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Michael McDonald

Michael McDonald

Michael is an assistant professor of finance and a frequent consultant to companies regarding capital structure decisions and investments. He holds a PhD in finance…

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Is Elon Musk Taking Advantage Of Solar City Investors?

Elon Musk's recent purchase of $65 million of SolarCity debt is raising some eyebrows. Musk has long been deeply involved in the fate of three prominent new tech stocks – Tesla, SolarCity, and privately owned SpaceX (perhaps the most exciting and revolutionary of the three). Musk is the CEO of Tesla, owner of SpaceX, and chairman of SolarCity. Musk’s cousins Lyndon and Peter Rive are CEO and CTO, respectively, at SolarCity, and SolarCity itself is in the process of undergoing a merger with Tesla.

The bonds in question are a very interesting investment proposition given the current low interest rate environment; they are senior, unsecured bonds paying 6.5 percent interest with an 18 month maturity in early 2018. To be fair, the bonds are open to retail investors, but there are relatively few left. In addition to the $65 million bought by Musk, Lyndon and Peter Rive are each buying $17.5 million of the $124 million offer. That leaves only $24 million of the $124 million in bonds for outside investors. While this is the first time that Musk has personally bought the Solar Bonds, Reuters noted that Musk's company SpaceX bought the large majority of a $105 million offering earlier this year.

For shareholders in SolarCity and Tesla, the move is at best opportunistic and at worst a sign of Musk hedging his bets on his firms’ futures. Musk of course holds a lot more stock in both SolarCity and Tesla than he does in bonds, so presumably he still has an incentive to see both companies succeed – but the move does smack of a bit of double dealing.

The problem is that bond investors are sometimes at cross purposes with equity investors. Bond investors see little upside from growth of a firm or long-term value creation – instead their goal is to get their funds repaid with the greatest degree of safety. Equity investors want to see money effectively invested for long-term profit creation.

The short-term nature of the bonds suggests that rather than seeing a dark future for Tesla or SolarCity, Musk may simply see the debt as an attractive personal investment. Yet with the high relative rate of interest being paid, the question remains - are SolarCity investors in essence giving Musk and the Rives a sweetheart deal? Related: Iran’s New Oil Contracts Are Nearly Upon Us

Again to be fair, as Lyndon Rive noted to CNBC "The bonds are issued directly, online, and there are no fees for investors either. That allows SolarCity to offer the bonds at a competitive rate for investors — 6.5 percent for 18-month bonds — and still come in lower than the cost of institutional non-asset financing." Rive also noted that “We invested in SolarCity's Solar Bonds because it's a very efficient way for the company to raise capital without paying expensive banking fees.”

All of that may be true, but the optics of the situation still could look bad to investors. SolarCity has never offered such a high coupon on its bonds before. That in turn means one of two things – either Musk and the Rives are getting a great deal from SolarCity at the expense of equity holders, or demand for SolarCity bonds has weakened considerably because bond investors see trouble ahead.

The second possibility would be especially troubling for Tesla shareholders as they consider the merger with SCTY. Musk is a fine CEO and a visionary business leader, but it’s hard to shake the feeling that this unusual move means bad news for shareholders one way or another.

By Michael McDonald of Oilprice.com

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