Tesla wants to absorb SolarCity and become a clean energy behemoth. But does their $2.7 billion offer make sense?
Tesla announced earlier in the week its desire to purchase SolarCity. The reaction it received from the markets was swift and brutal, knocking out some 10% of TSLA's market cap in an instant — and that's without any actual transaction actually taking place. Elon Musk — who is CEO of Tesla, Chairman of SolarCity, and the largest shareholder of both companies — called the deal "a no-brainer" and said the combined companies could be worth a trillion dollars someday. But it seems that not all investors are so sure about that.
In many ways a tie-up between Tesla and SolarCity makes a lot of sense. SolarCity has one product — solar panels — and that one product is designed to work in conjunction with Tesla's energy storage products — the Powerwall and Powerpack. Having the two under one company could provide some serious synergies. But it's not without risk, both short-term and long-term.
Tesla today is an automotive company, but the Tesla of tomorrow? That Tesla is an end-to-end clean energy company.
Many people look at Tesla as if it is an automotive company, and they're not wrong. Tesla today is an automotive company, but the Tesla of tomorrow, that trillion-dollar-valuation Tesla, that Tesla is an end-to-end clean energy company. Let's be clear: electric cars will always be a product at Tesla, but they also were a necessary first product from the company in building up its energy storage products.
The lithium-ion cells that go into a Tesla Model S electric sedan are the same lithium-ion cells that go into a Tesla Powerwall home energy storage unit. Building the manufacturing capacity and supply chain to make electric cars in mass quantities also gave Tesla the ability to manufacture standalone energy storage boxes. In fact, making a Powerwall or the larger Powerpack units is far easier than making the car — after all, there aren't any motors or windows or suspensions to worry about when what you're selling is a giant battery with an inverter.
There are pretty much only two reasons for anybody to purchase a Powerwall or Powerpack battery system: they want it as a backup power source for when the local grid fails, or they want it as an energy storage device tied to a solar array to provide power when the sun isn't shining. Utilities also are interested in Powerpacks as buffer devices to help manage fluctuations in the grid (especially when powered by wind or solar), but by-and-large Tesla's aim is to put battery packs into homes and businesses.
SolarCity focuses almost exclusively on residential solar installations. Many customers opt to install solar panels that will generate excess electrical power during the day, feed that excess back into the grid, and then pull from the grid at night when the panels are dormant. But SolarCity also offers Tesla Powerwall installations to buffer that excess daytime solar power for overnight use. With sufficient panels and sufficient storage, one could go completely off the electrical grid. Sounds nice, right?
The biggest problem facing both SolarCity and Tesla is one of cost. Neither large solar installations nor large lithium-ion battery packs are cheap.
The biggest problem facing both SolarCity and Tesla is one of cost. Neither large solar installations nor large lithium-ion battery packs are cheap. You might be able to justify the costs long-term, but for the vast majority of consumers they're both presently out of financial reach. Tesla's building its Nevada Gigafactory to accelerate the decline in battery cell costs (as well as to provide the necessary packs for the expansion of Tesla Motors) and SolarCity is building a Gigafactory in New York to bring down its own production costs.
With the two companies making huge investments in manufacturing infrastructure, a future of affordable home solar and battery could be on the horizon. Combining the two companies, as Musk pointed out on the conference call, would provide for additional cost savings — both for Tesla and those that could be passed on to the consumer.
Today, a SolarCity installation includes an inverter that converts the DC current from the photovoltaic panels into an AC current compatible with home electrical systems. A Tesla Powerwall also has a built-in inverter, flipping the AC power running into it into storage-compatible DC current. You can see the problem right there: DC current from solar is converted to AC, transmitted what is likely several yards at worst to the Powerwall, where it is run through an inverter to change it back into DC … and then it's converted back into AC power when it's drawn from the Powerwall for use. These inverters are not 100% efficient — the best may run at 90% efficiency, and they're less efficient when less current is being pushed through them. Inverters also are not cheap. Cutting the combined system down to one shared inverter would not only save on the installation cost, it'd make the overall system more efficient so you could get by with a less expensive system or draw from the grid less frequently.
There are additional cost savings to be be had on the corporate side. The combined companies would have reduced costs for installation, sales, and support. Solar panels would be sold alongside Tesla cars and battery packs in Tesla Stores around the globe (currently there are a few more than 200 Tesla Stores, but Tesla also is expanding its retail footprint). Essentially, we're running down the list of the benefits of vertical integration — owning the end-to-end system. Vertical integration is most evident today in the oil industry (irony!) where the same company (say, BP) pumps the oil, refines it, delivers it to the gas station, and sells it to the customer. Tesla has taken the same approach with its cars; adding solar alongside their battery offerings makes sense from that perspective.
