Tesla Motor's (NASDAQ:TSLA) CEO Elon Musk recently stated that he expects the acquisition of SolarCity (SCTY) to be supported by a super majority of shareholders. This would be a great news for SolarCity shareholders since the condition of SolarCity continues to deteriorate and the Company's survival as in independent entity is increasingly in question.
It is interesting to note that SolarCity has pre-announced earnings for the recently completed second quarter. While the headline numbers seem to suggest SolarCity beat guidance in Q2, the reduction of the yearly guidance should make clear that the company underperfomed. (We will have a more detailed analysis of Q2 earnings later).
The real problem here is that Mr. Musk would be hard pressed to support the current acquisition or its price range once SolarCity performacne comes in to full view. The ideal situation for SolarCity shareholders would be if Mr. Musk were to announce the acquisition in parallel with or ahead of SolarCity's Q2 results. Such a move would help put a cushion under SolarCity's price as it is faced with poor performance.
To its credit, it appears that SolarCity management is going about with its business normally while preparing for the Tesla acquisition. Management is likely mindful of recent Vivint Solar (NYSE:VSLR) experience where Vivint got flat footed on financing aspects during its proposed acquisition with SunEdison (OTCPK:SUNEQ). In this context, SolarCity stockholders should be pleased that SolarCity recently announced that it has raised $345M million of tax equity with four different partners in June and July. The Company also announced that it increased its debt aggregation facility by $110M.
From a SolarCity investor view point, this is a welcome sign as the Company needs to have the capital raised before it enters an agreement with Tesla. Access to capital can be critical in the event the Company's deal with Tesla does not materialize. In terms of the timing, it is a positive that the financing was raised when the interest rate macro environment is incrementally favorable to the Company. All else being equal, the timing of the deal should have led to more favorable interest rates and terms.
On the flip side, we note that Company did not release key details of the financing transactions. Given Musk enterprises' penchant for hyping every bit of news that can be remotely construed as a positive, we suspect there is bad news behind this financing. In the past, whenever the Company failed to reveal the terms of financing, it was indicative of poor terms or worsening trends for the Company. Given the history, we would not be surprised if this recent financing transaction is indicative of worsening trends.
Even assuming terms no worse than past, we foresee a marked deterioration of the Company's financial performance due to industry changes.
Setting aside potential financing problems, we see three factors leading to massive losses at SolarCity going forward:
- Due to the oversupply of modules in the second half of 2016, the ASPs of solar modules have been plummeting. This is expected to continue into 2017 as the industry faces significant overcapacity. The prices are likely to drop further if US tariffs are eliminated or bypassed. Currently, we estimate that module ASPs for multicrystalline modules, which dominate the residential solar space, to be in the range of $0.40 to $0.45 per watt by the time the Company ramps its Buffalo fab. Similarly, high efficiency monocrystalline modules which compete more directly with Buffalo fab modules will likely be in the $0.45 to $0.50. As the price of the modules and associated hardware goes down, it is increasingly difficult for SolarCity to sell lease products to residential customers. Competitors will increasingly use the lower prices to hawk direct purchases and loans.
- The declining module ASPs also mean that the Company's Buffalo fab output is increasingly uneconomical. It now appears that the Buffalo fab will generate a loss of at least $0.05 to $0.15 per watt even assuming SolarCity meets its internal $0.55 per watt cost targets. This assumes that the fab is fully utilized which itself is doubtful given the Company's recent history.
While the first two reasons stated above have the impact of reducing the size and profitability of the installation business, the third reason stated above means massive losses in the Company's manufacturing operation. At 1GW capacity and a minimum loss in the range of $0.05 to $0.15 per watt, we are looking at the manufacturing operation is likely to yield losses of $50M to $150M per year. This would be on top of the losses that Company would make in its installation business. Combining the losses on the installation and manufacturing sides, we are looking at a Company that is likely to generate economic losses of several hundred million dollars per year.
Given the Company's loss profile, it is highly unlikely that SolarCity will get a second bid. The usually vaunted "no shop" clause that acquirers prefer is meaningless in this situation. What SolarCity stockholders will likely benefit from is the break fee in the even the deal falls apart.
Without Tesla acquisition, it will be nearly impossible for SolarCity to survive these horrendous losses on the installation and manufacturing operations.
Timing the acquisition announcement simultaneously or ahead of earnings is a sad commentary on the corporate governance at Tesla. Mr. Musk is taking the non-insider common stockholders for a ride with these shenanigans. Ultimately, the Company will likely fail from such misadventures, but, how long Mr. Musk's teflon status will last is one for the history books.
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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.