Much has been written over past 48 hours about the proposed marriage of Tesla Motors (NASDAQ:TSLA) and SolarCity (SCTY).
Uncle Brian plays wedding planner today. No "what if" about this article. Both members of the loving couple have furnished their financials, and I'm taking a deep dive.
Yes, I know some raise their eyebrows about a marriage of cousins. But I'm not here as a moralist. I'm here to take a look at the books.
This one is, as Musk would have it, a "no brainer."
As the couple makes its way to the altar, SolarCity shareholders in general, and Elon in particular, are the obvious winners, if only they can get the Minister to bless the union.
1. SCTY Shareholders
Without this marriage, SolarCity shareholders face this stark and certain fate: bankruptcy.
For those who doubt that a single SolarCity is soon to be a SolarCity in Chapter 11, I offer the following chart. I trust the critics will tell me what numbers SolarCity's own accountants got wrong:
(Portion of the SolarCity Income Statements 2012-2015 courtesy of Nasdaq.com)
Aside from revenues and "gross profits," every single one of these key financial metrics is moving in the wrong direction, and is moving there significantly faster than revenues and gross profits are improving.
Let's look a little deeper and take a look at the bride's dowry. As of the end of Q12016, SolarCity had cash on hand of approximately $413 million. Over the past 4 quarters, its net operating cash flows have been:
- Q2 2015: -$140 million
- Q3 2015: -$214 million
- Q4 2015: -$263 million
- Q1 2016: -$193 million
This means, even if it shuts down its capital expenditures and invests not another penny in its growth or future, SolarCity has only two quarters remaining before the cash drains away and operations must cease. Tick tock.
For SolarCity, the debt and equity markets are officially closed. It's completely locked out. It has one potential partner, and one only: the kissing cousins at Tesla.
With its stock price slashed in half (and worse) since the beginning of the year, SolarCity would have to soak its shareholders with massive dilution to fund ongoing operations. Assuming, of course, any investment bank would even underwrite such a proposition. Highly doubtful.
Instead of a six-month march to oblivion, SCTY shareholders can instead hope for a pleasant premium over current valuation.
How nice it is to have a supportive family in a time of need.
2. Elon Musk
Of course, no one benefits more from this than Elon Musk himself. Not only does Elon bail out his original SCTY stake (he was from the start the largest shareholder in SCTY), but also his interest in the hundreds of thousands of SCTY shares he has added over the past several months.
Add to this the intertwined relationship of all three Musk entities, and the merger begins to take on the appearance of a CYOA (cover your own ass) maneuver.
Also, it is widely known that Musk, through privately held SpaceX (SPACE), has a large stake in SCTY bonds. SolarCity's impending bankruptcy leaves that debt holding seriously imperiled.
Couple this with Musk's use of his SCTY stock to back personal loans, and the possibility of a margin call that could topple the entire house of cards becomes an even greater self-serving motive for the Tesla/SolarCity buyout.
Sure, I have been very critical of Tesla's valuation in my contributions to Seeking Alpha. I believe the stock is ridiculously overpriced and the chance to make real money investing long at today's prices are slim and none.
However, I have always been reticent to criticize Musk himself, or to make the case that Tesla Motors is doomed to fail.
I've been willing to give Mr. Musk the benefit of the doubt, believing he probably had good motives for most of his actions, despite his obvious foibles and follies along the way.
No longer. This proposed merger leaves a bad taste in my mouth, and I do not feel I can give him a pass any longer. There is no way to spin the truth that this is a self-serving move on the part of Elon Musk.
1. TSLA Shareholders
The rationale for this is obvious. The market's reaction to the news, with TSLA dropping over 10% on the first day following the proposal, makes that clear.
What seems to be less widely appreciated, however, is the impact this will have on shareholders over the next several years. Yes, there will be an immediate dilution as a result of the stock swap proposed with the merger.
However, both Tesla AND SolarCity have a unique penchant for incinerating cash to fund ongoing operations. This is not investment for the future, mind you. This is an urgent need for far more cash than they generate simply to keep the lights on.
Most astute investors knew Tesla was going to have to raise more money sometime in the next 6-12 months, both to help meet lofty (unattainable?) production goals for the Model 3 and to support the albatross that is the Model X.
Pulling SolarCity into the fold both narrows the timeframe for the next raise and increases the amount required. Neither entity can stand on its own feet today, so uniting them does little to help the situation.
In addition to its operating losses, SolarCity also brings an enormous amount of debt service to the table for which Tesla will now be responsible. Besides having to fund its own unprofitable venture, and that of its "synergistic" acquisition, there will be approximately an addition $100 million in interest to be paid by the "new Tesla."
The dilution of TSLA shareholders will be immense, and probably frequent, in the coming quarters.
2. The Employees
Of course, reduction in SG&A really means reductions in overhead, and employees are a big slice of that pie.
No matter what, that means a lot of people need to hit the bricks. Granted, most SolarCity employees would have had to do so eventually anyway, but still.
Further, Tesla employees are now put in the position of their jobs being in greater jeopardy due to the increased likelihood of total company collapse. While working for Tesla, from a long-term perspective, was always a little risky (that's true of any startup), the risks in the New Tesla are even more significant.
