, pegs the odds of the merger passing at 50-50. Johnson, who has a sell rating on SolarCity’s stock and thinks it could fall as low as $7, said Tesla “failed to consider whether another solar company was a better fit,” and noted that none of the three potential suitors who had more extensive contact with SolarCity were willing to make a counter offer, according to a regulatory filing by the companies late last month.

“With a number of solar vendors available currently, at arguably depressed prices … Tesla failed to consider if any other solar companies offered more favorable synergies,” Johnson said in a research note.

Musk, who owns more than 20 percent of the stock in both companies and is SolarCity’s chairman, has argued that no company is a better fit for Tesla than SolarCity. With a commanding market share in the rooftop residential market, Musk has said that SolarCity, run by his cousin, Lyndon Rive, offers the best opportunity to link Tesla’s battery storage capabilities with a leading solar energy installer.

Some analysts wonder if Musk is taking on too much at one time.

“We see a lot more that can go wrong than can go right,” said Jeffrey Osborne, an analyst at Cowen & Co. “The company, while fundamentally well positioned for the long term, has a material amount of execution risk over the next 12 to 18 months.”

Tesla is developing its Model 3 sedan, which will sell for as little as $35,000 and will be its most affordable model, by far. As it moves to ramp up production of the Model 3, Tesla also is opening its battery gigafactory in Nevada.

SolarCity, for its part, is pushing to open its solar panel factory in South Buffalo, which will be the biggest in the Western Hemisphere, with production scheduled to start by the end of June as the company rolls out a new solar roofing product.

“The SolarCity acquisition only adds an additional layer of complexity at a crucial time when the company should be focused on the gigafactory ramp and Model 3 launch,” Osborne said. “We see the potential for delays in the introduction of the Model 3, ramp of the Gigafactory and integration of SolarCity, leading to increased cash burn levels.”

Cash is such a concern because neither Tesla nor SolarCity is profitable, although Musk, in a memo to employees this month obtained by Bloomberg News, urged them to cut costs and deliver “every car we possibly can” to push the vehicle maker closer toward generating more cash than it uses. Hitting that milestone would put Tesla in “a far better position to convince potential investors to bet on us.”

Together, the two companies will have about $5 billion in debt between them. And because neither one has a positive cash flow, they will have to raise billions in new capital to meet their ambitious plans, from opening the battery gigafactory and the Buffalo solar panel factory, to ramping up production of the Model 3.

The big question now, though, is how much interest Tesla shareholders have in approving the deal.

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