Is Tesla's Offer for SolarCity a Good Deal?

Tesla Motors (TSLA 12.06%) recently offered to buy out SolarCity (SCTY.DL) for a relatively unimpressive $2.8 billion in stock.

In this clip from the MarketFoolery podcast, Chris Hill, Simon Erickson, and Aaron Bush talk about a few of the potential upsides the deal would have for both companies involved. Then, they take a deep dive into some of the many factors that are making shareholders and media outlets so uncomfortable with the proposition -- from the ripe potential for nepotism to financial concerns for both parties -- and why we're likely going to see lawsuits crop up if and when the buyout goes through.

This is not a traditional buyout as the two companies already have Elon Musk in common. That complicates the deal even though the tech titan has recused himself from any board decisions made by either company.

A transcript follows the video.

This podcast was recorded on June 22, 2016. 

Chris Hill: Topic A is the fact that the news fairy showed up with Tesla Motors offering to buy SolarCity for the tidy sum of $2.8 billion in stock. There are a bunch of threads I want to pull here, but Simon, what did you think when you first saw the news?

Simon Erickson: I was not happy with the news fairy's news. She did not leave a good present, I don't believe, with this deal, because, from a SolarCity perspective, which we do have as a recommendation in several of our services, I think it's a really lowball offer. I think this is undervaluing the significant potential that SolarCity has for equity holders over the longer term. So yes, it is an all-stock deal. You do get to maintain the upside of shares of Tesla going forward. But I personally think the offer price is a little too low.

Hill: Now is the point, Aaron, where I mention that, since Simon used the word "lowball" to describe the offer, that Elon Musk is the CEO of Tesla Motors, and is the chairman of SolarCity. He owns roughly a fifth of both companies.

Aaron Bush: And his cousin is the CEO of SolarCity, as well. So you have a little bit of that going on, too.

Hill: A little bit.

Bush: A little. (laughs) 

Hill: Elon Musk has, I would argue, a very good reputation. And I think that is helping him right now, because if he didn't have a very good reputation, this would just look like... I don't want to say it would look dirty, but it would smack of...

Bush: Nepotism.

Hill: Yeah, and lining one's own pockets. So, from a Tesla standpoint... I should mention what the stocks are doing. SolarCity stock is up on this news. Tesla Motors shares were down about 10% overnight. This morning, they bounced back a little bit, but still down about 7%-8%. Aaron, when I look at the media coverage, there aren't a lot of people who are giving thumbs-up to this deal.

Bush: Yeah. My perspective on this is that it really is mixed. There are pros and cons to this deal. Starting with what I like, I think that bringing SolarCity in-house gives Tesla a pretty obvious benefit for their whole upcoming Tesla Energy business. On one hand, I think this deal makes good sense from a product ecosystem perspective. Tesla owners will get a cost-effective, environmentally friendly, and probably a cool brand-friendly way to charge their cars. And the future of Tesla Energy, so to speak, is probably bound to be something more intriguing because of this deal. And I think that's probably going to be a big business.

The other thing I like about this is more grounded in the numbers. If you listen to Tesla's past earnings call, where Elon Musk was talking about the importance of being the best manufacturer in the world, and the importance of vertical integration, and all of that, it becomes clear that SolarCity fits directly into that. With SolarCity, Tesla will be able to provide both greater scale and manufacturing expertise for SolarCity, which I think is deeply needed, or would just be massively helpful for their costs. And it will accelerate adoption of their total addressable market. So that is the good side I see for Tesla.

I mean, what I dislike--

Hill: Can I take a guess of what's on the list for the downsides?

Bush: Go for it.

Hill: I'm going to guess that somewhere on the list is the distraction element, because Tesla Motors is on the hook for delivering a whole lot of vehicles in the next couple of years. And now, if this deal goes through -- and there's no reason to think that it won't, but we can get to that in a second with Simon -- if this goes through, then all of a sudden, there's a whole other chunk of the business that is distracting Elon Musk and his team from delivering all of those vehicles.

