Tesla's Deal With SolarCity Is A Remarkably Bad Idea

| About: Tesla Motors (TSLA)

Summary

There is no business purpose to this merger at all.

SolarCity and Tesla's losses, already world leading separately, could easily bankrupt the entire combined company.

Musk gives the flimsiest of merger rationale, which I debunk completely.

I will say this flat out, there is no legitimate business purpose to this at all. Elon Musk is simply trying to prop up his cousin's failing business, which is down from almost $90 at its peak. Musk swoops in with a $27 bid, a 30% or so premium, and fatigued SolarCity (NASDAQ:SCTY) investors sell. Obviously, due to the nature of Tesla (NASDAQ:TSLA), there's no way that it would have ever involved any cash whatsoever.

Let's break down why exactly the merger is an awful idea.

Massive cash losses

Both are two startups trying to break into massively capital expenditure heavy industries. One, auto manufacturing, with the gigafactories and the auto plants. Two, solar panels, with the cutthroat competition of the solar installation business. None of these are cash generative, and in fact, both hemorrhage massive amounts of cash.

Last year, Tesla had negative $2 billion in free cash flow. Last year, SolarCity lost almost $3 billion. It's amazing the amount of money that these two companies can waste in a year. They have to spend this amount of money to fund their rapid expansion, but don't have a source of cash to draw upon, and are just two big babies, really, that don't have a source of free flowing cash to fund that expansion.

SolarCity is just a plain bad business

I've written extensively about why SolarCity is bad in my articles previously here and here. Essentially, the distributed solar model doesn't work. It's brutally competitive, undifferentiated, relies on capital market stability, and requires massive capex that is unsustainable. Furthermore, management has essentially lied to investors as to the actual returns of the business. They inflate their "retained value" metric by including renewals of contracts 20 years out, and use an absolutely ridiculous discount rate of 6% for future cash flows. They include no income tax, and disregard their convertible debt.

Suffice to say, I don't want a poisonous management at the helm of a bleeding business coming anywhere near Tesla, a company that I think does have a slight chance of succeeding, Volkswagen (OTCPK:VLKAY) competition notwithstanding.

Conflict of Interest

Elon Musk is the top shareholder of both companies, and his cousin is CEO of SolarCity. Elon gets to create a liquidity event for himself to swap his useless and worthless SolarCity stock for valuable Tesla stock and strengthen his control over the company, at a premium no less. If this doesn't scream conflict of interest to you, I don't know what will.

There is no synergy

Tesla put out a blog release here detailing the "why" of the merger. Let's break down why all of these reasons are complete nonsense.

"We would be the world's only vertically integrated energy company offering end-to-end clean energy products to our customers. This would start with the car that you drive and the energy that you use to charge it, and would extend to how everything else in your home or business is powered. With your Model S, Model X, or Model 3, your solar panel system, and your Powerwall all in place, you would be able to deploy and consume energy in the most efficient and sustainable way possible, lowering your costs and minimizing your dependence on fossil fuels and the grid."

  • There are no synergies here. This isn't even the correct definition of vertical integration! From Google "the combination in one company of two or more stages of production normally operated by separate companies." Production of what? Last I checked, cars and solar panels were two completely separate end products that do not intersect in any way.

"We would be able to expand our addressable market further than either company could do separately. Because of the shared ideals of the companies and our customers, those who are interested in buying Tesla vehicles or Powerwalls are naturally interested in going solar, and the reverse is true as well. When brought together by the high foot traffic that is drawn to Tesla's stores, everyone should benefit."

  • In any merger, management promises the world in synergies. When I think of synergies, I think of something similar to an enterprise software vendor acquiring another, and cross selling the two products, say a benefits software, and a relationship management software. Not cars and solar panels. In any case, if these people can afford $70k cars, why not just buy the panels outright?

"We would be able to maximize and build on the core competencies of each company. Tesla's experience in design, engineering, and manufacturing should help continue to advance solar panel technology, including by making solar panels add to the look of your home. Similarly, SolarCity's wide network of sales and distribution channels and expertise in offering customer-friendly financing products would significantly benefit Tesla and its customers."

  • Great, next time I need my teeth checked, I'll just have my optometrist do it. It's all medicine right? A processor and a ram chip, what's the difference? They're both computer things right? There's simply no synergy in design between a car and a solar panel.

"We would be able to provide the best possible installation service for all of our clean energy products. SolarCity is the best at installing solar panel systems, and that expertise translates seamlessly to the installation of Powerwalls and charging systems for Tesla vehicles."

  • This provides the barest of rationale, in that maybe they can save on storage space and don't have to build out a double network of sales points? Why SolarCity specifically then?

"Culturally, this is a great fit. Both companies are driven by a mission of sustainability, innovation, and overcoming any challenges that stand in the way of progress."

  • I don't work at either company, so I can't deny this, but this is so flimsy. No tangible benefit.

Essentially, if we're to buy this merger rationale, we could make sense of anything. Why don't auto manufacturers buy oil refineries? Why don't automakers buy auto part manufacturers? The point is, those are entirely different businesses, and so are a solar company, and an automaker.

If my Volkswagen article didn't convince you to get out of Tesla, this absolutely has to. Short or sell, either way, do not be long.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in TSLA over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.