The Silevo Acquisition
Tesla (NASDAQ:TSLA) subsidiary SolarCity closed on the acquisition of Silevo in September 2014. The main logic for the deal was described this way in SolarCity's 2015 10-K:
"The acquisition was expected to enable the Company to manage its supply chain and control the design and manufacturing of solar cells and photovoltaic panels that are a key component of the Company's solar energy systems, as well as enable the Company to utilize and combine Silevo's technology with economies of scale to achieve significant cost reductions."
Silevo had previously "inked a deal" with the State of New York for the state to build and invest up to $225 million in a new facility in Buffalo N.Y. for Silevo, and agreed to lease it to Silevo for a nominal amount. In exchange, Silevo planned to manufacture up to 200 mw of solar panels each year using their "state of the art" technology in a depressed corner of the state and committed to hire at least 750 state residents to work there. When SolarCity acquired Silevo, SolarCity got NY to "up the ante" to $750 million in exchange for various higher minimum commitments, including higher guaranteed employment in the state and an estimate of 1 gw of production annually at the factory. It was expected that the facility would be operational in 2016.
The Purchase Price
First, let's look at how the net purchase price for the acquisition was calculated and recorded on SolarCity's books. This information comes from p. 95 of the 2015 10-K, which I've simplified and reformatted a bit.
|Value of SolarCity stock paid (2.284 million sh.at $60.40/sh.)||$137,958|
|Estimate of Future performance stock payments||$115,319|
|Restricted Stock Issued||$132|
|Net Purchase Price||$270,908|
The $145.5 million in cash and stock paid up front as part of the estimated $271 million purchase price is straight forward. I'd like to mention the "estimated" future stock for performance. The maximum potential payout was actually about $150 million if Silevo were to meet all targets. SolarCity used the $115 million figure as a best guess of the future payments by adjusting the percentage probability of each of those future payments being made and then discounting them back for time.
Now let's look at the net assets SolarCity put on their books when they acquired Silevo.
|Assets Acquired:||$ 000's|
|Cash, Accounts Receivable, Inventories prepaid assets etc.||$12,622|
|Property, Plant and Equipment||$28,281|
|Build to suit lease||$4,000|
|Total Assets Acquired||$326,944|
|Less Liabilities Assumed:|
|Accounts payable and other accrued liabilities||-$5,427|
|Deferred Tax Liability||-$27,332|
|redeemable non controlling interests||-$14,174|
|Total Liabilities Assumed||-$56,036|
|Net Purchase Price||$270,908|
The first item worth mentioning from the above table is that there were $56 million of debt and other liabilities assumed as part of the acquisition. Although it may be to acceptable to report the purchase price as being $271 million, I believe the higher gross price of $327 million is a better way to think of it. If a couple were to buy a $150,000 house for example, by making a $50,000 payment at closing and taking over the seller's $100,000 mortgage, they wouldn't tell their friends the house cost $50,000 but rather $150,000.
Accounting for the Transaction
The gross assets SolarCity put on their balance sheet were $327 million, most of which were the "intangible" assets, i.e. "goodwill" (which some might define technically as not being an intangible) and "developed technology," totaling $282 million. You might wonder how these figures were arrived at. They're simply "plugs." SolarCity had struck a deal to buy Silevo for $271 million in cash and stock plus assume $56 million in liabilities. They then looked at the assets they acquired and were able to record them at an estimated fair market value. That left them $282 million short. Since SolarCity was really buying Silevo for the perceived value of their technology and felt the purchase price justified it, they were able to put this $282 million on the balance sheet in these two categories to get everything to balance. How they determined the exact proportion of this $282 million to put into each category shall probably remain one of life's little mysteries and really doesn't matter for purposes of this analysis. The developed technology is being amortized over 10 years, while the goodwill stays on the books as long as there is perceived value by the company and its accountants.
The Contingent Payments:
During 2016, SolarCity was able to make final determinations as to the estimated $115 million contingent payment amounts and make payments and adjustments on their financial statements. Here's what the 10-K says:
"As of March 31, 2016, the Company determined that the first milestone was achieved and adjusted the accrued contingent consideration balance associated with the first milestone to the full amount payable of $48.3 million. On May 5, 2016, the Company issued 1.6 million shares of its common stock, valued at $34.2 million based on its stock price on the issuance date, to settle the liability. Accordingly, the Company recognized a gain of $14.1 million upon the settlement of the liability associated with the first milestone, which is included as an offset to general and administrative expense.
As of December 31, 2016, the Company determined that the two remaining milestones will not be achieved by Silevo. As a result, the Company changed the estimated probabilities and adjusted the accrued contingent consideration balance to $0, for the two remaining milestones. Accordingly, the Company recognized a gain of $84.0 million, which is included as an offset to general and administrative expense."