Bush: Yeah. I'm not sure how much mindshare or time it will take away from Elon and the current Tesla executives for this. It certainly will take some away. But I think probably the biggest distraction is more financial. SolarCity carries a lot of funding needs. And there's been a whole web of how that's been funded, Tesla being part of that, I think even SpaceX was part of that too, and other players. I view this just as much as a potential burden on Tesla's financials. They already have a pretty significant sum of debt, but this could distract them financially when they already need to raise money left and right. I think that's a challenge.

Then, SolarCity has changed their strategy a few times over the past couple of years. Probably twice or so. Going into the Tesla fold will probably cause them to change their strategy again, which brings more uncertainty. And I don't really know how that'll play forward. So it is a mixed bag.

Erickson: I'll jump in on the capital requirements for both of these businesses. You've got Tesla trying to build out the Gigafactory right now and scale up for the Model 3 -- huge capital allocation requirement. You've got Tesla building a plant for the in house manufacturing of their own solar panels -- huge capital requirement. Tesla is diluting its shares to make this acquisition, which is another hotly contested topic for investors, too. I just don't think now is the right time for SolarCity to be acquired. At least for shareholders, it seems like we're at the apex of fear right now.

We've seen a lot of political headlines. We know what happened in Nevada where they had a retroactive decision that was very anti-solar, not solar-friendly. I think all of that is baked into an undervalued share price for SolarCity right now. I just don't think now is the time to go out and put yourself up for sale to be acquired by Tesla -- who needs some money for their own projects anyway.

Bush: Yeah. And you mentioned how there's a Musk factor -- people respect him so much, therefore he can get away with things like that. The other key element to all this is just the reflexivity between all of the news game he's playing, all these deals that he's making. This would not be possible if he weren't using shares. Shares are at a pretty lofty price compared to what the business is doing--

Erickson: For Tesla.

Bush: For Tesla. So he's basically keeping the hype going, keeping the news rolling, to keep the shares up so that he can continue to raise money this way, make deals this way. So there's added risk from that as well.

Hill: Simon, when I hear -- and it doesn't even have to be in this deal, but in the past, when I've heard acquisition deals and offers referred to as "lowball," there's a pretty good chance that shareholder lawsuits follow. Do you think that we're going to be seeing that with SolarCity shareholders?

Erickson: I would almost guarantee you'll see those, the lawsuits popping up in the next couple of weeks or so. Tesla is in due diligence right now. We're going to have an upcoming vote on this. But you have to consider purchase price and Elon Musk's affiliation with both parties when you consider those.

Bush: One thing I would briefly add to that is that both Elon Musk and the Rive brothers of SolarCity have agreed to not vote their shares for this. There probably will be lawsuits, because there always are lawsuits, but it's actually more shareholder-friendly with them stepping out and allowing the more third-party shareholders to be voting instead.

Erickson: True. And Chris, if I could just take a moment to explain why I keep calling this a lowball offer. The majority of the value of SolarCity right now is already baked into existing contracts they already have. Residents and businesses sign 20-year contracts to provide power to them at low rates, which SolarCity inks. That's a contractual obligation, it's existing business already. And when you look at the present value of all of those existing contracts, it's about $20 per share today. Really, the high end of Tesla's offer, which is, as of yesterday price, about $28.50, Tesla is saying all of the growth of this business is worth only about $8.50 per common share of SolarCity today. When you look at, historically, how much value they're adding to shareholders every year, I think that is not capturing the long-term potential of this multitrillion dollar electric energy industry in the United States.

Hill: Last question, and then we'll move on. Is there a price that you would feel good about as a SolarCity shareholder? Or do you just look at this and say, "No, I want them to keep giving this a shot, and try and go it alone."

Erickson: There's a definite range, I have to recrunch the numbers, because the Nevada decision actually is affecting the business of SolarCity recently. I don't think that affects everything two years out, but in the last six months or so, we have seen fewer bookings, which is affecting the operations of SolarCity, which is how we model a company like this. But I will say this is historically at very, very low multiples of what typically SolarCity has sold, in terms of a multiple of their value of their current business and the value of the growth of their business.