On Thursday, a drama that’s enveloped Tesla Motors Inc (NASDAQ:TSLA) and SolarCity Corp (NASDAQ:SCTY) shareholders since early August finally came to a close, as owners of SolarCity stock overwhelmingly told owners of Tesla stock they want to merge.
The pairing is expected to win all the necessary approvals, though it’s hardly a unanimous “aye” from all involved parties. More than a few owners of Tesla stock are convinced the automobile manufacturer is stepping into a money pit by buying the struggling solar power player.
Thing is, this union may not be the drag on TSLA shares a few grumblers expect it to be.
A Method to the Madness
The reasons for the doubts are understandable. Not only is SolarCity habitually unprofitable, that loss is generally getting bigger. While the top line was still increasing as of the company’s most recent earnings report, and the loss was reeled in, its GAAP loss was still alarmingly large. The quarter did mark a turning point, however, at the same time the solar market itself took a tenuous, but important, turn.
The mass market adoption of solar power was initially put into motion by leasing deals. Rather than require the purchase of relatively expensive solar panels, installers facilitated long-term leases of rooftop systems. A company like SolarCity reaps the tax breaks of ownership and effectively splits the electric savings with the customer.
As the market has evolved and prices for solar panels have come down, however, homeowners and building owners have increasingly opted to simply purchase the panels they’re installing on their roofs. Last quarter, 23% of the company’s booked MW installations were purchased rather than leased, and that figure is expected to rise in the future.
This represents a significant change in the way the company’s books work.
In simplest terms, the revenue from panels installed under lease agreements flow in over a 20-year period, whereas a system that’s outright sold to a customers is fully booked when it’s sold. Leased systems also sit on the company’s book as an asset, which allows for depreciation, although it’s also an asset that can never actually be deployed again. Never mind the fact that the incur a huge upfront cost.
To that end, observers aren’t quite sure if the paradigm shift is a blessing or a course for SolarCity, and by extension for Tesla stock. Tesla Motors CEO Elon Musk isn’t confused, though. He believes the pairing of the two companies could add $500 million to the carmaker’s cash flow within three years. That’s not free cash flow, mind you. As Goldman Sachs added to Musk’s math, actual free cash flow would be at breakeven levels for the three-year span given the company’s current trajectory.
Either way, a breakeven would be a virtual victory for the beleaguered company. The “how?” stems (or will stem) from the ongoing migration to purchased systems rather than leased systems in conjunction with the continually evolving solar market and solar technologies.
In the Meantime …
To be fair, one must tread lightly into any conversation about SolarCity’s impending profitability — plenty of things must fall in line to get SolarCity over that hump. It’s not out of the realm of possibility though.
One of the big strides toward that end zone is the recent introduction of solar shingles, as opposed to solar panels that are mounted among shingles. Tesla unveiled them in late October. Details are scant so far, but the consensus is that they could be prohibitively costly … perhaps costing around $40,000 per typical home. Like traditional solar panels, though, their cost will go down as their efficiency improves. In the meantime, there’s no denying the aesthetic improvement they bring compared to typical solar panels.
Tesla will further be able to offer a soup-to-nuts solution for solar power customers, also offering the battery-based storage needed to supply electricity when the sun’s not shining. Its Powerwall is a perfect fit for that role.
The clincher: Tesla Motors will also likely have an easier time raising capital for SolarCity than SolarCity might enjoy on its own.
Throw in the fact that 2016 solar power installations in the U.S. are projected to more than double 2015’s total installed capacity (yet still only makes up a fraction of our power-production capacity), and the undertow looks even more bullish.
But another round of financing will become inevitable? It was inevitable anyway.
Bottom Line for Tesla Stock
Just to alleviate any potential confusion, there’s no absolute assurance whatsoever that the Tesla stock price will improve with SolarCity being brought into the fold. Not even the experts agree on the impact the team-up between SolarCity and Tesla might have on the combined entity. Glass Lewis calls the proposed acquisition a “thinly veiled bailout” of SolarCity, while Institutional Shareholder Services Inc. says the union is “necessary step” for both companies.
Assuming the business and science continue to evolve as they already are, this deal could actually work out surprisingly well. That is, Tesla will bring scale and sales-skill to the table. The scientific progress will take care of itself.
A red-hot success? No, that might be overstating what’s in the cards. The upside is there, though, and the timing — which is the critical part — is right.
Solar power isn’t on the fringe any longer, and it’s not affordably priced. The industry doesn’t need fat subsidies or complicated leasing arrangements to compel consumers either. That’s all only become a reality in the past several months.
TSLA could indeed be worth a shot here based on what the market’s missing about where solar power is now, and where it’s going next … and this is coming from an observer that’s rarely been impressed by either company.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
