When I first read the headline Wednesday morning that Morgan Stanley (MS) had made the case for a merger between electric car-maker Tesla (TSLA) and spaceflight company SpaceX I thought at first that it had to be a joke.
Morgan Stanley? Really? But sure enough, one of the most respected investment banks on the planet had indeed published a research note saying just that.
Aghast, but still intrigued, I read further, trying to understand what good could possibly come of such a union. Perhaps there was some hidden synergy of which I was unaware. Alas, no wisdom was to be found. Instead, we were treated to an argument that boils down to three points:
- Tesla is in financial trouble and facing mounting competitive pressures that threaten the company’s survival. SpaceX, a well-capitalized and quasi-profitable company could keep its ailing sibling afloat.
- Tesla CEO Elon Musk is getting bored with electric cars and wants to spend more time at SpaceX and if he steps down as head of Tesla the artificially high share price will deflate. A merger with SpaceX would bring the rockets under Tesla’s roof, keeping Musk from bailing out.
- Tesla and SpaceX are different companies, with different teams and resources. Making them one company would mean they could share resources and collaborate more effectively.
If those justifications sound simplistic and silly, that's because they are. Let’s take each in turn to demonstrate why this merger would be a terrible idea for SpaceX and do nothing to save Tesla.
1. Fixing Tesla’s Financial and Competitive Woes
This is the meatiest of Morgan Stanley’s arguments, yet its prescription boils down to a simple formula: Tesla is in trouble so it should bolt on a better business to save its bacon.
Even the most committed Tesla bulls cannot help but admit that things are not going too well on either the financial or the competitive side. On November 1st, the company reported its worst financial quarter ever, posting a loss of $619 million for Q3 2017. Put another, more terrifying way, Tesla is burning through close to half a million dollars every hour. Meanwhile, the vaunted promises about its Model 3 have been pushed back or slashed. Having completely flubbed the long-established goal of producing 5,000 Model 3 vehicles per week, Musk has simply pushed the date out. 2018 will see the 5,000-a-week production. From Musk’s lips to God’s ears!
Meanwhile, competitors have been turning the screws ever harder on Tesla. BMW (OTCPK:BMWYY) continues to produce vastly more electric cars, Porsche (PAH3) is moving in on its luxury niche, Toyota (TM) is cutting into its lead in battery technology while also pursuing commercial fuel cell technology, and General Motors (GM) could take top spot in the realm of autonomous cars. No amount of vain boasts of electric vans or gigafactories can alter the fundamental economic and competitive realities pushing Tesla into a corner.
The author of the Morgan Stanley note certainly has no illusions about Tesla’s current prospects on its own, stating:
"We have argued for some time that Tesla's addressable market of sustainable transport will attract fierce competition from some of the world's best capitalized tech firms with arguably superior access to capital, talent and business models that can monetize vehicle data and content opportunities, threatening the long-term independence of Tesla as a standalone entity."
The author acknowledges that Tesla’s capital-intensive business model makes it unattractive to independent suitors. So, with “no apparent natural buyer”, an unnatural union with the smaller but well capitalized, and occasionally profitable, SpaceX – which Musk effectively controls – is one of the only viable options for Tesla’s future. In other words, no independent company interested in its own growth and development will touch Tesla, but Musk might be able to wrangle his way into its coffers to feed the auto-maker’s insatiable hunger for cash.
The inherent problem with that logic is that it assumes SpaceX is little more than an appendage of Elon Musk to be done with as he pleases. That might fly with a small startup and its founder, but a company valued at $21.2 billion after raising $351 million in its last funding round earlier this year is not a private piggy-bank, no matter how charismatic the CEO. The Morgan Stanley analyst made the notion of a raid-for-cash even more laughable when he suggested SpaceX’s true value is now $46 billion – not far off Tesla’s own market capitalization of approximately $52.5 billion.
SpaceX has done a remarkable job of creating a profitable – or nearly profitable – rocket business. Hanging a Tesla-shaped albatross around its neck with the express aim of using its cash flow and to exploit its better access to capital markets would severely damage SpaceX’s future and be destructive to shareholder value. It may be a private company, and Musk may like to treat it like a fief, but that does not mean it can abrogate its fiduciary duty to the investors who have poured huge sums of cash into it for the sake of Tesla. These are businesses, not charities. They may share a CEO but that does not give him the right to rob Peter to pay Paul.
