At long last it's happened: Someone has upgraded SolarCity (SCTY +0.00%) stock -- and not despite Tesla Motors' (TSLA +0.97%) questionable decision to bid to buy it, but because of it.
Yesterday, at the same time as analysts at Argus were announcing yet another downgrade of Tesla stock and calling the bid "ill-timed," risky for Tesla stock holders, and "inappropriate," analysts at Avondale Partners were looking closely at the other side of the equation. What they found, as detailed on the pages of TheFly.com, was that no matter what happens to Tesla, this deal could be very good news for owners of SolarCity stock, so long as it just goes through.
But is Avondale right about that? Here are three things you need to know.
It's morning in America for SolarCity stock, and Avondale is taking a shine to Tesla's buyout offer. Image source: SolarCity.
Thing No. 1: You see, there's this buyout...
By now you've almost certainly heard the news. Out of the blue, electric-car maker Tesla Motors announced last week that it plans to acquire solar panel lessor SolarCity. Tesla's CEO is Elon Musk, who is also the chairman of SolarCity, which immediately raises the question of whether there's insider dealing going on, and whether Musk is using one of his companies to bail out the other.
Thing No. 2: Why would SolarCity need to be bailed out?
We covered this issue a few weeks ago. Basically, the problems with SolarCity are these: It's not profitable, it's burning a lot of cash (nearly $2.8 billion over just the past 12 months), and it's carrying a lot of debt -- roughly $2.3 billion net of cash, according to data from S&P Global Market Intelligence.
Now, this is not necessarily bad-bad news. In fact, it's kind of integral to SolarCity's business plan, which requires it to build and install as many solar panels as possible, as fast as possible, in order to grab as much market share as possible, before any of its rivals can beat it. Once those panels are in place, SolarCity can then sit back and collect lease revenue on them -- essentially ad infinitum.
But in the meantime, SolarCity is burning a lot of cash, and racking up a lot of debt. That raises the fear that SolarCity might not ever circle the Monopoly board and collect $200 for its solar leases. It might go bankrupt first.
Thing No. 3: Why this is a problem, and why Tesla could be a solution
With its cash on fire, SolarCity can't pay down its debt to improve its balance sheet. Rather, to raise capital to continue its growth spurt, the company must sell stock. But with its stock down nearly 60% over the past year, SolarCity gets a lot less cash per share of stock it sells today than it used to.
Tesla stock, on the other hand, has proven a whole lot more resilient than SolarCity. While Tesla, too, is unprofitable, cash-burning, and in debt, it's carrying a whole lot less debt than SolarCity (only about $1 billion net of cash). And with Tesla stock still selling for upwards of $200 a share, and having a whole lot more shares and market cap to play with, a combined Tesla-SolarCity could raise a lot more cash from selling new shares to investors than can SolarCity on its own.
This is why a merger with Tesla would be good news for SolarCity: It gives the solar lessor a longer lease on life.
The most important thing: Valuation
Now here's why the merger could be even better news for SolarCity shareholders: Regardless of whether Tesla's buyout succeeds in saving the solar business, it could produce nearly immediate profits for SolarCity stock owners when the merger closes. This is why Avondale is upgrading it today.
When Tesla bid to acquire its sister company, you see, it offered to pay for the merger in stock, offering 0.122 to 0.131 shares of Tesla common stock for each share of SolarCity common stock. As my fellow Fool Daniel Sparks explained earlier, "At the time of the offer, this valued SolarCity shares at between $26.50 to $28.50, or a premium of about 21% to 30% of SolarCity's stock price before the offer was made. ... [but] the value could change depending on where the stocks are trading at the time of closing."
Currently, with Tesla shares changing hands for just over $200 a stub, a 0.122 exchange ratio values SolarCity stock at only about $24.50. If the merger closes at 0.131, SolarCity stock is worth about $26.30. And of course, if Tesla shares soar back to their 52-week high of $286.65, SolarCity shareholders could conceivably receive as much as $37.55 per share -- a nearly 60% premium to yesterday's closing price.
Granted, that last scenario sounds pretty pie-in-the-sky right now. But you'll notice that all three scenarios hold out the promise of at least some profit for investors in SolarCity stock. And with the initial shock and awe of Tesla's news out of the way, and Tesla stock mostly stable in its pricing again, the odds do seem to favor Avondale's recommendation of SolarCity stock working out.
Avondale is right to recommend it.
