Is Tesla Stock A Buy After The SolarCity Merger? Tesla Motors Inc (NASDAQ:TSLA)

  • Shares of SolarCity and Tesla gained yesterday after shareholders approved the merger of the two companies.
  • With the merger, Tesla has moved one step closer to becoming a clean energy company.
  • The deal will open up several opportunities for the merged entity in the long run, but in the short run, challenges remain.

On Thursday, shareholders of Tesla (NSDQ:TSLA) and SolarCity (NSDQ:SCTY) handed Elon Musk an early Christmas gift when they approved the merger of the two companies. According to a statement from Tesla Motors, "Excluding the votes of Elon and other affiliated shareholders, more than 85% of shares voted were cast in favor of the acquisition." .  The deal which has been in the headlines for the past couple of months had its own share of controversies. Many investors believed that the deal will increase the risk levels of the Tesla Motors. But there are also investors who believe in CEO Musk's vision of transforming Tesla into a pure energy company.

The Synergy?

Elon Musk, the brain behind this deal has been the strongest proponent of the merger. Although he and other company insiders recused themselves from voting on the deal, he had been campaigning hard for it. Musk believes that SolarCity will have strong synergy with Tesla as solar technology is complementary to Tesla's current business. Tesla already uses solar energy to power its charging stations.

The merger will create one of the largest players in the clean energy business. Mr. Musk estimates the merger to add $1 billion in revenues in the next year. He has also said that the merged entity will have more than $180 million in direct cost savings from combined selling and marketing operations, and lower corporate and administrative overheads. Tesla also said that SolarCity will add over half billion dollars in cash over the next three years to Tesla's balance sheet.

Tesla is already partnering with SolarCity to produce solar roofs. The company will roll out the solar roof by summer 2017. The company will roll out the different designs in the next three months according to their popularity. The cost will vary depending on design and difficulty of installation. According to Musk, the solar roof will be cheaper than a regular roof (even after including labor cost and excluding subsidies) and the electricity will be just bonus. To quote him:

"The important thing is that the apples-to-apples comparison compared to a regular roof will be at least at, and we believe slightly below the cost of a regular roof, and the electricity is just a bonus,"

The long-term benefits of the merger appear to be strong as the demand for clean energy is only likely to grow. But the short to medium term challenges are huge. (Also Read: Can Tesla Motors Inc Prosper Under Trump Administration?)

The Debt Problem

The deal has not found favor with many investors and analysts. To quote CFRA analyst Efraim Levy:

"We believe that shareholder approval of the TSLA purchase of Solar City is dilutive to TSLA's profitability, will detract from senior management attention, and contribute to increased capital market funding requirements in '17," 

One of the biggest concerns which many analysts and investors have is the debt level of SolarCity. SolarCity has more than $3.4 billion debt. The debt load has increased by $700 million in the last 9 months. This is a huge debt burden for a company which has been making operating losses for several quarters and guzzling cash. Many investors fear that Tesla will have to devote large financial resources to service SolarCity's debt burden, which may impact its own capital expenditure. And investors must remember that Tesla is also not exactly a cash generating machine. The merger increases Tesla's risks.

No Sunshine For Solar Energy Industry

The solar energy industry in the US has seen some strong growth in last few years. But that growth may slow down with the change in administration. The Federal government, led by President Obama himself,  has been one of the biggest cheerleaders and supporters of the renewable energy industry. The current administration has encouraged the clean energy sector and imposed regulations on the coal and oil energy companies.

Obama's Clean Power Plan calls for energy companies to lower their greenhouse gas emissions. However, the new administration is not in favor of these regulations. Trump's likely EPA head Myron Ebell has called the Clean Power Plan illegal and Paris Agreement unconstitutional. Even the President-Elect himself has called global warming a "Chinese conspiracy". The changes in the Federal government policies will definitely hurt the solar energy industry.

This comes at a time when Solar energy industry is already facing severe challenges. The industry is expected to grow this year at 16%, against earlier estimates of 23%. In 2015 the industry grew by 71%. According to GTM Research's latest global solar demand monitor, the demand will decline by 7% next year, before recovering to grow at 9% CAGR till 2021. The MAC Global Solar Energy stock index is down 44% so far this year. Most of the solar energy stocks are down. Even SolarCity stock was down 63% YTD, before the merger announcement. (Also Read: Is Tesla Stock A Buy After The Trump Win?)

What Next For Tesla Stock?

In October Goldman Sachs had cut Tesla's price target from $240 to $185, even while it raised its earnings and revenue forecasts. It said that the price cut was warranted by the significant increase in the risk due to the merger and the roll out of Model 3. Considering that Tesla stock is trading around $185 the risks from the merger may have already been factored in the stock price. However, the recent election has brought in significant political risks for the company. On the other hand, the merger will also open up several other revenue opportunities for Tesla. Tesla stock continues to remain a risky bet in the short term. But the long term opportunities remain. The next few months will be crucial for Tesla.

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Neither Amigobulls, nor any members of its staff hold positions in any of the stocks discussed in this post. The author may not be a certified/registered investment advisor, and the opinions expressed should not be treated as investment advice. Buying and selling of securities carries the risk of monetary losses. Readers/Viewers are advised to carry out their own due diligence and consult their investment advisors before making any investment decisions. Neither Amigobulls, nor the author have any business relationship with any of the companies covered in this post.

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