The two final contingent payments were resolved in 2016, one by making partial payment of $34.2 million in stock, the other by a determination that nothing further was due and so it was removed from the books. The three elements of these transactions, $34.2 million payment, and then the $14.1 million gain and $84 million gain, totaled $132.3 million, somewhat greater than the initial $115 million. I believe this was due to accretion over time of the original $115 million.
I find it very hard to accept that it was appropriate that these adjustments actually resulted in boosting income and further that they were credited as a reduction to G. & A. rather than simply being a goodwill and developed technology adjustment. These numbers were "plugs" to start off with, to simply balance the original purchase price. This methodology gave SolarCity management a strong incentive to overestimate the likelihood of these benchmarks being met when the transaction closed.
It is interesting to note the number of shares that were issued to settle the actual $34.1 million payment. The dollar amount was firm, so the shares issued depended upon the market price of SCTY stock at the time of settlement. Because the stock price had decreased to around $20 when the transaction occurred, 1.6 million additional shares had to be issued. When the original $138 million payment was made, less than 2.4 million shares were issued. I doubt if many SCTY shareholders noticed how much additional dilution occurred due to this. Of course, this also affected the number of shares issued by Tesla in the acquisition.
I find it curious that the final adjustment was not made until year end. The financial statement disclosure says SolarCity reviews the estimated amount at each reporting period. It is hard to believe that what they estimated at Sept. 30 to be a liability in excess of $80 million was actually determined to be zero three months later.
It is also worthwhile to look at the Q4 2016 income statement to see what the impact of this transaction was on the G & A expense. Well, you know what? There may be a Q4 2016 income statement somewhere, but I can't find it. In the past, they were contained in the SolarCity earnings press releases. Now that SolarCity is no longer a publicly traded entity there are no longer press releases. There are only cumulative income statements for the year in the 10-Ks. To calculate G & A, I had to compare the 10-Q for September 30 with the year end 10-K. The 10-Q indicated total G & A for the first nine months was $260.4 million, while the total for the year was $229 million, so G & A was actually an income item in the fourth quarter of more than $30 million. Furthermore, if someone compares G & A from 2015 with G & A for 2016, the total has gone down by about $15.5 million. ($244.5 million to $229 million). This would appear to support SolarCity's cost control narrative. If you adjust it for these two transactions and add back the $98.1 million, however, G & A actually went up by $82.6 million in 2016 compared to 2015.
Also, $84 million G & A adjustment occurred as a result of a review at the end of a reporting period (December 31). Most likely this resulted in an $84 million reduction in Tesla's G & A expenses as well when the numbers were consolidated. If the adjustment were made prior to the acquisition, this adjustment would not have benefited Tesla's reported numbers.
As you can see, this final adjustment occurring in Q4 2016 rather than earlier resulted in multiple benefits to the company.
How much has Silevo cost SolarCity to date?
Now that the final payment has been made to the Silevo sellers, we can now start to estimate the total cost of the Silevo deal to date. Instead of the original $115 million contingent payment value amount, we can substitute the actual amount of $34.1 million, so we come up with an adjusted gross initial purchase price of $245.7 million.
Since the acquisition in Sept. 2014, SolarCity has spent considerable additional amounts on developing solar module manufacturing capability. A manufacturing facility was opened in Fremont in the fourth quarter of 2015 and they began spending on R& D there at that time.
The amount spent in 2015 appears to have been approximately $10 million, since the 2016 10-K indicates R & D expense decreased from $65 million to $55 million in 2016, and said the decrease was mainly due to establishment of a separate category, called "pre-production expenses" for Silevo R & D activities in 2016. Presumably the separate category was established because it became a material amount in 2016 - $55 million. SolarCity defines "pre-production" expense as "costs we incur in our Fremont California manufacturing facility prior to attaining commercial production (including salaries, other personnel related costs, raw materials costs and other production costs for solar modules run through the production line during this period)."
When we add these expenses to the initial purchase price for Silevo, the investment there increases to a total of roughly $310 million, (partly capitalized, partly expensed).
What's the Rest of the R & D for?
We now know that $55 million of the R & D expense in 2015 was related to something other than Silevo module manufacturing and that there was a similar amount in 2016, or a total of $110 million. It is hard to imagine much was spent on anything other than establishing a manufacturing capability in solar panels and the solar roof tiles, but I'll give the company an allowance of $10 million for other activities. Therefore I will add $100 million to the $310 million and estimate that SolarCity has spent a total of about $410 million establishing this capability since September 2014.
