Tesla Motors (TSLA) is bidding on SolarCity (SCTY) – many people are surprised for a lot of reasons and wonder whether Elon Musk is putting too many eggs in one basket – but there are still some (not all defenders on the sell-side who see positives in the deal – what is probably more surprising is how many analysts who many times are just cheerleaders are skeptical of the details- below is a brief summary of what analysts are saying.
We have remained Overweight on SCTY given depressed valuation, yet have noted several challenges the business is likely to face. While we still expect strong growth in the distributed solar market, our recently revised estimates are below the company’s already lowered 2016 installation target of 1.0-1.1GWs. This drives our modeled cost per watt figures higher, and we no longer assume SCTY can hit its $2.25/watt total installed cost guidance in 2017. Additionally, recent regulatory developments have been mixed, with opposing parties recently discontinuing negotiations regarding net metering and rooftop solar policy in Arizona – a key state for SCTY – but in NY, a compromise reached among parties looks promising in our view. In addition, SCTY must habitually raise significant amounts of tax equity and debt to grow and has recently seen its financing costs rise. See our note highlighting key risks for rooftop solar companies here. Overall, we note that we are still in the early stages of assessing the impacts of this potential deal. The transaction must be approved by shareholders of both Tesla and SolarCity.
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Our Take. As we fail to fully grasp the rationale behind TSLA’s proposed acquisition of SCTY, we believe yesterday’s announcement suggests SolarCity has very little value. What do we mean? Well, to make our point, let’s consider the following dynamics:
(1) TSLA is a high-tech car company that pioneered electric vehicles & battery storage while SCTY is a low-tech solar vendor, suggesting, in our view, few synergies beyond the obvious renewable energy relation (i.e., SolarCity buys panels, installs them on rooftops & extends financing; not a difficult model, just capital-intensive) – to wit, a car co. is proposing to buy solar co. with no tech advantage which, while both are bleeding cash, would lead to significantly neg. EPS accretion.
(2) The proposed premium to SCTY’s stock price is +30% (midpoint) from yesterday’s close, yet SCTY’s stock was $29.6 not two months ago (5/3) & this premium is still -44.6% below the stock’s avg. price of $49.6 during ’15 & just +2.8% above the stock’s avg. price of $26.7 in YTD ’16 – in other words, if TSLA truly believes in SCTY, then why/ such a modest premium?
(3) Can Tesla afford this? TSLA had $1.4bn of cash on its bal. sheet in1Q & $3.2bn in debt; since then, Tesla raised $3bn in a follow-on offering (5/19), but earmarking that amount for its ambitious Model 3 prod. line, TSLA will need another ~$2.1bn of equity to acquire SCTY [= $27.5 (midpoint premium) x 76.2mn (98.3mn shares net of Elon’s 22.2mn shares already owned)] – this would again dilute existing TSLA shareholders by another 6% [= $2.1bn ÷ $32,3bn (mkt cap)].
As disclosed today after the market close, Tesla has proposed to acquire SolarCity in a stock-for-stock transaction with an exchange ratio of 0.122x-0.131x shares of Tesla stock, implying value of $26.79 to $28.77 per SolarCity share based on Tesla’s 7/21/16 closing price. The proposal is subject to satisfactory completion of due diligence, negotiation of mutually agreeable definitive transaction documents, and final approval by the Tesla Board of Directors. Tesla intends to proceed only on a friendly basis, and is prepared to make the consummation of the transaction subject to the approval of disinterested shareholders of both SolarCity and Tesla. SolarCity’s largest shareholder and Chairman of the Board, Elon Musk as well as SolarCity’s Director Antonio Garcias will recuse themselves from voting on this proposal at the SolarCity Board. Tesla does not anticipate significant regulatory or other obstacles for a prompt closing.
