SolarCity Corp. Is Getting the Short End of the Stick From Tesla

Last week, Tesla Motors (TSLA 4.96%) made a bid of $2.8 billion in stock for energy company SolarCity (SCTY.DL). Many SolarCity shareholders believe the offer significantly undervalues their company, especially considering Tesla CEO Elon Musk is the chairman of the board at SolarCity.

In this clip from the Motley Fool Money radio show, Chris Hill, Simon Erickson, Matt Argersinger, and Jason Moser look at why both stocks have seen price declines since the announcement, and what exactly Tesla Motors has to gain from the deal. They also dive into why SolarCity in particular isn't getting the good end of the proposed arrangement, and why it isn't such a hot move in the short term for Tesla, either.

A transcript follows the video.

This podcast was recorded on June 24, 2016.

Chris Hill: The second most surprising story of the week is Tesla Motors' offering to buy SolarCity for $2.8 billion in stock. Elon Musk is the CEO of Tesla Motors. He is also the chairman of the board of SolarCity. So boy, that must have been a quick meeting, Simon.

Simon Erickson: Wow, right? Elon Musk talking to himself: "Is this a good idea?" "Let's think about it, Elon."

Hill: You're a SolarCity guy, and you don't like this deal, for sure.

Erickson: I don't. But first, I'm shocked. Any other week, this would have been the most important news. [laughs] It's just shocking to hear that this is the second biggest story of the week.

I don't think this is a great deal for SolarCity, from the valuation perspective. I think it does make sense strategically, definitely for Elon Musk, and his vision of what he wants the future to look like, to fold SolarCity into the larger Tesla deal. But I'm hung up on the valuation on this right now for a variety of reasons. I'll just go through two really quickly. The first is, there's a large percentage of the valuation of SolarCity today that's tied up in existing contracts they've already signed and the ink is dried on. So when you consider the amount of growth that this deal, which at the high end was at a high of $28.50 per share of SolarCity, down significantly now that Tesla's price has fallen. But it's just not giving enough credit for the growth tear that SolarCity's been going on. And, considering also it's going into a multitrillion-dollar market, which is the electric energy industry of the United States.

The second thing is -- I just don't think it's the right time right now. You have 50% of the public float of SolarCity sold short right now. You've seen a lot of political headlines that are anti-solar in the news. And I just don't think this is the time that you want to put your company up for sale, especially considering that SolarCity was up to $57 per share at the end of last year. I just don't think the time is right.

Hill: And Matty, you look at what happened to Tesla Motors' stock this week, down more than 10%. You would be hard-pressed to find someone on Wall Street who likes this deal in either direction.

Matt Argersinger: Right. I think it makes a lot of sense for Tesla. I'll get into that in a second. But you're right. The market doesn't like the deal, because I think they look at Tesla, especially, integrating SolarCity while they're trying to build a Gigafactory, they have billions in capital needs of their own, they're trying to meet the tremendous demand for Model 3 cars in a few years. To integrate SolarCity at this point would really muddle things up. 

At the same time, I think this was Elon Musk's plan all the time. I think he set up to build not just a motors company or an automobiles company but an energy company. And he's built the stationary storage part of it, he's built the electric car -- he's never had the electric generation part of it. That's sort of the trifecta. SolarCity gives them that, SolarCity is the largest solar panel -- of course, he's on the board, he's the cousin of the CEO and the CTO. I think this was always going to happen. 

I agree with Simon. I think Musk recognizes that the market doesn't understand SolarCity, is probably undervaluing SolarCity. It's his opportunity, and Tesla's opportunity, to make a deal at this price. So, not good for SolarCity shareholders, I agree. But for Tesla, this is a deal that probably makes sense.

Erickson: And I might add, too, that Elon Musk has excused himself from this vote. He owns 20% of Tesla, 20% of SolarCity also, and he and his fellow board member, Antonio Gracias, are both excusing themselves from this vote, making it even more important for individual shareholders.

Hill: I think that's a good move, and certainly Elon Musk has largely a really good reputation in the business community. I think that's also a good thing, because if this were any other CEO -- in fact, if this were a lot of other CEOs that we've talked about in the past -- this wouldn't pass the smell test! The fact that one person is the chairman of one company, and the CEO of the other, and says, "Oh, I'm going to put my two toys together."

Jason Moser: I think it's very difficult to figure out, honestly. SolarCity is one of those businesses that I -- Matty mentioned the market not really understanding it. I don't think that's a very big leap there. I think it's a very, very difficult business to fully understand. There are a lot of dots to connect. There are abundant capital needs that this business is going to need for many years to come. I think, at least, for the business' sake, it probably makes sense to be a part of Tesla's business, so to speak. I think SolarCity and Tesla together, that makes sense. Maybe it takes SolarCity from under the microscope that it's under now.

For shareholders, yeah, this is probably a bad deal. I mean, the shares are far lower than where they were just a few months ago. Again, it requires such a long-term outlook. When you talk about these 20-year contracts and the cash flows that come from that, it's just a really tough business to fully understand. I think it's a good lesson for investors to at least say, "Listen, if you get into a situation like that where you're with a business that you like what it stands for, you're not quite sure how all the pieces work together, it's OK to maybe be a part of it." But make sure you position size accordingly, because you still need to be able to answer those questions. If you just put your faith in leadership, that's fine. I think Elon Musk is an exceptional leader. But they're not always going to be that way.

Erickson: Just to put some numbers, like Jason was saying about those future contracts that they already have, 20 years signed with SolarCity, the net present value of the future cash flows related to those, when you subtract out all of the cost and all of the debt, so the value to us in present value for shareholders, is about $20 per SolarCity share today. And they're looking to add, in my model, between $5 and $7 per share this next year. That's one of the reasons that we are considering this to be an undervalued deal for SolarCity.

Hill: Last question on Tesla Motors, Matty. When you look at the next two years for this company, does a deal like this amp up the pressure on Elon Musk with respect to things like getting the Gigafactory online and delivering, by the way, those 500,000 vehicles in 2018?

Argersinger: I think it does. They're going to need capital. SolarCity needs capital, so if they integrate SolarCity, I think the capital needs of the combined company will only go higher, and certainly the risks go higher, as well. Again, long-term, and if you believe what Elon Musk says, he thinks this opportunity is a trillion-dollar company, someday. I mean, you know, he's throwing numbers way out there. We love that, because we love Elon Musk, but the risks have certainly been amped up, I think, with this deal.

Erickson: And Chris, I would like to propose the combined company would have the ticker MUSK. I'm just saying.