Is the Silevo Goodwill and Developed Technology Justified?
The $167 million of goodwill put on SolarCity's balance sheet as a result of the Silevo acquisition was justified as follows:
"The goodwill recognized was primarily attributable to the value of expected synergies, efficiencies and cost savings that the Company expects to achieve in leveraging Silevo's technology in the volume manufacturing of high efficiency photovoltaic panels, in addition to the value of the assembled workforce and the manufacturing experience of Silevo."
The justification for the $115 million of developed technology was:
"The acquisition of Silevo's technology is anticipated to reduce the Company's costs of procuring photovoltaic panels, reduce the number of photovoltaic panels and other components used in solar energy systems, reduce the installation time of solar energy systems and improve efficiencies and profitability."
We are now approaching the three-year mark since the deal with Silevo was originally closed. It may be possible that some of these justifications materialize after the Buffalo plant goes into operation, but it is pretty clear that to date the benefits have been non-existent. Recent developments with Silevo's operations in China to do not portend well for this, however. The 2016 10-K (p. 61) says:
"The Company commenced winding-down its solar module manufacturing operations in China, due to the tariffs imposed by the U.S. government on solar panels manufactured in China, and recognized an impairment charge of $13.9 million during the year ended December 31, 2016."
I can understand the tariff issue, but shouldn't Silevo be able to at least sell its panels in China if the technology is better than others? The $13.9 million appears to be most of the net carrying value of the investment in China. Gross investment was $28.7 million at year-end 2016 but an unknown amount of depreciation and amortization was taken against this value. This also means the ONLY remaining material assets from the Silevo deal are the goodwill and developed technology.
As was announced a while ago, the panel manufacturing in Buffalo will now mainly be done by Panasonic and mainly with Panasonic technology. In fact, this article from PV Tech, titled "Silevo Technology Ditched as Tesla's Buffalo Fab run by Panasonic" indicates Panasonic will be manufacturing its own HIT cells and modules there. Tesla and Panasonic actually issued somewhat inconsistent press releases recently regarding Tesla's role there. Even if you accept Tesla's claims, however, whatever is produced at Buffalo will be close enough to what is sold by other manufacturers to be able to determine whether or not they are better, cheaper and more available than the competition. If not, then the justification for the goodwill and developed technology values go "out the window." Panasonic and Tesla have executed a detailed contract, so it should be relatively easy to do that comparison now, even before manufacturing begins.
Enter stage right: solar roof tiles, a product no one else is manufacturing in quantity, which makes it hard to do such a comparison. It is interesting that the solar roof concept began to be discussed within about 10 days or so of the tentative Panasonic deal being disclosed. This is why it appears to me this product may simply be an attempt to justify to the accountants a reason to keep the full amount of the goodwill and amortized amount of the developed technology on the balance sheet at least until the economic and relative success of the solar roof tiles can be evaluated determined. I certainly hope that Tesla is not spending actual cash to postpone an accounting adjustment on its books.
Further complicating this is the fact that there has been roughly $165 million of R & D spending subsequent to the Silevo deal. ($65 million for Silevo modules and another $100 million of unspecified R & D, as discussed above). Even if the products at Buffalo are successful and profitable, how much will be due to the acquired Silevo technology vs. the new spending? (And,of course, this spending is continuing.) Technology in the solar industry is changing rapidly, so it seems hard to justify the value of three year old solar technology that is just beginning to be commercialized in any case.
Simply focusing on the Silevo deal, one acquisition of SolarCity, I find many aspects of the accounting that appear to be extremely aggressive, potentially greatly overstating actual income and the value of various assets. It is hard to find much real earnings potential in the Silevo deal that SolarCity actually paid a great deal for. This suggests to me a significant risk of writedowns in the future. It certainly supports the narrative that the SolarCity acquisition may have simply been a "bailout." I now understand why Jason Wheeler departed Tesla before he began to be responsible for SolarCity financial reporting in addition to Tesla's.
It should also be noted that the $84 million G & A adjustment in Q4 I discussed above is unrelated to the two items Paulo Santos highlighted in a recent article of his, namely the $88.5 million non cash gain Tesla reported due to the drop in its price during the period before the deal closed and the $98 million which came from SolarCity's VIE accounting. These three "funny money" items potentially improve GAAP by over $270 million, or more than $1.60 per TSLA share.
SolarCity made a few other major acquisitions in the past 2-3 years which also added a great deal of goodwill and intangibles to the balance sheet but limited amounts of hard assets. I may examine the results of these acquisitions in a future article.
Disclosure: I am/we are short TSLA.
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.
Additional disclosure: I have a modest short position, mainly through OTM calls.