Musk may think he can get away with it; after all, he did with SolarCity in November 2016. But SolarCity was valued at just $2 billion in that deal. SpaceX is a radically bigger pill to swallow. Tesla will almost certainly choke on it.
2. Merging the Companies Will Keep Musk in Tesla’s Driver’s Seat – and Tesla from Crashing and Burning
This justification for merging is perhaps even more worrying than the first, even if it is simpler. In essence, the Morgan Stanley note admits that Tesla’s share price – and hence its valuation – is inflated and that only the force of Elon Musk’s personality is keeping it from sputtering.
If a key pillar of a company’s share price is based on a cultish belief in its CEO, then that’s a real problem. Of course, the Morgan Stanley analyst puts it more delicately, calling it “key man risk”, but the meaning is the same. Morgan Stanley notes the concern that Musk’s attention has been wandering, and threatens to carry him away from Tesla for good:
“Investors widely expect Elon Musk to, over time, devote increasing amounts of his time and talents to SpaceX, raising the very real question of who could replace him at Tesla. A combination of efforts between the two firms could address this important issue.”
In other words, Musk wants to tuck and roll out of Tesla and catch the SpaceX rocket. Morgan Stanley worries that his transitioning from Tesla would leave a void of leadership. And, while it is left unspoken, it is rather easy to insert the additional line: That void would swallow Tesla’s share price as investors shake themselves free of Musk’s almost hypnotic power and realize that Tesla is just an electric car company with some extraneous bolted-on bits, including a dead-end solar power program.
But Morgan Stanley’s answer is strangely juvenile. It seems to assume that, if Tesla and SpaceX become one company and Musk remains CEO, somehow the underlying pathologies afflicting Tesla will just go away. That is not how business works, alas. Whether he stays or goes, the problems will still need to be addressed. Furthermore, one might contend that a CEO whose energy is not devoted to half the business might not be inclined to dedicate lots of time to addressing its problems. One CEO hat or two, it would still be Musk’s problem – and clearly he’d rather be planning the next phase of mankind’s colonization of the solar system.
3. Merging Tesla and SpaceX would allow them to collaborate more seamlessly
The idea of Tesla and SpaceX merging involves only their financial resources, but also their technology and talent. The assumption our Morgan Stanley analyst makes is that, by bringing all these geniuses under one roof, they will achieve that most sacred corporate Holy Grail: synergy. Presumably that synergy will be so potent as to find a way to get Tesla out of its jam without stripping away SpaceX’s resources.
The only thing Morgan Stanley could point to as an example of how a merged company would better function is the fact that Tesla and SpaceX have collaborated recently on manufacturing and software development. Hardly a glowing recommendation!
It feels almost contemptuous on the part of Morgan Stanley to suggest this merger. It seems hard to imagine a credible investment bank making a similar recommendation if it were discussing two similarly sized public companies with independent management. Clearly, the recommendation is designed to favor a suffering public company at the expense of shareholders in a private one.
Conclusion: Keep the Looters Away
While Elon Musk was able to wrangle Tesla’s shareholders into absorbing SolarCity last year – along with its crushing debt pile – he will not likely be able to convince SpaceX’s stakeholders to go along for a similar ride. SpaceX is between ten and twenty times bigger than SolarCity was – and it is actually a functional company rather than a debt-riddled wreck.
A merger between Tesla and SpaceX would represent a case of looting the latter for the short-term benefit of the former. There is no economic or business justification worthy of even a cursory evaluation. It would be a smash-and-grab plain and simple. SpaceX’s business, which is occasionally profitable and has the potential to be one of the great companies of this era, would be subordinated to the task of keeping Tesla alive in the vain hope that the auto-maker will one day soon be the most dominant car company since the days of Henry Ford.
Pipe dreams have driven Tesla up this far and their evaporation will see it crash. Let’s hope it doesn’t take SpaceX with it.
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.
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