But that's a long-term play. While Musk may be optimistic that we'll be talking about mass solar+battery installations in just a few short years, that would require everything to go right for Tesla and SolarCity. That includes getting customers and investors on board with the plan. A combined solar+battery company absolutely makes sense from a practical standpoint, but when you look at the numbers for both Tesla and SolarCity the plan looks less like a slam dunk unless you're willing to wait many years for a return on your investment.
Musk is optimistic that we'll be talking about mass solar + battery installations in just a few years, but that would require everything to go right.
Let's be clear: Tesla has a huge amount of debt and continues to spend more money than it makes on a quarterly basis. SolarCity is likewise burdened with substantial debt and losses. Combining the two would yield potentially substantial cost savings, but we're still talking about roughly $13 billion in debt between the two. It's easier to see a path forward for Tesla Motors to hit profitability — if you cut out the costs of their continued manufacturing expansion then Tesla is actually turning a profit on the production and sale of the Model S and Model X.
As the saying goes, though, you've got to spend money to make money. And while Tesla could subsist as a niche luxury electric car manufacturer, it's not content to do that. So Tesla's spending $5 billion to build the Gigafactory and is doing huge work at the Fremont factory to prepare for the launch of the $35,000 Model 3 sedan. It's easy to look at Tesla and see the road towards being a successful company over the long term — there are plenty of examples of successful carmakers. But as Musk said, this isn't about being a successful carmaker alone: "The world doesn't lack for automotive companies. It lacks for sustainable energy companies."
But it's worth considering if the SolarCity acquisition proposal could be a distraction at the wrong time for Tesla. Musk mused that maybe they should have tried to buy SolarCity earlier, but right now we're at the most critical time in Tesla's short history: the ramp-up for the Model 3. Starting at $35,000, the Model 3 is half the cost of the next-cheapest Tesla, and they've already seen nearly 400,000 reservations placed for the car. Volume production is slated to begin at the end of 2017 — a highly ambitious timeline for a company that so far has failed to meet any of its previous production timelines. The Model X was famously delayed by 18 months, and while Tesla has learned from that debacle, it still needs to demonstrate that they can apply that new rigor. Adding in the complexities of absorbing SolarCity could prove to be an unwanted, if not fatal, distraction.
Tesla just recently issued $1.7 billion in new shares to help finance the Model 3 ramp-up — that funding will pay for the needed manufacturing capacity, but it won't do much to pay for the cars themselves. The proposal for SolarCity sits at around $2.7 billion in an all-stock exchange, so while Tesla wouldn't have to raise new funds for the acquisition, they would be issuing a few billion in new stock to owners of SCTY shares instead. If Tesla weren't the much more valuable of the pair, it'd be more of a merger than an acquisition.
A SolarCity acquisition could be a distraction at the most critical moment in Tesla's short history: the ramp-up for the Model 3.
Speaking of owners of SolarCity stock, Musk wouldn't benefit tremendously from the deal. He owns 22% of SolarCity shares, which would convert into Tesla shares. And while the offer was a roughly 30% premium over the pre-offer valuation of SolarCity, Musk's 27% stake in TSLA saw a significant hit from the announcement. In fact, he lost more value in Tesla shares than he gained from the bump in SolarCity shares. And all of that is paper value anyway — neither company pays a dividend to stockholders and the shares are worth only what the market is willing to pay for them, and they're really only valuable when you sell them. Even so, with no immediate personal gain evident here, Musk as both largest shareholder and board member of both companies has recused himself from voting on the proposal and is leaving it to the shareholders (after due diligence is conducted by both companies).
As Musk said repeatedly on the call, even as the largest shareholder in both companies he cannot set the value on his own — it's the markets that set that value. Between individual stakeholders (both large like Musk and smaller traders) and institutional buyers, it's the day-to-day interpretation of the company's current and future value that determines the stock price and thus the acquisition price. And while it's easy to blame short sellers for the steep plunge in TSLA after the SolarCity proposal, it's the opinion of the institutional and individual traders at large that drive the macro trends in a stock.
Tesla buying SolarCity has huge potential upside in the years to come, but that upside won't come for many years. Both companies are saddled with huge debt loads and are vigorously spending cash to build up manufacturing capacity and deliver promised products on time and on budget. There are two sides of the coin when it comes to weighing the value of a Tesla acquisition of SolarCity.
In the long run it makes all of the sense in the world. There are cost savings to be had across the board if the two companies are one, and it will only make expanding both businesses easier.
In the near term it's a big undertaking for companies with lots of red on their balance sheets, both facing critical junctures in their growth. A botched merger — or even a successful one that just doesn't pan out — could doom the combined company where before only one would fail.
In the end, it's going to be up to the shareholders of both companies — is the huge long-term potential worth the huge short-term risks?