On the media call, TSLA highlighted potential synergies in the servicing operations (fewer trips to install storage/solar units), product development (integrated solarstorage products), and possible crossing selling opportunity at TSLA stores. However, we note that no specific synergy estimates were provided. SolarCity and Tesla have worked together on a battery offering, and there may be some potential future synergies on the SG&A front, but we note Elon Musk was unaware of how many Tesla customers have solar – implying customer acquisition synergies may not be the primary focus. Current residential solar penetration is no more than 1-2% across the US, and one of SCTY’s most stubborn cost items is opex on an absolute and relative basis, which grew from $414M in 2014 to $767M in 2015. Potential to reduce customer acquisition cost could bode well for SCTY cost structure, but SCTY’s value proposition has been focused on saving money on a utility bill – not luxury goods. However, the reintroduction of SCTY loan product could prove enticing for TSLA buyers as it would allow system ownership. TSLA storage infrastructure is very limited.
SCTY received a takeover offer from Tesla Motors (TSLA/covered by Ryan Brinkman). The all-stock offer price of $26.50-$28.50 is slightly above our $25 price target for SCTY, and a 25-35% premium to Tuesday’s closing price. We are skeptical that there are near-term customer, productor technology synergies for this proposed business combination; however, we think the proposal offers reasonable value, which might give capital hungry SCTY better access to wholesale capital markets via its acquirer’s balance sheet. Another reason this deal may potentially make sense is that the prior go-it-alone approach suddenly seems unattractive and the incremental cost of capital needed to fund standalone growth would probably increase if this combination does not proceed, in our view. We maintain our $25 price target, below the offer range.
Frankly, we believe the synergies between SolarCity and Tesla can be realized through go-to-market partnerships without requiring a single ownership structure. There would be limited synergies, in our view, of a single solar and electric vehicle company combining to be an energy powerhouse. Possible synergies could be the reduction in G&A (SCTY spends ~$350m/yr in G&A, or about $0.33/watt which potentially could be cut in half); reduction in selling expenses due to cross-selling at TSLA’s retail stores; or customer acquisition benefits as electric vehicle owners are natural candidates for rooftop solar and broader energy management offerings (although this could have been expressed via a cross-marketing agreement instead of an acquisition). Many may argue that this could improve SCTY’s access to capital markets, but one may ask, If TSLA shareholders are not supportive of the acquisition, will capital market access actually improve? We are skeptical.
Overall, while we see potential for synergies, and we acknowledge that the acquisition of Solar City would only increase Tesla’s outstanding shares by 8-9%, we believe that Tesla Investors will generally view this development as a negative, as it could produce a distraction while management would benefit more by focusing on their impressive growth plans (i.e. growing from 50k to 500k to 1,000k units).
Little in the way of synergies, much in the way of cash burn: TSLA announced yesterday after the close that it offered to buy SCTY in an all-stock deal valued up to $2.9bn (based off the most recent price of Tesla). While no doubt the Tesla bulls will hail the combination as visionary, we believe the assumption of another $2.6bn of debt to fold in a solar company with limited synergies and uncertain growth/cash prospects only reinforces our negative view of TSLA (UW, PT $165). For SCTY (UW, PT $20).
We feel confident in saying this was not an outcome the Market expected. Investors struck us as perplexed that Tesla would take on added distraction during the ramp up of the Model 3 sedan, which is at a scale the company has never delivered and crucial to the company’s future success. That said, one must remember that Tesla’s mission as a company is to “accelerate” the world’s transition to sustainable energy. In other words, anytime an opportunity to presents itself to achieve its goals faster, Tesla is likely to give it healthy consideration. SolarCity is the largest installer of solar generating capacity in the U.S. (28% of distributed solar installations in the U.S. in 2015; 1.5% globally).
FBN we think there are positives
…but we think risks to the model are increasing. However, we are not sure that acquiring SCTY is actually necessary, and we think that many investors in TSLA may not appreciate the bolting on of a solar play with estimated revenue of $587M in C2016 (~7% of TSLA’s estimated $8.5B in revenue in C2016) and estimated NG EPS of -$9.79 in C2016 and -$9.65 in C2017. We are therefore lowering our PT from $350 to $275.
