Tesla Motors: Does It Really Understand What It’s Buying in SolarCity?

While we previously pegged the odds of Tesla’s proposed merger of SolarCity at a 50/50 probability yes/no, we now peg those same odds at 70/30. However, with an 0.11x exchange of Tesla stock for each share of SolarCity, if the deal were to close today, SolarCity would be valued at $20.21/share, or 2.0% upside. However, were the deal not to close, we believe SolarCity’s stock would trade down to $6/share (we believe SolarCity is still creating negative value for each system sold on an unlevered basis. Thus, on valuation, applying 70% to $20.21 + 30% to $6, on arrives at a probability adjusted year-end 2016 price target of $16, or 20% downside.

So, despite advisory firm Institutional Shareholder Services’s (“ISS”) approval last week, why do we still see a 30% chance some shareholders “walk” on this deal when the date for approval (i.e., Thursday of this week) is so close, and the merger-arb spread has come in so much? In short, we assume investors aren’t willfully ignorant. What do we mean? Well, in SolarCity’s C3Q16 10-Q, which was released last week, we gleaned two key takeaways, including:

§ SolarCity sold roughly 25% of their panels to the Commercial and Industrial (“C&I”) segment during the quarter; and, despite the company reporting C&I prices for their systems sold at roughly $3.00/W, based on checks we did months ago, we know that C&I prices in the US are 35%-50% below what SolarCity has reported; thus, if one were to spread the SG&A across proportionally to the average selling price (“ASP”), SolarCity’s creation cost would be significantly higher than the reported $2.89/W level, which would also mean a huge miss on megawatts (“MW”) deployed in C3Q16, not the beat reported; and

§ SolarCity changed the useful lives of their systems from 30 years to 35 years in the quarter, artificially (we believe) reducing depreciation expense, allowing the company to inorganically beat on EBIT and thus EPS.

We believe these actions are HIGHLY questionable, and assume Tesla investors either: (a) lack a very basic understanding of the solar market, or (b) lack a very basic understanding of accounting. But it doesn’t end there. In addition to these forms of what we see as accounting chicanery, SolarCity claimed that it generated cash in the quarter. However, when adjusting for the debt the company issued in the quarter (i.e., excluding it), its cash balance fell from $146mn in C2Q16 to just $67mn in C3Q16. Thus, again, assuming the portfolio managers at Fidelity, Baillie Gifford, T. Rowe Price, Vanguard, Black Rock, Morgan Stanley, etc. are aware of this, and not under Mr. Musk’s “spell”, we still see a 30% probability this deal does not close. As such, we would be short the stock ahead of Thursday’s vote.

Tesla-SolarCity merger: How risky is all that debt?

Billions need to be raised

Musk said earlier this month that he expects SolarCity to generate $500 million in cash for Tesla over the next three years. He predicted that SolarCity would add more than $1 billion to Tesla’s revenues next year.

Analysts at proxy advisory firm Institutional Shareholder Services, which recommends that investors approve the merger, estimate that, after the deal closes, Tesla will need to raise between $2.5 billion and $3.5 billion during each of the next two years.

If Tesla can’t raise all the money it needs, some of its ambitious plans could be delayed – or derailed. In one hypothetical scenario that SolarCity management spelled out in an August regulatory filing, if the solar installer struggled to raise new capital it might be forced to cut off funding for the Buffalo solar panel factory to reduce its cash needs by more than $400 million through the end of 2018.

State and company executives have said that’s a worst-case scenario meant to meet legal requirements that regulatory filings warn investors about all potential risks. But it also underscores the importance of raising capital to the companies.

“The issue,” the Institutional Shareholder Services analysts said, “is whether Tesla can handle these needs.”

Overcoming SolarCity’s Language Barrier

As you know, elections breed a fair amount of cognitive dissonance.

Which brings us, naturally, to the other vote taking place this month: the decision on Tesla Motors Inc.’s acquisition of SolarCity Corp., scheduled for Nov. 17.

The latest ¯\_(ツ)_/¯ episode came on Friday morning. International Shareholder Services Inc. issued a report urging investors to vote for the deal and containing this gem of a line:

Tesla has — within the confines of its suboptimal governance structure — taken the requisite steps to reassure its shareholders…

Taking steps within confines is, of course, a ticklish task. Even Elon Musk seemed surprised at the outcome. Later that day, though, rival proxy-advisory firm Glass, Lewis & Co. took a somewhat different view:

Stripped from the pretense of creating a fully-integrated renewables retailer serving a loosely framed end-market, we believe non-affiliated Tesla investors should be concerned the proposed tie-up of Tesla and SolarCity mostly amounts to thinly veiled bailout plan (sic).

