Tesla (NASDAQ:TSLA) CEO Elon Musk's proposal to acquire SolarCity (NASDAQ:SCTY) underscores that he has become a liability to the company. Increasingly, Musk's decision-making is characterized by desperation and irrationality. The proposal to buy SolarCity is such a patently bad idea that it should be rejected by Tesla stockholders, and while they're at it, clean the management house.
For the Company and the Cause
I came to this conclusion after much soul-searching. Unlike many Tesla bears, I genuinely share Musk's vision for battery electric vehicles and sustainable energy generation. I genuinely want Tesla to succeed and, since the beginning of the year, have become increasingly concerned that it would not.
That concern rose almost to the level of stark terror following the 2016 Q1 earnings report. As I discussed, the goal of producing 500,000 Tesla vehicles by 2018 seemed rooted in desperation. It had become clear that Model X deliveries were not going to achieve the goal of positive free cash flow and non-GAAP profitability. Tesla was running out of time and so the production schedule for the Model 3 was moved up.
In my analysis, I estimated that Model X gross margin was just 5.9%. Not nearly enough to cover associated operating costs, especially if warranty repairs are factored in. In retrospect, the decision to start production of the Model X in its current form was just one of a string of bad decisions made by Musk. The Model X simply wasn't ready, and its reliability and quality issues have been a huge black eye for the company.
The SolarCity acquisition is just the latest, and most egregiously self-serving, bad decision. This has been extensively analyzed here on Seeking Alpha, so I'll just touch on a few key points. For more analysis, I recommend Rogier van Vlissingen and Gary Bourgeault.
First let me say that, in contrast to many bearish views of the deal, I don't think it has nothing to recommend it. Much has been made of Musk's use of the word "synergy." But there are benefits.
The most important one is the environmental appeal of combining solar array installation with a Tesla car purchase. This addresses one of the fundamental objections of Tesla's critics, that the cars aren't as environmentally friendly as they seem, because production and operation of the vehicles depend on electricity generated from fossil fuels.
Bundling of solar array and vehicle purchase could also bring some rationality to the current SolarCity financing approaches. The Power Purchase Agreements (PPA) in which SolarCity finances and "owns" the panels have been widely criticized. An outright purchase of the panels, combined with the vehicle, and financed for a reasonably short term makes much more sense.
A significant part of SolarCity's operating costs is in Sales and Marketing, and these could be significantly curtailed by combining with Tesla. Tesla's current showrooms could become one-stop shops for cars and Tesla Energy (including arrays) products.
Unfortunately, the benefits are far outweighed by the financial weakness inherent in the combined company. If either company were strong financially, it might make sense. The combination of the two is simply frightening. Both companies have massive debt. Both companies have negative and worsening free cash flow. Both are losing money on a GAAP basis. And for both companies, it's not obvious how things will get better.
Stretched Beyond Thin
Since the Q1 conference call, it's been apparent that Musk is simply stretched too thin. During the call, he sounded exhausted and repeated arguments about how difficult it is to build a car that he had made previously. I've wondered how he could possibly serve as CEO of SpaceX (Private:SPACE) and Tesla and be Chairman of SolarCity. Combined with his various avocations such as Mars Colonization and Hyperloop, it all seems too much.
It has become too much. With the SolarCity proposal, we see Elon Musk at his worst. Advocating an action that is egregiously self-serving, since he owns a significant share of SolarCity. At the same time, it's as if he's given up caring about making Tesla profitable.
One might well question whether Tesla can be profitable. There is reasonable room for doubt, but I'm reminded of the situation that faced Steve Jobs when he returned to Apple as the CEO in 1997. At the time, Apple was attempting to become a mass-market computer company, licensing the Mac OS to other manufacturers even as it fielded low cost Macs of its own in hopes of increasing market share. In the process, it was losing buckets of money.
The first thing that Jobs did was chuck that model. He understood that Apple couldn't be profitable as a mass market computer company. Neither can Tesla be profitable as a mass market automobile company. The idea that Tesla's financial salvation lies in the mass market is completely fatuous, and it shows how impaired Musk's decision-making has become.
If Tesla has a future, it's as a niche luxury car maker. That's the only near-term path to profitability and Tesla needs to become profitable. Even the Model 3, with all the lessons learned, will probably need to be priced $10-20,000 above the base $35,000 in order to be profitable. Low volume, high performance cars offer much better margins anyway.
And maybe like Apple, at some time in the future, Tesla can figure out how to break out of the niche automaker status with new products and new technologies. But that time isn't now, or probably any time before 2020.
Based on the string of bad decisions, it's clear that there needs to be a change in management decision making. I don't see that change occurring unless Musk is removed. SpaceX has been accomplishing some wonderful things. Musk should focus his attention on SpaceX.
It's not clear that new management can save Tesla, but I've become convinced that new management (the right new management) offers the best hope for Tesla. Until said managerial change, I rate Tesla a sell.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.