Direction Alerts Sunday Edition

[Direction Alerts] Is There An Upside To The Tesla - SolarCity Merger? Why This 15% Isn’t Without Risk “Solar and batteries go together like peanut butter and jelly.” So said Tesla CEO Elon Must in a conference call in August. For Musk, the very existence of Tesla is to help the world transition away from our reliance on greenhouse gas-emitting hydrocarbons. To do this, his [master plan]—first published in 2006 and updated earlier this year—boils down to this: 1. Build a low-volume car (the Tesla [Roadster]) that would be necessarily expensive. 2. Use that money to develop a medium volume car (the Model S) at a lower price. 3. Use that money to build an affordable, high volume car (the Model 3), and 4. To provide solar power because electric vehicles still need to be plugged in to charge, and two thirds of our energy is still generated from coal and natural gas. The point of all of this, in Musk’s words, is to accelerate “the advent of sustainable energy, so that we can imagine far into the future.” This is the justification for his Tesla and SolarCity merger. For Musk, this merger is in-line with his long-term strategy, but does this acquisition really make sense for the underlying businesses? It seems as though the deal is weighted largely on long-term vision, and while it’s a noble vision, it’s light on the near-term benefit for shareholders. The two companies both need to raise capital, they collectively burned through nearly $5 billion in cash last year, and it seems that cash-burning SolarCity will drain Tesla’s juice when it needs all it can get to achieve its aggressive Model 3 roll-out plan. All this considered, some think there is an upside to the deal which we’ll discuss further on. But first, let’s take a deeper look at both companies and the deal itself. Tesla Tesla Motors has defined itself as the electric car company in the automotive industry. In addition to building and selling all-electric vehicles, the company also offers electric vehicle powertrain components and its Powerwall solar energy storage system. Since it’s IPO in 2010, it’s stock price has increased from its initial offering of $17 to $201 by close on October 6, 2016. That’s a 1,082.35% increase since its IPO. The company released its first vehicle, the Roadster—the world’s first ever all-electric sports car—in 2008 with limited quantities and a high price tag. In 2012, it delivered the Model S, a luxury sedan, with greater availability and priced to compete with comparable BMW, Mercedes, and Audi models. Both models were released with impressive product launches helmed by Musk, media buzz, and money in the door. Finally, earlier this year, Tesla announced the Model 3, a mass-market vehicle priced in the sweet-spot at $35,000. The release of the the car set the industry abuzz when over 300,000 buyers lined up to reserve their Model 3s with a $1,000 deposit each. With the Model 3, Tesla earned over $300 million from reservations alone, and, with a price tag of $35,000, has a future expected revenue of $18 billion when the Model 3 begins shipping in 2017. Considering that Tesla earned $4 billion in car sales last year, the magnitude of the revenue from the Model 3 is a game-changer. But that $18 billion in added revenue doesn’t come cheap, and the company isn’t projected to become profitable until into the 2020s. Beyond the media attention and new money that comes with each flashy new product launch, the company is in a highly capital-intensive industry. This requires the company to continually invest billions into scaling and staying a step-ahead of the competition, and Tesla has said it needs to raise more cash by the end of the year. Because Tesla designs their cars from the ground up, their cost of goods immediately eats up 80% of revenue, and R&D costs add another 16%. These two expenses alone take up the majority of the company’s top line. Couple that with the current construction of the expensive $5 billion Gigafactory. Once it’s done it will be capable of producing more than half a million batteries per year, making it possible for the company to reach its target of producing 500,000 vehicles annually by 2018. The catch here is that delivery of the Model 3, the vehicle that will propel Tesla into profitability, is dependent on the completion of the Gigafactory. Tesla is notorious for missing delivery targets, and I, for one, question the company’s ability to transition smoothly to a higher-volume production schedule especially considering that the mass-market Model 3’s delivery is contingent on an assembly line that isn’t even built yet. But with all of this, there was a glimmer of hope this past week. On Monday, Tesla announced that it sold more cars than expected this quarter. This quarter was really the last chance the company had to unlock the door to raising much needed cash by the end of the year. What’s particularly impressive about this is that year-over-year growth is 111%, and it proves that Tesla can actually hit or exceed a sales target even after misses in the two prior quarters. My conclusion about Tesla is that it’s propped up by the hope of future profits, an altruistic mission, and an almost cult-like belief in its charismatic CEO, Elon Musk. The company can succeed, the potential is there, but it needs to successfully raise cash this year if it’s going to win big with the Model 3. Let’s take a look now at SolarCity. SolarCity SolarCity has potential too, but its problems are greater. The energy market in the U.S. is massive. While solar only comprises 1% of the overall energy supply, it is steadily gaining traction, and SolarCity is the leading solar panel seller. To take advantage of the growing solar trend, SolarCity has scaled very quickly over the past decade, doubling capacity every year and compiling huge amounts of debt. The company is run by two of Elon Musk’s cousins, and Musk is the Chairman of its board of directors. The majority