Wednesday, 22 June 2016

Tesla Plans to Acquire SolarCity: Time to Short the Stock

Tesla Motors (NASDAQ: TSLA) recently announced to acquire Solar City (NASDAQ: SCTY), a provider of renewable solar energy for residential and commercial customers. On the surface, the rational is the vertical integration related to the combination of two businesses, which could prove beneficial for Solar City in the competitive solar market. But, there are many caveats that come with the deal, if it goes through.

Firstly, both Tesla and Solar City are cash hungry businesses. Tesla is ramping up Model 3 production. Solar City hasn’t been able to generate positive cash flow for the past four quarters. Same holds true for Tesla. If Tesla provides batteries for SolarCity’s products at low price, it’s going to hurt its margin and cash flow.

Tesla is financing the deal by issuing more shares. The company has already raised cash for its Model 3 plans. Now, further dilution to EPS will put a pressure on the stock price.  Looking at SolarCity, a rate hike by FED in future will further affect the margin of the company on financing residential and commercial projects. Not to mention, the competition from other Solar power providers at home at abroad.  

Overall, the deal doesn’t seem to be a good one, at least from a short-term perspective. Cash burn will increase; EPS for Tesla will go down affecting the stock price negatively. Tesla is already trading at a value not justified by conventional valuation techniques. Therefore, risk-averse investors should steer away from Tesla while risk seeking investors can gain from shorting Tesla Motors now.