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More Than Money at Stake in Tesla's SolarCity Deal

Elon Musk, Tesla and SolarCity’s chairman and largest shareholder, has termed the proposed merger between the two companies a “no-brainer.”
ENLARGE

Elon Musk, Tesla and SolarCity’s chairman and largest shareholder, has termed the proposed merger between the two companies a “no-brainer.”


Photo:

TROY HARVEY/BLOOMBERG NEWS

By

Charley Grant

Sept. 26, 2016 11:24 a.m. ET

The vote on Tesla Motors
TSLA


0.24
%




’ proposed merger with SolarCity
SCTY


1.60
%




 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 shareholders can 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.

These circumstances amount to a strong reason to vote down the deal. Given the reasons for caution, such a result might normally spark a sharp rally in an acquirer’s stock.



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But, in Tesla’s specific case, rejecting the merger isn’t without its dangers. It would call into question investor confidence in Mr. Musk, which has heretofore been unbending. The financial consequences of that, while difficult to measure, could be significant. Tesla trades at nearly 250 times forward earnings, according to FactSet, exceptionally high for an auto maker. Belief in Mr. Musk’s business acumen is a big reason why.

And there is significant shareholder overlap between the companies. Six of the 10 largest independent Tesla investors also own SolarCity, according to FactSet. SolarCity stock is down nearly 60% in the year to date; the deal falling through could push the shares even lower, perhaps sending it searching for a new partner.

For his investors, confidence in Mr. Musk has always trumped financial performance worries, which suggests this deal will go through.  But that scenario means Tesla shareholders could end up biting off more than they can chew.

Write to Charley Grant at [email protected]

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More Than Money at Stake in Tesla's SolarCity Deal Reviewed by on . ENLARGE Elon Musk, Tesla and SolarCity’s chairman and largest shareholder, has termed the proposed merger between the two companies a “no-brainer.” Photo: TROY ENLARGE Elon Musk, Tesla and SolarCity’s chairman and largest shareholder, has termed the proposed merger between the two companies a “no-brainer.” Photo: TROY Rating:
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