of its business is operating leases. The company pays the up-front costs of and owns its solar systems, then sells the power produced to its customers for the length of their contracts. SolarCity’s sales costs are significant and ultimately account for more than 20% of the all-in costs per new installation. And, the company relies heavily on third-party financing to pay for its systems. The company’s stock has lost more than half of its value this year, dropping from around $50 per share at the start of the year, to $19.51 at the close on October 6. The big concern with SolarCity is that it burns through cash and had roughly $3.35 billion in debt at the end of June of this year. In August, the company tried to raise $124 million from investors, offering an unusually high 6.5% interest rate on an 18-month debt offering. Musk and his cousins, SolarCity’s executives, bought $100 million of the debt. SolarCity was able to raise $305 million in mid-September by selling future cash flows from some of its solar projects to a hedge fund advised by George Soros, but the reality is that it will constantly need to raise more money from investors to fund its business model of leasing solar energy systems to customers with no upfront costs. Investors wanted SolarCity’s high costs to come down, but that has yet to happen so Tesla has stepped in. The company has no other buyers, and its short-term financing needs add urgency to the closing of the acquisition. The Deal When it comes down to it, Musk is taking two bad businesses in terms of cash, and joining them together. The $2.6 billion all-stock offer is expected to close in the fourth quarter. If the deal goes through, SolarCity shareholders will be offered 0.11 shares of Tesla for every share they own. Musk has said that by merging the two companies, he hopes to “be able to expand [each company’s] addressable market further than either company could do separately,” and suggests that because the two have “shared ideals,” each would be able to increase the sales of the other. “Those who are interested in buying Tesla vehicles or Powerwalls are naturally interested in going solar, and the reverse is true as well,” [said Musk]. It’s generally expected that Tesla shareholders will back the merger in a vote later this month as they believe in Musk’s long-term vision that combines electric vehicles with the battery storage and solar panels to keep them charged. But approval by Tesla shareholders isn’t a sure thing. Several shareholders and analysts have raised concerns about SolarCity’s cash-burn and need for major financing during a time when Tesla is in the midst of its own expensive projects. Not only that, but Tesla is facing four shareholder lawsuits over the deal alleging that Tesla executives and board members breached their fiduciary duty by entering into the merger process as Elon Musk and others hold shares in both companies. While shareholder litigation isn’t uncommon in deals like this, it does show dissension among voting shareholders and does have potential to delay the deal. On the other side, considering the spread between Tesla’s offer and SolarCity’s current stock price, SolarCity’s shareholders are expected to approve the merger. So What’s The Problem? The problem is that nothing about this merger really makes that much sense or is that straightforward. For Tesla, the timing is terrible. The company is building its Gigafactory which will allow it to pump out a half-million vehicles per year, a capability it has to have if its Model 3 will be successful. Tesla needs the Model 3 to be a win in order to finally reach profitability and in order to be propelled into becoming a much more significant player in the automotive industry. Both the Gigafactory and the production of the Model 3 require a lot of cash and a lot of fundraising, and taking on the cash-burning SolarCity will only be a distraction from this work and could end up doing significantly more harm than good for Tesla. Add to that the idea that with SolarCity’s cash problems, it seems the company is not that far away from bankruptcy. In the last year, the company has attempted to reduce its high operating expenses that are a result of its rapid expansion, but all it has to show for these efforts are missed growth targets. Musk has said that SolarCity could raise the capital it needs on its own, dismissing the idea that the company is being bailed-out by Tesla. But then, if SolarCity could raise capital on its own, why wouldn’t it do that instead of taking an all-stock offer in a time when it’s trading at half of what it was earlier this year? As a SolarCity bankruptcy isn’t all that far away from possibility, it would seem more logical for Musk to wait until it did happen and then buy the company at a steep discount. But again, nothing about this merger makes a whole lot of sense. Merger Arbitrage So how can we learn from the Tesla and SolarCity merger? Normally when a merger is announced, merger arbitrageurs take positions in both the acquiree and the acquirer, with the typical trade being purchasing shares in the target of the acquisition and selling the shares of the acquirer in order to lock in the spread between the two to create riskless profits. In an ideal scenario, which the merger of Tesla and SolarCity is not, both the acquiree and the acquirer would be fundamentally solid companies. In an all-stock offer like that of the Tesla and SolarCity deal, ideally, company A, our acquirer, would make an all-stock offer that is above the stock price of company B, our acquiree. An arbitrageur would sell short their stock in company A, and purchase stock in company B, and when the deal closed, they’d end up with the offer equivalent value of company A’s stock, collecting the spread between the two. In the Tesla and SolarCity case, that spread is north of 15%, which isn’t bad at all for a short-term trade and there are, understandably, [analysts who like the