Tesla’s Life Saving Offer to acquire Solar City

SolarCity-Tesla-300x115Last Tuesday, June 21, Tesla Motors (NASDAQ: TSLA) made an offer to acquire Solar City (NASDAQ: SCTY) for $2.8 billion.  Any particular bias aside, the acquisition of Solar City could make sense from a strategic point of view:

  • It could help Tesla achieve its business objective to provide end-to-end sustainable energy solutions to its customers;
  • Tesla could leverage Solar City’s sales force to sell EV’s (electronic vehicle) to customers with solar installations;
  • Tesla could leverage Solar City’s tech force to install Tesla’s Powerwall and the battery pack.

The biggest impediment for consumers to buy an EV is the range your car can go before you need to charge it. Most EVs nowadays have enough range to commute in the city. Thinking of going on vacation with your EV? You better think twice. Currently, there is no reliable infrastructure where EV drivers can charge their cars. The result is often called range anxiety. Put simply, range anxiety is freaking out you’ll run out of battery in the middle of nowhere.

Range anxiety is real and Tesla knows it. The company has tried to address it by improving battery life but this approach takes time, costs money and it doesn’t really solve the problem. Even the longest lasting battery is bound to run out of juice at some point.

There is another solution – it’s not cheap but it is more effective. Building a network of charging stations along the major highways, just like gas stations, would do a lot better job at assuaging range anxiety than any promises of batteries with eternal life.

Elon Musk and Tesla know this. They also know that several years ago Solar City had a mutual project with Rabobank to install charging stations along Hwy 101 at Rabobank locations.

Solar City’s project with Rabobank is neat but not revolutionary. But What if Solar City were to build such an infrastructure along all major highways in the US? Such a project requires a long-term bet on EVs and them gaining major popularity nationwide.

Building a charging station infrastructure would make the sale of EVs easier but it will also provide a new revenue stream for Tesla. Just like gas stations, Tesla would charge its users for their consumption, just like gas stations do. Tesla could also benefit from a first-mover advantage by being the only game in town offering battery recharging solutions on the go.

Why Solar City Need This Deal Desperately

In the past three years Solar City has been running financial losses to the tune of $57 million a year.

Solar City’s cash flows from operations dropped with a thud in 2015 to -$790 million and since 2014 the company has been burning through cash.

The dismal financial picture is only the tip of the iceberg.  The biggest threat to Solar City’s survival is its own business model. The billionaire hedge fund manager Jim Chanos explains that “the problem with Solar City is they’re losing money on every installation and making it up on volume”.

Solar City’s business model works like this: you lease a solar PV installation from them, they install it on your roof and then you pay them rent. Solar City pays for the installation and they do the maintenance on the system if anything goes wrong.

After the lease is up, the panels are yours or you pay some nominal amount to Solar City to acquire them.

The key to making this model work is to price your panel lease in a way that they:

  • pay your capital outlay over some reasonable period of time (e.g. 10 years),
  • cover your annual maintenance cost,
  • pay for your general overhead, and
  • give you some reasonable rate of return.

In theory, this sounds like a sound model but if you scratch the surface you discover holes that would make any investor cringe.

For starters, the solar panel lease rates are market driven. Worsening economy would put pressure on Solar City to lower its lease rates in order to appeal to home owners.

Most people install solar panels on their roofs for two main reasons: because it could save them some money and because it is cool.

If the motivation of Solar City’s customers is primarily to save money by paying less in electricity prices, the incentive is not big. The only way for Solar City to increase it is to drop its lease rates, which would mean incurring even bigger losses.

If the cool factor is the primary driver, then Solar City is really riding a trend – even if it is a long-lasting one.

Even if all of the latter risks are endemic to the solar industry at large, this next one is related specifically to Solar City’s business model.

Solar City leases solar panels to home owners and makes its money by charging a lease. Since Solar City puts up the capital investment upfront to install the solar panels, it needs its customers to stay solvent and pay their lease for at least 5 to 10 years. This is how long it would take for the company to recover its original capital investment. If Solar City is forced to drop its lease rates to stay competitive, it might take longer.