Of course, if this does not occur, it is even worse news for everyone involved. Except perhaps those who are short the "New Tesla".
It is true that Tesla has an ugly SG&A number relative to revenues, but SolarCity's is even worse. In fact, in 2015, SG&A for SCTY was almost double revenue. Well, just under $400 million in revenue vs. more than $700 million in SG&A, but still. Yikes!
If the New Tesla is going to survive, much less thrive, there will need to be HUGE reductions in overhead.
The Results of the Pen-to-Paper Exercise
Let's take a quick look at the financials for the New Tesla. Certain departments can be merged/eliminated, and staff and redundant locations can be eliminated.
Let's assume the most positive scenario. Redundancies are found, and SolarCity SG&A expenses can be reduced by half. That is incredibly ambitious, but I'm an optimist at heart.
I went back to 2013 and made the assumption that the merger had taken place on that date. There were no "growing pains", and the combined organization was able to reduce SolarCity's former SG&A expenses by half from day one.
Of course, this is overly optimistic, but balance is important if we want to be fair. Here's a chart outlining the results, with the "old Tesla" on the left and the "new Tesla" on the right.
Tesla Operating Income
"New Tesla" Operating Income
Folks, this is JUST OPERATING INCOME! And that number for last year is over a BILLION. With a "B"!
For the "accounting challenged", this doesn't include debt service or capital expenditures to support growth. This is just the results of making and selling the products. And it is exceedingly generous in its reduction of costs for the new enterprise.
Anyone (besides Elon or his cousins) want to stand up as best man or maid of honor for this coupling?
A Note About the "Vertical Integration" Synergies
Many of those who came out in support of the proposed merger were touting the potential synergies between the companies and the "vertical integration" of a new energy company.
First of all, this is a gross misuse of the term "vertical integration". Neither company produces an element essential to the function or production of the other, which is all that needs to be said about the vertical integration nonsense.
Regarding potential horizontal integration, or potential sales overlaps between the products, there is nothing in this merger that couldn't be accomplished through another form of partnership that is less damaging to TSLA shareholders.
As demonstrated above, the potential cost savings by merging these two entities are minimal at best, and even so create an undue burden on Tesla's already shaky financials.
If you're not already dubious about synergies, consider this from Wednesday's conference call:
Thanks so much. At what point are we going to get financial details here? And clearly, there's been an awful lot of crosspollination with the boards, former CFO of SolarCity's on the board of Tesla, JB, is on the board of SolarCity. There has been a lot of sharing. To have a price here without some sort of scope of return on capital, I think it would be incredibly important for us. So, when are we going to get that information? And without you're begging off the detailing on synergies but I think getting specific about return on capital for Tesla shareholders would be essential to getting this done; when are we going to that information?
I Agree. I was probably saying like we have to do this in a bit of an unwieldy way because I'm largest shareholder of both companies. If that wasn't the case, we could do a lot of this and then kind of present to you it like the full and final details of the proposed merger and -- but before we -- since I'm the largest shareholder of both companies, we have to tell you at the beginning of the process and not the end. So, we will certainly have all that done for you, but the reason it's not just all in a neat package is because this is a sort of an odd case where we have to tell you at the start of the process, before we have all the answers rather than at the end of the process. We will get, definitely get all that information and I'm confident it would be extremely compelling.
Even a segment of the Knights Teslar are starting to see this move for what it is, as pointed out yesterday by SA Contributor Montana Skeptic.
As I mentioned before, I have been skeptical of Tesla's valuation for quite some time. That said, most of me has hoped for them to succeed. They are no less than an innovative American company that employs thousands of American workers, and their success would be nothing short of story-book material.
The fairytale ending becomes far less likely should this unholy union occur.
I have also been overly generous in my thoughts about Elon Musk. Despite the accounting opacity at Tesla (and SolarCity); the off-the-hook projections for growth, production, sales, and financial metric improvements; and the intentional obfuscations of truth relating to operational details; I always wanted to believe Elon felt he was doing what he thought was right.
This proposed merger however, benefits few other than Elon himself. With the exception of a few lucky investors who may have purchased SCTY recently or below its current price, most are going to lose. They are just going to lose less than they would have otherwise.
Elon is the primary beneficiary of this move, and his recent acquisition of more shares is stomach-turning. This plan wasn't conceived yesterday, and it wasn't conceived fewer than six months ago. TSLA investors are being asked to foot the bill for SolarCity's failures, and there is little positive to be gained.
Even worse, none of this was discussed or disclosed prior to the latest equity raise. If this isn't illegal, it is at best highly unethical, and much of the esteem in which I once held Mr. Musk has evaporated.
In planning this incestuous union of cousins, Elon Musk has stacked the gift registry with expensive presents for himself, and it breaks my heart. Sadly, this marriage will more likely end in mutual destruction than divorce.
Author's note: All of the opinions expressed in this article are mine and are not intended to serve as investment advice. These opinions drive my own investing strategy, and mine alone. Please do your own due diligence and consult with a professional advisor before making any investment decision.
Special thanks to Seeking Alpha contributor Montana Skeptic for his assistance with the "word-smithing" and styling of this contribution. Any errors are mine and mine alone, and his assistance to the process of preparing this and other pieces has been invaluable. My gratitude is sincere and heartfelt.
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.