Tesla (TSLA, Financial) recently announced it is interested in buying SolarCity (SCTY, Financial) in a deal that would value SolarCity at roughly $26 to $28. Tesla CEO Elon Musk has called the deal a “no-brainer” and says it would greatly benefit Tesla.
The Street obviously disagrees with Musk as Tesla has dropped over 10% since the announcement was made. To put it into perspective, Tesla lost over $3 billion in market cap whereas SolarCity gained just $400 million. Clearly, the market has valued the deal at -$2.6 billion, and I would have to agree.
Both Tesla and SolarCity burn through millions of dollars in cash every quarter. Both the companies have been reporting massive losses for years, and I don’t see how acquiring SolarCity would benefit Tesla in any way.
Tesla recently unveiled the Model 3, and the car has already received 400,000 preorders. In order to manufacture cars in such a large capacity, Tesla will need a lot of funds. Moreover, Tesla has ambitious plans to grow its production capacity going forward. All in all, Tesla will need a lot of money to fund these projects, and acquiring SolarCity will be a big burden for the company.
SolarCity is a highly leveraged company. In fact, SolarCity’s debt is so high the company’s interest expense is almost as much as its gross profits. There is no way that SolarCity’s business model is sustainable in the long run. Hence, buying SolarCity will have a huge negative impact on Tesla’s cash flow, which in turn will delay its growth plans going forward.
If the deal goes through, Tesla will need to dilute more shares in order to fund both its production expansion and SolarCity’s consistent losses.
Moreover, the acquisition will also attract a bunch of class action lawyers. The decision to acquire a company requires months of planning, and Tesla had to be planning this deal for at least a few months. Yet the company didn’t disclose it when it diluted shares. Moreover, Musk himself bought SolarCity’s shares when the stock dropped after its disastrous earnings. All in all, the deal will cause a lot of trouble for Tesla and its shareholders.
Conclusion
Given the amount of money SolarCity loses every quarter, the acquisition doesn't make any sense. Tesla will definitely have to dilute more shares if the acquisition goes through. Hence, I am bearish on Tesla for now.
Disclosure: I don't hold a position in any of the stocks mentioned in the article.
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