Overall thoughts. We recognize that the company is an undisputed leader in solar and applaud its leadership on many fronts—operating a national solar EPC, developing innovative financing, and greenfielding a solar cell and module manufacturing facility. That said, a company can only fight so long on so many fronts. We believe an acquisition would serve as yet another front or major challenge given the potential integration challenges of the two companies. With the tumult over the past few years, we have seen SCTY’s shareholder base turn over a number of times as investors have been whipped-sawed with three CFOs, a rolling set of novel valuation metrics, the pursuit of a 1GW manufacturing facility, among other challenges. We were candidly looking forward to a longer period of stability with the new CFO Tanguy Serra, given his veteran industry experience. If this acquisition comes to pass, the risks and challenges of the SCTY model would be commingled with the risks and opportunities of TSLA. While we acknowledge the virtue of Mr. Musk’s clean energy vision and mission (philosophically we support them), we do wonder if his vision truly needs to happen through the integration of these two companies. Is the risk/reward calculus better with the two companies together or separate? We discuss our view of each of TSLA’s proposed benefits in detail further in our note, but our fundamental questions are, “Does the combination need to happen, and does it need to happen now?” We would argue no, unless of course SCTY would be much worse off without TSLA’s balance sheet. All of our fundamental research suggests SCTY continues to be able to access all types of funding it needs for its business. So Mr. Musk could be acquiring SCTY at what he sees as a bargain.
TSLA’s interest in SCTY is multifaceted, and SCTY stands to benefit from the TSLA platform to drive meaningful sales leverage. The two companies are closely aligned culturally. TSLA’s network of brick and mortar showrooms offers SCTY a first of it kind sales channel for residential solar, while SCTY’s 360k customer installed based allows for ample cross-sell opportunities of TSLA’s new Model 3 and home energy storage applications. TSLA brings SCTY deep domain expertise in design, engineering and manufacturing as the company looks to vertically integrate, while SCTT’s expertise lies in selling and financing complex consumer durable assets, not unlike autos. Finally, SCTY fits into TSLA’s long-term strategy of delivering exceptional customer experiences while enabling consumers to reduce materially their carbon footprint. The combined company would be a true end-to-end sustainability-as-aservice provider, bringing a 21st Century automaker and utility into a single offering.
We would not be getting involved until clarity improves. While we remain constructive on the company’s car business ramping toward its 2016 delivery targets of 80,000-90,000 given our recent more positive checks and factory tour, this acquisition presents a new overhang on the stock that could persist beyond solid near-term execution. We have been Sector Weight on the name on longer-term views that the Model 3 ramp appeared overly ambitious despite our views of solid near-term execution. Now, with potentially more financial risk arising from the SolarCity acquisition (although still somewhat unclear just how much), we are not apt to become more constructive. Namely, (1) given the massive potential production ramp the company is about to embark upon, Tesla and TSLA investors surely could have done without adding another $3 billion in debt to its balance sheet and incurring incremental cash burn, and (2) Tesla’s opportunity to ramp its storage business looks to be meaningful but significantly smaller than the car business over time (we forecast $25 billion in 2020 revenue versus the energy storage business at $3.2 billion) begging the question of whether the risk is worth the reward.
Reiterate Outperform and $338 price target. TSLA announced it has made a proposal to acquire SCTY (Outperform) in an all-stock transaction. TSLA believes it can benefit from SCTY’s sales and distribution networks, and we believe the transaction would add cross-selling opportunities for Tesla Energy products and TSLA’s vehicles for SCTY’s large customer base. We believe TSLA shares could face pressure in the near term as the news is digested and due to potential arbitrage opportunities, although we continue to believe TSLA offers significant upside potential for long-term investors.
We still think the odds of negative catalysts outweigh the odds of positive catalysts in the next 6-12 months. The reasoning behind our Neutral stance remains unchanged. We agree with many shareholders who view TSLA as a disruptive, once-in-a-generation company; continued support from these die-hard investors should protect TSLA on the downside. But we still think Model 3 delays and/or quality problems are likely to arise given TSLA’s aggressive production timeline, and this potential acquisition only bolsters our opinion. So in short, we are content with our Neutral stance.