Two years ago, I warned investors to avoid “kissing cousins”
My reasoning was simple: Though at the time it was an industry leader in the rooftop solar panel sector, SolarCity had demonstrated a perverse reverse economics of scale in its business model. The higher revenues rose, the weaker its operating margins became, and the more cash it bled.
SolarCity’s first quarter 2016 results were its worst yet. Sales grew 57 percent from the previous year but the company lost per dollar of revenue. That’s when Tesla made its takeover offer to take over the company, a step hedge fund manager Jim Chanos at the time dubbed “brazen and shameful,” “a bailout” and “the worst example of corporate governance.”
Two years later, it’s hard to argue with Mr. Chanos’ analysis. To be sure, the past two years’ implosion is not all Tesla’s fault or even SolarCity’s. As Bloomberg New Energy Finance points out in a report dated July 26, “at least 11 former residential solar market leaders have been shuttered, entered into bankruptcy or been acquired for pennies on the dollar of capital raised.”
The hypothesis that rooftop solar adoption would trigger a “death spiral” for incumbent utilities—with customer defections to rooftop solar driving rate increases and still more defections—has proven laughable. And the “growth at all costs” model pursued by most management teams including SolarCity’s has left companies with no reserves to weather the normal ebb and flow of demand.
Currently, only about 40 percent of rooftop systems deployed are still owned under a leasing model requiring a middleman like SolarCity. Instead, most adopters are buying their own systems and plugging into the utility grid on their own.
SolarCity, however, is also a unique profile of disaster, with quarterly lease deployments plunging more than 90 percent since the merger. Added to the company’s pre-deal operating weakness, that performance lends credence to charge that the $2.6 billion Tesla paid to buy the company out was little more than a bailout of CEO Elon Musk’s cousins Lyndon and Peter Rive.
Whether that eventually translates into lawsuits is an open question. But for Tesla shareholders, the key issue now is whether the demise of the rooftop business will wound Tesla as it tackles major challenges meeting promises at its core electric vehicles unit.
The recent revelations related to the former SolarCity were accompanied by the unexpected resignation of Tesla co-founder J.B. Straubel, the company’s long-time chief technology officer. Straubel has pledged to stay on as an advisor to the company. But his estimated $30 million in profits selling Tesla shares the last nine months sound yet another note of caution for investors, as the stock year-to-date has now lost nearly one-third of its value.
To say tracking the fortunes of Tesla’s rooftop business has been difficult since the SolarCity merger would be a serious understatement. Forget about sifting through the breathless hype that underscores the quarterly press releases.
The most recent of these concluded only “we are in the process of improving many aspects of this business to increase deployments.” There was a 13 percent sequential increase in “energy generation and storage revenue” from the quarter ended March 31. That, however, was more than offset by a 2 percent year-over-year decline. The release also showed a 104 percent lift in megawatt hours of “storage deployed,” though also a 65 percent decline in “solar deployed.”
For the most part, numbers showing profitability of rooftop solar and related “power walls” after expenses are mixed in with results from the automotive side. We know “cost of revenue” for this business was 88.5 percent in the second quarter 2019 and 88.2 percent in the year earlier period. But we have no idea what percentage of what Tesla calls “Operating Expenses” are actually attributable to “energy,” and what comes from the automobile business.
Operating Expenses in the second quarter did come in at 118 percent of revenues after subtracting out what the company calls cost of revenues. We also know that interest expense on the company’s debt rose by another 5.1 percent in the last 12 months, despite generally declining borrowing rates. And management increased debt by $1.35 billion while issuing roughly $850 million in stock during the quarter to cover its cash shortfall.
Numbers like those continue to inspire short sellers of Tesla stock. And in fact, short interest has now climbed to 31.44 percent of the company’s float, up roughly 62 percent since the beginning of the year.
We’ve also seen a growing number of investor bets against Tesla’s bonds. The SolarCity 5.45 percent notes of April 2030, for example, now trade for less than 66 cents on the dollar for an elevated yield to maturity of nearly 11 percent. That’s versus a coupon interest rate of just 5.45 percent, which the company was able to get when it issued the securities back in April 2015.
You certainly won’t find Tesla’s total debt picture front and center in its earnings releases. And it’s a safe bet the $9.4 billion in current debt has been little more than an after thought for the company’s many fans so far. But with 16 of the 36 Wall Street analysts covering the stock now rating it sell versus 11 buys, there’s rising risk it will become increasingly expensive to service this load, almost all of which matures by 2025.
That starts with a 1.625 percent convertible bond coming due November 1 that trades at a steep 227 percent premium to conversion value. Barring a big jump in Tesla shares in the next three months, the full $566 million will have to be paid off in cash. That means either issuing more stock or borrowing at a much higher interest rate.
In the July issue, I affirmed Tesla as my 2019 “pan” in the Utility Technology sector and advised selling. That’s still my advice.
It’s always possible Elon Musk will pull yet another proverbial rabbit out of a hat. And if he does, Tesla short sellers will be caught in a devastating squeeze. But for those who want a play on solar and energy storage,
