Moments ago, in a webcast announcing that Tesla shareholders overwhelmingly approved the Solarcity merger, with some 85% voting for the transaction and following the proxy ISS recommendation which recommended to accept the deal, Elon Musk encapsulated the sentiment by saying “I think your faith will be rewarded. I think there will be some really amazing stuff that comes out.”
From the press release:
Tesla’s shareholders have overwhelmingly approved our acquisition of SolarCity. Excluding the votes of Elon and other affiliated shareholders, more than 85% of shares voted were cast in favor of the acquisition. With SolarCity’s shareholders also having approved the acquisition, the transaction will be completed in the coming days.
We would like to thank our shareholders for continuing to support our vision for the future. We look forward to showing the world what Tesla and SolarCity can achieve together.
The reason why the result may come as a surprise to many analysts is that there has been much speculation that the merger will be a disaster for Tesla, as a result of the unprecedented cash burn at SolarCity, ignoring the potential conflicts of interest embedded in the deal, which are a case study in extended family cross holdings…
… and ignoring a new administration that will be far less “green energy friendly” than the previous one.
Perhaps the most scathing report on the now effectuated deal came out yesterday from Axiom’s Gordon Johnson who slammed the deal as a result of the following reasons:
SCTY Moves to SELL from HOLD; Year-End 2016 Price Target Edges to $16/share (20% downside)
While we previously pegged the odds of Tesla’s (TSLA; NC) proposed merger of SCTY at a 50/50 probability yes/no, we now peg those same odds at 70/30. However, with an 0.11x exchange of TSLA stock for each share of SCTY, if the deal were to close today, SCTY would be valued at $20.21/share, or 2.0% upside. However, were the deal not to close, we believe SCTY’s stock would trade down to $6/share (we believe SCTY is still creating negative value for each system sold on an unlevered basis – Exhibit 10). Thus, on valuation, applying 70% to $20.21 + 30% to $6, on arrives at a probability adjusted year-end 2016 price target of $16, or 20% downside.
So, despite advisory firm Institutional Shareholder Services’s (“ISS”) approval last week, why do we still see a 30% chance some shareholders “walk” on this deal when the date for approval (i.e., Thursday of this week) is so close, and the merger-arb spread has come in so much? In short, we assume investors aren’t willfully ignorant. What do we mean? Well, in SCTY’s C3Q16 10-Q, which was released last week, we gleaned two key takeaways, including:
- SCTY sold roughly 25% of their panels to the Commercial and Industrial (“C&I”) segment during the quarter; and, despite the company reporting C&I prices for their systems sold at roughly $3.00/W, based on checks we did months ago, we know that C&I prices in the US are 35%-50% below what SCTY has reported; thus, if one were to spread the SG&A across proportionally to the average selling price (“ASP”), SCTY’s creation cost would be significantly higher than the reported $2.89/W level, which would also mean a huge miss on megawatts (“MW”) deployed in C3Q16, not the beat reported; and
- SCTY changed the useful lives of their systems from 30 years to 35 years in the quarter, artificially (we believe) reducing depreciation expense, allowing the company to inorganically beat on EBIT and thus EPS.
We believe these actions are HIGHLY questionable, and assume Tesla investors either: (a) lack a very basic understanding of the solar market, or (b) lack a very basic understanding of accounting. But it doesn’t end there. In addition to these forms of what we see as accounting chicanery, SCTY claimed that it generated cash in the quarter. However, when adjusting for the debt the company issued in the quarter (i.e., excluding it), its cash balance fell from $146mn in C2Q16 to just $67mn in C3Q16. Thus, again, assuming the portfolio managers at Fidelity, Baillie Gifford, T. Rowe Price, Vanguard, Black Rock, Morgan Stanley, etc. are aware of this, and not under Mr. Musk’s “spell”, we still see a 30% probability this deal does not close. As such, we would be short the stock ahead of Thursday’s vote.”
SCTY PowerCo Valuation (C2Q16) – Using SCTY’s Numbers
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Needless to say, Gordn’s faith is weak. We look forward to finding if the faith of the 85% of total TSLA shareholders will indeed be rewarded as promised.