Deal Professor: Silicon Valley Style Puts Gloss on Tesla’s Bid for SolarCity

Deal Professor: Silicon Valley Style Puts Gloss on Tesla’s Bid for SolarCity

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Harry Campbell

If Tesla Motors’ proposed acquisition of SolarCity wasn’t a Silicon Valley deal through and through, it would have been dead on arrival.

The deal is about as conflicted as they come. Elon Musk owns large interests in both companies and had the idea for SolarCity, which is led by his cousin. Mr. Musk is also chief executive and chairman of Tesla and is chairman of SolarCity.

Incestuous ties like these are not uncommon in Silicon Valley. Yet SolarCity is struggling. Its stock price has declined by more than two-thirds since early 2015 and its revenue is down as solar takes a beating from low oil prices.

Given the context and the initial bumbling of the process, it is understandable why some thought that Mr. Musk’s interest in SolarCity was a way to bail out his investment.

The initial market reaction when the offer was announced in June indicated as much. Tesla’s stock price declined more than 12 percent in the wake of the possible bid.

After the decline in Tesla’s stock price and the criticism of the conflicts, one might have thought that the merger was as dead as pets.com.

But a good narrative in Silicon Valley means everything, and Mr. Musk has long played the role of visionary to great effect. He put this to good use in the last few months to shine up this deal.

Lawyers were brought in to tidy up the process. SolarCity shopped itself around but found no other buyers — who else would buy when Mr. Musk had so ardently expressed his desire to acquire a company of which he already owned a fifth?

So an agreement was reached at a reduced price for SolarCity.

Most important, Mr. Musk amped up his vision.

In capital markets today, conglomerates are hated and companies are carved and diced to the finest business. But not Tesla.

Tesla has been portrayed as a car company and a battery company, but now Mr. Musk’s vision has turned Tesla into an integrated solar company with SolarCity the crucial missing piece. Well-heeled consumers would get their car from Tesla, as well as their home battery storage and solar from SolarCity to power it all.

That is the vision anyway, for those who can afford it and live in sunny climes. To increase excitement for the deal, Mr. Musk successfully exhorted Tesla to get to a profitable quarter in order to “throw a pie” in the face of all the Wall Street “naysayers.”

Analysts, investors and reporters were given personal access to the rock star entrepreneur himself. Mr. Musk used the time to pitch new products including glass shingles — solar roofs that would generate energy and also look beautiful.

The strategy appears to be working.

The influential proxy advisory firm, Institutional Shareholder Services, has endorsed the merger. “The transaction is a necessary step toward TSLA’s goal of being an integrated sustainable energy company,” I.S.S. wrote, using Tesla’s stock market ticker symbol.

In addition, the advisory service cited the low premium and the fact that Tesla, a $30 billion company, could probably handle SolarCity’s $3.1 billion in debt with the ability to raise more needed capital in the markets.

Tesla itself has said it will need to raise cash this year in connection with the production of the Model 3, and SolarCity’s financing needs will add to that strain. And in an investor presentation, Tesla said that much of this would be project financing and that SolarCity would add $1 billion to Tesla’s balance sheet over the next three years.

Then there are the structural biases for a deal. The shareholders of Tesla are largely also invested in SolarCity. Mr. Musk owns 21.7 percent of SolarCity and 20.1 percent of Tesla. But the second-biggest shareholder of each is the mutual fund giant Fidelity, which owns 8.9 percent of Tesla and 11.6 percent of SolarCity. Vanguard, BlackRock and Bank of Montreal are in the top 10 shareholders of each.

Theoretically, these institutional investors are supposed to look at each investment separately, but a bailout of SolarCity by Tesla might be in their best interest. Certainly, the voting dynamics work in Tesla’s favor.

But the biggest spur pushing this deal toward success may be the willingness to believe in the Silicon Valley magic.

Take the I.S.S. report. It cited three reasons for the deal. Ultimately, it came down to what the advisory service said was that vision of an integrated solar company.

Really? Would any other industry get this pass? Let me answer that: No. The simple truth is that Silicon Valley visionaries are given freedom no other chief executive would. To put it another way, there is a Musk pass (as well as a Zuckerberg pass and a Brin and Page pass). (Glass Lewis, the other large proxy advisory service, refused to give Mr. Musk his pass, calling for a vote against the deal because of the conflicts.)

SolarCity may also have made strides in core markets, but it will have a tougher time in New York and Michigan and markets where there is less sun. And SolarCity will have to work out the financing to get its new customers to be able to afford these batteries, solar cars and beautiful new roofs featuring “Tuscan shingles, slate tiles, and Spanish-style curved clay shingles.” All in a time that interest rates are likely to rise.

But how could you not bet on Mr. Musk’s vision?

Because of this last fact, I fully expect this deal to happen. Perhaps this is to be admired. Too often, institutional investors play it too safe. Now, public shareholders can profit from some risk-taking instead of leaving it all to the venture capitalists.

Still, questions persist about the business model of the combined company. The solar market is saturated and limited to people with the cash to buy panels. This is why financing is such an important part of the equation. And are there legions of potential customers willing to spring tens of thousands of dollars for terra cotta glass solar shingles?

There is great risk here, as well as possibly great rewards. In most cases, institutional shareholders would pass on the deal solely because of the risk, let alone the conflicts and conglomerate issues. And it raises the question of whether Silicon Valley should, alone among other industries, have a special pass to make deals that no company in any other industry could.

Even institutional shareholders seem to lose their heads when it comes to Silicon Valley.

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