Tesla Shareholders Should Back SolarCity Merger, ISS Says

Industry: Energy 2016-11-06

Tesla Motors Inc. got the blessing of advisory firm Institutional Shareholder Services on Friday for its proposed $2.3 billion acquisition of SolarCity Corp., giving shares of both companies a boost.

Shareholders of both companies vote for the deal on Nov. 17, ISS said. Tesla, with a market value of about $30 billion, would be able to bridge the funding gap with cash-burning SolarCity, and the deal is a necessary step in the electric-car maker’s push to become an integrated sustainable energy company, the firm said in a report. ISS also said Tesla gave minority shareholders enough of a voice to overcome governance concerns.

“I thought they wouldn’t recommend us, but they did,” Tesla Chief Executive Officer Elon Musk said in an interview on CNBC. “They tend to be a bit negative.”

The proposal to merge the two companies has been controversial since it was announced June 21 and Tesla shares fell 10 percent the next day as some stockholders worried that the solar panel installer’s debt and cash situation would be a burden on the carmaker. There were also corporate governance concerns because Musk owns more than 20 percent of both companies and his cousin, Lyndon Rive, is SolarCity’s CEO.

The ISS report said that, while Tesla has a “suboptimal governance structure,” the requirement that a majority of unrelated shareholders be required to approve the deal helps get past that issue.

SolarCity shares rose 9.8 percent to $20.36 at 12:13 p.m. New York time and climbed as high as $20.70 for their biggest intraday increase since June 22, just after the deal was announced. Tesla gained 2.3 percent to $191.66.

ISS said Tesla “is paying a low to no premium to take over SolarCity.” The announced cost synergies of $150 million, even if capitalized at a low multiple of 10 times, would create $1.5 billion, the equivalent of almost two-thirds of the acquisition price, according to the firm.

For SolarCity shareholders, the offer represents a 14 percent premium over the stock price the day before the proposal was announced, ISS said. It also gives those shareholders Tesla stock, which is easier to trade, the firm said.

Musk is the chairman and CEO of Tesla and the chairman, as well as chairman and the largest financier of SolarCity. Since the deal was announced, Musk has stressed the clean-energy synergies between the two companies, noting at a Los Angeles event to tout a new solar roof product that solar and battery storage go together like “peanut butter and jelly.”

Deal Critics

Some shareholders have raised concerns about overlapping boards and corporate governance issues, while others worry that integrating SolarCity will be a distraction from Tesla’s plans to bring the Model 3 car to market next year and ramp up output at both its auto factory in Fremont, California, and Gigafactory battery plant near Reno, Nevada.

CtW Investment Group, which manages money for pension plans who own Tesla shares, said the merger is still fraught with governance issues.

“ISS’s concerns about Tesla’s ‘suboptimal governance structure’ underscore that even if this deal is approved, there are deep governance failures at Tesla,” said Dieter Waizenegger, CtW’s executive director. “The company must upgrade its board to reflect that it is a complex, multibillion-dollar operation, not a startup. That means adding independent directors with the expertise the company is sorely lacking.”

Investor Jim Chanos, whose firm Kynikos Associates Ltd. saw weakness in Enron Inc. before its collapse, has a short position in Tesla and said he thinks the SolarCity deal will lead to insolvency of the combined company. He said in an e-mail that backing from ISS is “great news for Tesla bears.”

Analysts also have been skeptical. David Tamberrino of Goldman Sachs cut Tesla shares to neutral from buy and lowered the share price target to $185 from $240, saying the acquisition makes the automaker a riskier bet.

Taking on ‘Naysayers’

Musk sought to allay many concerns in a presentation to analysts Nov. 1, saying that SolarCity will add $1 billion in revenue to the combined company in 2017 and $500 million in cash to Tesla’s balance sheet over the next three years. He also said that “quite a few naysayers from big hedge funds” have been wrong about Tesla in the past with a “batting average of zero.”

The presentation came six days after Tesla posted a surprise third-quarter profit and positive cash flow. The company’s 71 cents-a-share profit blew away the average estimate of a 54-cent loss in a Bloomberg survey of analysts. Tesla was aided by an unusually large amount of revenue from selling zero-emission vehicle credits to other carmakers. With that revenue expected to recede and capital spending said to rise by about four times in the fourth quarter, some analysts expect the cash burn to resume.

Still, the profit was the kind of news Musk had hoped for heading up to the shareholder votes. He also told investors that the combined company would not have to raise money anytime soon.

Tesla said in a statement Friday that it appreciated the ISS recommendation and that the combined company would result in “a better outcome for shareholders, customers, and the environment.”

Other proxy advisers such as Glass Lewis & Co. and Egan-Jones Ratings Co. are expected to issue recommendations on the merger proposal. The opinions aim to influence the vote of fund managers and other shareholders in the deal.