I have tended to hew more to that view (see here and here). The idea that SolarCity is a vital, healthy, must-have target is belied by the fact that it agreed to sell itself for a low-ball, all-stock offer that, as of early Monday afternoon, barely provides a premium to the undisturbed price:

Tesla and SolarCity are dealing with a critical business problem

As Tesla prepares to acquire SolarCity and create an integrated auto-energy-power storage company, SolarCity’s legacy business model is undergoing a change.

SolarCity reported third-quarter earnings on Wednesday, and the company noted a shift from its traditional solar-panel leasing operations to a newer loan program that brings in more cash, Bloomberg reported.

Here’s Bloomberg’s Christopher Martin:

SolarCity is facing shifting consumer sentiment over solar power. Homeowners increasingly prefer to purchase the rooftop systems rather than the decades-long leases that make up most of the company’s business. Rive said in an Oct. 9 interview that 30 percent of September sales came from cash installs, or loans, instead of leases.

Cash and equivalents rose 78 percent to $259.3 million from the end of the second quarter, and Rive said he expects improved cash generation in the current quarter and next year.

This is important for a couple of reasons. First, Tesla and SolarCity, as a combined company, will be rolling out a new solar-roof product that’s designed to be a fully integrated roof, not a group of solar panels attached to an existing roof. That’s something that Tesla will want homeowners to buy, through financing, when it comes time to install a new roof.

Second, leased solar panels might make it easy for customers to get into solar energy, but when it comes time to sell the house, the lease could be an issue. SolarCity can arrange for it to be transferred, but what if the new homeowner doesn’t want to deal with the cost?

SolarCity’s $8 Billion Turns Out To Be Just $1.1 Billion

When Tesla (NASDAQ: TSLA) announced in June it would buy SolarCity (NASDAQ: SCTY), I got really excited. For months, I’d been studying SolarCity’s financials and I had been stunned by the many misrepresentations of its value in the company’s publications.

Preparing the merger, I thought, would make a lot of 3rd parties take a closer look, so we would finally get a true picture of what the highest paid Bay Area executive under 40 had been achieving so far.

Unfortunately, the 3rd parties brought to the table by Tesla and SolarCity did not offer a lot of joy. They stuck to the numbers given to them by the people who paid them, so the story of deception just continued.

In fact, smooth sailing made executives of Tesla even more courageous, because on October 25, they showed the following graph in a presentation given to Institutional Shareholder Services Inc.

Solar Roof Is Dead On Arrival - Yet Another Reason Why Tesla’s Merger With SolarCity Makes No Sense

Tesla (NASDAQ:TSLA) in an unusual presentation Friday evening, put together a press event to discuss a new product that the Company will enable with SolarCity (NASDAQ:SCTY).

By the end of the presentation, details on cost, performance, or any other specifications were nowhere to be found - other than that the solar shingles look beautiful. Per the company, the product will not be available till next summer. With almost a year to go for purported availability and no specs to offer, why do the product unveil now?

Make no mistake. Solar Roof was a dog and pony show to sell Tesla’s merger with SolarCity to fans and investors.

In spite of the lack of details, what was disclosed was sufficient to conclude that this product is going nowhere.

Firstly, we need to point out that solar shingles is not a new concept. A Google image search will show many different solar shingles including some aesthetically pleasing options. However, none of these have been successful and many companies pitching these products have gone bankrupt.

While there are many reasons for the lack of success, the most important reasons are that the cost of these products was high and the performance was low. These products did not make any economic sense in spite of their supposed aesthetic advantages. We discuss later in this article why the solar roof solution has no practical merit.

Coming back to Tesla, just about the only thing that is going for the Solar Roof concept, and the only thing that Mr. Musk emphasized, is the look of the products (4 different varieties - see image below).

Solarcity Earnings Heading Quietly Into The Sunset

SolarCity’s Wednesday started with a bang and ended with a whisper.

At the end of a day many Americans spent adjusting to the election of Donald Trump as president, SolarCity Corp. reported its third-quarter results. Despite these being potentially the last ever set of numbers as a public company, they were even more downplayed than usual, with no accompanying analyst call.

This might seem strange, given shareholders are due to vote in about a week on whether to approve the company’s merger with Tesla Motors Inc. and that Trump’s elevation is widely seen as a yuge risk to the incentives underpinning the solar leasing business (the stock dropped 4 percent on the day). Bear in mind, though, that last week’s Q&A with the management of the two companies wasn’t the most convincing sales pitch. On that basis, maybe it was best to let the figures speak for themselves.

Not that they were entirely convincing. The first thing to note was the cut to guidance on installations, something SolarCity has now done in all three of this year’s quarterly updates.

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