- SolarCity acquisition has increased the risk and uncertainty surrounding Tesla stock.
- Tesla is facing strong cash burn and its cash position is turning precarious.
- While the long term upside remains, the stock is at best a risky bet.
The past few weeks have not been exactly great for Tesla (NASDAQ:TSLA) stockholders. There has been one bad news after another for the company, a fatal accident, a Tesla car catching fire and the SpaceX launch failure among others. While the Tesla stock had remained relatively resilient in face of cascading negative news, last week was quite difficult with the stock falling almost 10%. Tesla stock had gone below the psychologically important $200 mark before bouncing back in Tuesday's trade.
The bad news started trickling in with Tesla announcing its delivery miss for the June quarter. Instead of the promised delivery of 17000 units, Tesla managed to deliver only 14370 units. The miss was significant. And Tesla stock, unlike most other stocks is moved more by its delivery numbers than its earnings numbers. However, Tesla stock remained remarkably resilient as many investors hoped that it would be able to achieve the lower end of 80000-90000 units delivery target.
SolarCity Deal Is Riddled With Regulatory And Financial Problems
And then the SolarCity deal was announced. The all-stock deal valued SolarCity (NASDAQ:SCTY) at $2.6 billion. Following the announcement both the stocks tanked. While Tesla stock is down more than 15% since the agreement was signed, SolarCity has plunged around 30%. While the deal does have synergies for Tesla, including the opening up of the fast-growing renewable energy sector, it is muddled with corporate governance, regulatory and financial problems.
To start with, Elon Musk is the largest shareholder in both the companies. Musk owns more than 20% in both the companies, making him the largest individual shareholder in both the companies. And add to that, SolarCity’s CEO Lyndon Rive is Musk’s cousin. It is not only the CEOs, both the boards are so interlinked that the merger proposal was considered by only two of SolarCity’s directors. However, according to recent filings by Tesla on the SolarCity acquisition, Elon Musk was not present during the board meeting when the decision was made and is not planning to vote during shareholders vote on the deal.
The deal could also spell regulatory trouble for Tesla and Elon Musk with some analysts stating that the recent filings indicate a case of nondisclosure. According to the filings, the first time the deal was discussed was in February between Musk and Rive. However, Tesla failed to disclose this issue (a potential risk) to potential investors when it raised additional funds later this year in May.
The Cash Flow Problem
But the most important problem with the deal remains the cash flow problems. Both Tesla and SolarCity are cash guzzling company's burning millions of dollars every quarter. While Tesla has negative cash flow from operations in last seven quarters, SolarCity has lost money in every quarter the last ten quarters. In the latest quarter, SolarCity had around $240 million in cash on its book, while the cash burn from operations was more than $389 million. In fact, during the negotiations, SolarCity was almost running out of cash. With $3.5 billion in debt, a collapse of the deal will bring a survival problem for the company. The acquisition of a cash burning company definitely adds to the risk of Tesla stock.
This comes at a time when Tesla needs huge investments for its Model 3 brand and gigafactory. Tesla had recently raised $750 million in additional stock offering in May. In fact, Tesla has raised money (stock or debt) in all the last ten quarters. But with the addition of SolarCity the cash requirement will only increase. Tesla is planning to raise money from investors in the next quarter. And it is realising that if the cash and profit position don't improve the difficulty in raising funds will only increase.
In an email to staff which was accessed by Bloomberg, Mr. Musk has said, “We will be in a far better position to convince potential investors to bet on us if the headline is not ‘Tesla Loses Money Again,’ but rather ‘Tesla Defies All Expectations and Achieves Profitability,’” . “That would be amazing!". Musk also urged staff to cut costs and deliver "every car we possibly can" in August.
The details of the email show Tesla's desperations and indicate that Tesla's third quarter is also not likely to be a great one. Tesla really needs to put its best foot forward in the coming earnings results if it wants to raise money, especially since the risks have increased after SolarCity acquisition. Analysts' estimates for Q3 earnings have only been trending downwards though it is still in the positive space.
The Upside Potential
But in spite of the risks, there is no denying that Tesla has long term potential. It has a product which enjoys tremendous loyalty. The Model 3 has huge demand. There is also the autonomous car market in which Tesla is a strong contender. And if the SolarCity deal works out (a very big if) Tesla will become one of the largest renewable energy player. But to realise that long term potential Tesla needs to manage its short term carefully.
The uncertainty surrounding the stock is reflected in the fact that there is no consensus among the analysts with 12-month price target varying from $500 (Charlie Anderson of Dougherty & Co) to $160 (Colin Langan of UBS Securities). According to Bloomberg:
"Of 19 analysts surveyed by Bloomberg, as of Friday seven had a buy rating, seven had a hold, and five recommend selling the shares."
The acquisition of SolarCity and the very high cash burn rate will act as a strong headwinds for the stock in near term. Tesla stock is only for the long term, deep pocketed, risk-taking investors.