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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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Will Tesla’s $2.6 Billion SolarCity Gamble Pay Off?

Tesla

Whether or not SolarCity was a good investment on the part of Tesla has been of speculation late as the company released its latest quarterly report.

It seems that the $2.6 billion worth of debt that Tesla added to its balance sheet – not to mention the unquantifiable amounts of investor anxiety – has been paying off. More than half of the $300 million increase in the cash flows of Q4 were derived from the SolarCity deal. This is in stark contrast to the condition of SolarCity prior to the acquisition, which was mostly characterized by regulatory setbacks and diminishing cash flows.

At the rate of growth and expansion Tesla is currently moving, consistently increasing cash flows will become more and more important. For example, the company is continuing with its plans to bring to market its solar roofing later this year. However, there are concerns that these panels will not succeed in the marketplace without further R&D. The concerns range from consumer reception to regulatory setbacks. The highly-anticipated project will likely be one of the biggest destinations for these increased cash flows.

As a result, Tesla has decided that the SolarCity division of the company will be focused on maintaining profitability as opposed to dramatic growth. Its method of accomplishing this goal? Reducing advertising costs, using preexisting Tesla stores to sell SolarCity products, and shifting away from the panel leasing model. The update also included reference to a potential return to growth later in the year if the need for new sources of cash becomes apparent. Related: OPEC Deal Cancelled Out By Rising Shale Output

Further alleviating worries come in the changes Tesla has made to SolarCity’s original business model. Rather than have costumers install their solar systems at no upfront cost in return for 20 years of guaranteed payments from the energy produced by the panels, Tesla’s business model is one in which customers buy the system outright. This is to the benefit of the customer as well as Tesla, which receives a lump sum.

These cost-cutting measures are significant, as SolarCity has undertaken the task of opening the largest solar panel factory in the Western Hemisphere. While this South Buffalo factory is necessary to the success of SolarCity as a division of Tesla, the question remains whether the company would have shelled out the money to build the plant had it not been for the $750 million investment on the part of New York State. Related: Panic In Vienna: OPEC Needs To Bring Down Costs To Compete With U.S. Shale

Regardless of this investment by NYS, the project pales in comparison to the billions that Tesla is planning on spending on production of the Model 3. These giant costs are part of an overarching sentiment that Tesla’s other divisions are drags on the growth of the company as a whole. Take for instance Tesla’s gross margin from energy storage and generation: 2.7 percent. The report stated that the long-term expectations for gross margin will be similar to the automotive industry. However, the automotive industry’s gross margin is a gargantuan 8 times larger than that of Tesla, at 22 percent.

These concerns have led to speculation of a new issuance of common stock by Tesla. As much as $2.5 billion could be raised if issued at its currently high stock prices.

Whether or not SolarCity is a net positive for Tesla remains to be seen. However, the numbers do not deter Tesla CEO Elon Musk from his original goal of the acquisition, which is to usher the world into a new age of renewable energy.

By Michael McDonald for Oilprice.com

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