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.
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).
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