Tesla Runs Over Corporate Governance

The past month has not been kind to Tesla Motors (NASDAQ: TSLA) and Elon Musk.Elon Musk Tesla
The National Highway Traffic Safety Administration opened an investigation into Tesla’s autopilot feature after a driver’s death. The NHTSA also is looking into a suspension issue with the Model S and it criticized the nondisclosure agreement Tesla has buyers of its cars sign.
And among other Tesla problems, the auto company missed its quarterly production target – again!
The company also faced growing criticism from some who say that it had vastly downgraded its limited warranty on the Tesla Powerwall to become nearly worthless.
Finally, of course, there is the highly panned offer from Tesla to buy another Elon Musk company, SolarCity (NASDAQ: SCTY).
For me , that is the most troublesome of all the Tesla news.

The Tesla – SolarCity Deal

To many, the buyout looked like a bailout of one Musk company for another. SolarCity has more than $3 billion in debt and Goldman Sachs claims it is very close to breaching its loan covenants.
Corporate governance questions are being raised because Musk owns 21.1% of Tesla and 22.5% of SolarCity. And two Musk cousins are the CEO and CTO of SolarCity. In addition, only two of Tesla’s directors have no ties to SolarCity and only one SolarCity director has no ties to Tesla.
Another factor raising eyebrows is the fact that Elon Musk has pledged four million of his 22 million SolarCity shares as collateral against his personal borrowings from Morgan Stanley.
SolarCity shares have plunged this year. Was Musk near getting a margin call? That’s a very legitimate question many are asking.
For his part, Musk called the deal a “no-brainer.” He sees it as the next logical step in his vision of the future of sustainable energy and transportation. The newly-merged firm would be an “integrated sustainable energy company” that would become the first company with a trillion dollar valuation, says Musk.
One thing is certain. Existing Tesla shareholders will see their stake further diluted as Tesla will issue another $2.5 billion in stock in order to buy SolarCity. Tesla is offering between 0.122 and 0.131 of its shares for each share of SolarCity.
If one includes the stock offering in May, Tesla’s existing shareholders are seeing nearly a 14% dilution of their shares in just a few short months.
That isn’t the biggest concern for me.

More Tesla Problems: Infinite Cash Burn

Here is the major concern: combining two companies that have seemingly infinite cash burn and growing competition too.
Tesla’s core business saw cash burn of more than $3 billion in the past six quarters alone. And capital needs are expected to intensify as it moves the Model 3 toward production.
SolarCity’s net loss last year was $240 million. Barclays’ analysts say SolarCity’s free cash flow in 2016 will be a negative $1.8 billion. These same analysts forecast a combined company in 2018 could burn as much as $3.8 billion.
David Bechtel, one of three principals of Barrow Funds, told MarketWatch the idea of a tie-up between the two companies was “downright frightening.”
And apparently, so do famed short sellers Jim Chanos and Andrew Left. Chanos and Left are short both Tesla and SolarCity. In fact, Left said SolarCity would go to zero without a Tesla bailout.

Executives Departing Tesla

Chanos points to the number of high-profile executive departures from Tesla. He told CNBC in May that a historical signpost of a company in trouble is when “numbers of senior people leave over a short period of time.”
As far other Tesla problems and the SolarCity deal, Chanos said, “they’re losing money on every installation and making it up on volume and that’s a problem when you have a levered balance sheet.”
Bottom line here is that the best outcome for Tesla shareholders is that the deal will be voted down.
I would never short any of Elon Musk’s companies. He has too many “fans” that believe everything the visionary says. But with Tesla trading at more than 120 times forward adjusted earnings and SolarCity being a consistent money loser, I will pursue my dreams with other stocks.

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