If a Solar City customer defaults on the lease, the company is out of luck. It could take the panels down and re-install them somewhere else but the cost of doing this could be prohibitive.

When it comes to Solar City the risk is even higher. Most of its installations are along the coasts. You need only a regional housing crisis to wipe out most of Solar City’s active leases.

If the existing Solar City model looks like a total mess, Elon Musk offers a neat way out. By getting Tesla to buy the company, Solar City’s shareholders will get ownership in a bigger and more diversified company. Tesla would also give Solar City an opportunity to adopt a more sustainable business model and acces to larger capital markets than their current business model.

The only question that remains is, when I can drive my solar city powered Tesla across the country?

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Victor Kalchev is a financial analyst employed within in the renewable energy industry for the past several years. He holds a Master’s in Business Administration and has been involved in market valuations of renewable energy projects.

Market Structure and its relevance to Volatility

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In-depth conversation about value and volatility in the markets must first begin by addressing the world we live in today.  Whether you sit on the fence, or are passionately for/against the need for High Frequency Trading (“HFT”) in our markets, is beside the point. They exist today and we have/will just have to learn to co-exist, perhaps even adapt.

A chronicle of the history of the modern stock market can be best explained with books like Scott Patterson’s Dark Pools, while Michael Lewis’ Flash Boys, sheds even more light on prevailing practices within our exchanges post 2007.  Do yourself a favor and add these books to your amazon wish list.  Utilize these resources to learn as much as you can to learn about how we got to this present age of HFT.

How did it start, what allowed their existence?

Reg NMS is a U.S. financial regulation promulgated and described by the United States Securities and Exchange Commission (S.E.C.) as “a series of initiatives designed to modernize and strengthen the National Market System for equity securities.” The Reg NMS is intended to assure that investors receive the best price executions for their orders by encouraging competition in the marketplace.  It was established in 2007. Its aim was to foster both “competition among individual markets and competition among individual orders” in an effort to promote efficient and fair price formation across securities markets.

Intent vs. reality:

If we read the above the intent of the S.E.C., are alarm bells going off in our heads? I mean what could be malicious about the preceding statements? However, the world we live in is capitalistic and purely profit driven.  Despite the S.E.C.’s intent with those regulations, eventually market participants involved in HFT practices evolved their strategy to utilize:

  1.  Use of extraordinarily high speed and sophisticated programs for generating, routing, and executing orders.
  2.  Use of co-location services and individual data feeds offered by exchanges and others to minimize network and other latencies.
  3.  Very short time-frames for establishing and liquidating positions.
  4.  Submission of numerous orders that are cancelled shortly after submission.
  5.  Ending the trading day in as close to a flat position as possible (that is, not carrying significant, unhedged positions overnight).

It may surprise you to find out that “trading ahead of the market” or “front running” is entirely legal.

The S.E.C.’s perspective (2014):

“HFT typically exceeded 50% of total volume in U.S.-listed equities and concluded that, “by any measure, HFT is a dominant component of the current market structure and likely to affect nearly all aspects of its performance.”

That study goes on to find “there is great diversity among HFT trading accounts in terms of the aggressiveness of their trading. Some are highly aggressive and some are mostly passive. Moreover, the largest and most profitable HFT accounts are the ones that are most aggressive.” 

What we can ascertain today:

In an article on Vanity Fair, Michael Lewis explains his views a year after his book, Flash Boys went on sale.  “And since late 2007, as a study published in early 2014 by the investment-research broker ITG has neatly shown, the cost to investors of trading in the U.S. stock market has, if anything, risen—possibly by a lot.”

We can ascertain that increased volatility is not only prevalent but widespread in our markets today.  Whether the increase in this volatility actually serves a purpose is difficult to decipher.  All we know is that aggressive HFT’s are the ones that actually make money at the end of the day and their profits (perhaps even guaranteed profits) are influenced by their aggressive trading behavior.  This fact alone should make us all buckle our safety belts and be prepared for a bumpy ride.