trade]. The problems are that 1) while the deal will probably go through eventually, there isn’t a guarantee that it will go through in the fourth quarter as projected, leaving you with the ever-struggling SolarCity stock, and 2) even if the deal does go through and SolarCity shareholders realize the >15% gain, they are then stuck with Tesla stock. Since the announcement of the merger, both SolarCity and Tesla have been declining as the general consensus is that the merger is a bad idea. Take a look at this chart from [Bloomberg:] [Direction Alerts] The chart shows SolarCity trading at almost a fifth below Tesla’s takeover offer, demonstrating that investors are losing faith in this deal. What usually happens in a merger situation is that arbitrageurs buy shares in the target of the acquisition and sell short the acquirer’s shares to lock in the spread between the two, but that’s difficult in Tesla’s case as almost a quarter of the stock’s float is already sold short making borrowing the stock expensive. Considering the billions in debt that both companies are in and the fact that they are both burning through cash—though SolarCity at a much more concerning rate than Tesla—merging the two companies and their collective problems could spell disaster for Tesla. Bottom line, if this were a good deal, I’d recommend you buy shares in SolarCity and collect the spread when the deal with Tesla goes through, but it’s not. What I can recommend is that you keep an eye on news regarding mergers and acquisitions as you never know when an opportunity will come around where you’ll have an ideal scenario for merger arbitrage. It could be a great way to make solid short-term gains, and you may end up owning a really fantastic stock. Trade Smart, Kristina Keene Marketing Director, Investiv The Direction Alerts service is owned and provided to you by [Investiv, LLC.] --------------------------------------------------------------- If you are having trouble reading this email, you may [view the online version] This email was sent to {EMAIL} by Investiv, LLC 3400 North Ashton Blvd. | Suite 170 | Lehi | UT | 84043 [Forward to a friend] | [Unsubscribe] Disclaimers Investing is Inherently Risky There are risks inherent in all investments, which may make such investments unsuitable for certain persons. These include, for example, economic, political, currency exchange, rate fluctuations, and limited availability of information on international securities. You may lose all of your money trading and investing. Do NOT enter any trade without fully understanding the worst-case scenarios of that trade. And do NOT trade with money you cannot afford to lose. Past performance of an investment is not necessarily indicative of its future results. No assurance can be given that any implied recommendation will be profitable or will not be subject to losses. Hypothetical Results Are Reported Results and examples used in the Company’s advertisements, books, videos, websites, and other media—including on the Site and the Network—are, in some cases, based on hypothetical (simulated) trades. Plainly speaking, these trades were not actually executed. Hypothetical performance results have certain limitations. Unlike an actual performance record, hypothetical results do not represent actual trading. Also, since the trades have not been executed, the hypothetical results may have under-or-over compensation for the impact, if any, of certain market factors, such as lack of liquidity. Hypothetical trading programs generally are also subject to the fact that they are designed with the benefit of hindsight. Hypothetical results also do not account for commissions or slippage. The Company’s simulations assume purchase and sale prices believed to be attainable. Yet traders are going to be getting into trades at different times and using various exit approaches, which may result in different pricing and outcomes. You may or may not receive the best available price on the purchase or the sale of a position in actual trading. Information provided by the Company is not investment advice. The Company is not a registered investment adviser, stock broker, or brokerage. You agree that the Company does not represent, warrant, or take responsibility that any account will or is likely to achieve profit or losses similar to those shown. Examples published by the Company are selected for illustrative purposes only. They are not typical and do not represent the typical results of all stocks within the Company’s software or its individual scans and searches. No independent party has audited any hypothetical performance contained at this Web site, nor has any independent party undertaken to confirm that they reflect the trading method under the assumptions or conditions specified. Offers Disinterested Commentary and Analysis The Company does not receive any form of payment or other compensation for publishing information, news, research, or any other material concerning specific securities on the Network that is intended to affect or influence the value of securities. The Company, and its personnel, do not engage in front-running of recommendations and do not trade against one’s own recommendations. The Company and its management may benefit from an increase or decrease in the share prices of the profiled companies, and/or may have other actual or potential conflicts of interest. If a particular security featured in a newsletter publication is concurrently owned by the Company in its corporate brokerage account, or in any of the individual accounts of the Company’s principals or analysts / writers, that fact will be disclosed. The Company, its principals, analysts and writers may choose to purchase a security or derivative featured in one of its newsletter publications, but typically will wait three (3) trading days from the date of publication before initiating said purchase. [Disclaimers, Terms & Conditions] | [Privacy Policy] Copyright 2016