As one Goldman Sachs executive, Brian Levine, put it, “Unless there are some changes, there’s going to be a massive crash”, he said, “a flash crash times ten”…”I think it’s a business decision. I also think it’s a moral decision.” (p. 238 – Flash Boys)

Bitcoin – the evolution of a digital currency

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What is Bitcoin?

Bitcoin, the most popular digital currency, emerged from a 2009 paper written by a programmer or group of programmers under the name Satoshi Nakamoto.  Satoshi left the project in late 2010 without revealing much about himself. The community has since grown exponentially with many developers working on Bitcoin. The Bitcoin network uses a public ledger to record transactions made under pseudonyms, a technological breakthrough that allows purchases and sales without using a trusted third party, such as Visa Inc. or Western Union Co.
Since Bitcoin is open, no company, country, or third party is in control of it, and anyone can participate.   It is the first decentralized peer-to-peer payment network that is powered by its users with no central authority or middlemen.

How does Bitcoin work?

Since bitcoin is like electronic cash, most purchases take place online. It’s also possible to send and receive bitcoin in person at retail shops, or anywhere else where bitcoin is accepted.

Behind the scenes, the Bitcoin network is sharing a public ledger called the “block chain”. The blockchain, which tracks who owns what, similar to how a bank tracks assets. The authenticity of each transaction is protected by digital signatures corresponding to the sending addresses, allowing all users to have full control over sending bitcoins from their own Bitcoin addresses. In addition, anyone can process transactions using the computing power of specialized hardware and earn a reward in bitcoins for this service. This is often called “mining“.

How does one acquire bitcoins?

Validity Concerns?

While a growing cadre of retailers are beginning to accept Bitcoin, recent events have underscored concerns about the viability of the currency. The governments of India, China and Russia have sought to ban or limit its use, and the Mt. Gox exchange filed for bankruptcy protection in February, 2014.

A lot of people believe that Bitcoin’s full potential hasn’t been realized yet. Aside from making relatively fast peer-to-peer transactions, there’s no good case for using Bitcoin over traditional currency for most consumers. Plus, there still isn’t a wide array of merchants that accept it. What’s more, Price volatility is another major barrier to getting consumers on board.

That might not change anytime soon. At the moment Bitcoin is mostly in the hands of speculators and investors, and they’re playing the market like traders, which drives more volatility.  The following illustrates the volatility and Bitcoin prices since its inception.

bitcoin price

There are clearly still a lot of concerns with the validity of Bitcoin and potential mainstream adoption of the currency, however, this Author is long Bitcoin and sees the disruptive way that it could potentially change our day to day lives.  At the very least, my opinion on the asset, is congruent with some respectable, credible early adopters.

To be clear, nothing here is a recommendation to buy or sell the security, its just my opinion on it.

Is there a Gap? Will it close?

Alas when it comes to the market, timing is everything.

What we try and discern is whether the difference between Intrinsic value and Price exists, if not, what seems to be higher, and what the future might bring.  Traditional tools for intrinsic analysis includes DCF, multiples, CAPM, Gordon Growth, Excess Return Models and the like.  What it ultimately brings is one/group of analysts perspective on risk, reward, and their idea of what investors are likely to buy into the company.  If you think that makes sense, take a look at $YELP or $GRPN and try to make sense of what people are paying for equity considering the financial performance of the Company.

Tools for pricing include multiples and comparables, charting and yes! technical indicators.   Your fundamental research can indicate what the stock should be trading at but what that fails to include is the raw emotion that traders and investors have in the market.  Takeaway: Just coz a stock should be trading at a certain price doesn’t mean that’s what the market is offering that to normal investors (Remember when $TWTR’s IPO was set by the analysts at $18-24 and when it finally got to the public it was around $40.)

The chart below has really helped me grasp an understanding between the differences of price and value.