Why I Voted for Tesla’s Acquisition of SolarCity

Tesla has the potential to disrupt the auto and energy markets and I have been intrigued by what the future holds if they deliver on their commitments. I’ve written a series of posts to help me think through how this will all play out. I welcome feedback and counter arguments to help me sharpen my thinking. I do not work in the automotive or energy markets nor do I know anyone at Tesla, so this is all written as observations and conclusions from afar.

This is the second installment in my series of posts about Tesla. My first post discussed the financial repercussions of self-driving capabilities. Future posts will discuss ownership models in a self-driving world, how self-driving networks will transition from inception to saturation, and what to expect in the competitive landscape.

Reap What You Sow

Tesla has been one of the driving forces behind the expansion of electric vehicles (EVs). EVs are becoming a bigger segment of the automotive market every day with no sign of slowing. Eventually this will have huge repercussions for the energy grid because autos will substitute an off-grid energy source (oil) for an on-grid energy source (electricity). The grid is a slow-moving expensive beast to manage and is unlikely to expand quickly enough to handle the increased loads from an influx of EVs. This extra energy will have to come from somewhere, and solar has a good chance to be a big part of the solution.

As a pure automaker, Tesla may benefit in a small way by the entire industry moving to EVs instead of ICE — for example, by potentially sharing costs of charging stations or selling batteries to other automakers. However, Tesla stands to gain much more if they participate in this monumental grid transition and help alleviate strain on the system. With a combination of energy generation, storage, and software services, Tesla can maximize the benefits they receive from the EV movement they helped accelerate.

Economic Moats

The combination of solar, storage and autos creates a giant economic moat that can protect Tesla from competition for many years. The barriers to entry in the automotive market alone are staggering. The barriers to entering the solar, storage AND auto markets would limit competition to only the most ambitious and well-funded companies in the world. It is very unlikely that another startup can create a successful company that addresses all three markets due to the insane amount of capital required. Therefore, it is almost certain that any challenger to Tesla in all three markets is a company that already exists. There are a host of reasons it is very unlikely an existing company would be willing and able to compete in all three markets, which I will go into in a separate post.

Even if a super-rich and capable company wanted to enter these markets, Tesla’s unique combination of skills in software engineering, auto manufacturing, battery technology, self-driving, solar manufacturing, and energy management software would set them apart competitively for many years and be hard to replicate. However, the low likelihood that anyone enters the solar, storage, and auto markets only matters if there are synergies to the company by combining the three. That leads us to…

Merger Synergies in a Self-Driving World

Tesla’s financial pitch for the merger synergies really amounts to decreased administrative and sales overhead, plus a more cost-effective installation process. This is likely to be a benefit, but it is much less interesting to me than cross-selling opportunities or how Tesla and SolarCity could benefit each other when a self-driving capability is fully functional. In a self-driving world with the Tesla Network humming, an owner of a vehicle in the Tesla Network will be earning a substantial amount of money by selling time in their car to people who need transportation. Once the network becomes dependable and the revenue streams are consistent, banks could securitize the Tesla Network revenue and the owner (or Tesla) could get an upfront payment for the future Tesla Network revenue streams — similar to a bond. If I were Tesla, I’d try to sell customers on a car, solar and battery package for very low upfront cost and securitize the future Tesla Network revenue streams. This arrangement makes a Tesla system package more attainable for an average consumer, provides them with cheaper electricity, immerses the consumer completely in the Tesla ecosystem, and doesn’t hurt Tesla’s cash position. Seems like a win-win and no brainer, but it is dependent on the success of a self-driving network, which only reinforces how essential that effort is to Tesla’s success.

Obligatory Discussion of How This All Might Collapse

Of course, whenever discussing Tesla, one has to mention the risks to their vision, because there are many. I think of the main risks in three buckets: financial, operational and regulatory.

Financial Risk

Tesla needs a ton of money to build everything they need to deliver the Model 3 and a robust service and supercharger network, and need even more cash if they are not consistently profitable. This means there is a strong likelihood that they will need to tap the capital markets for more cash in the next few years, or at least until self-driving capabilities are delivered. This exposes them to risk that the financial markets will dry up ala 2008 and no one will be willing or able to fund Tesla’s growth, putting them in a cash crunch from which they cannot recover.

Assessment of risk: Medium. I think it would take another financial downturn at the level of the Great Recession to truly hurt Tesla’s ability to raise money. In this low interest rate environment, there are so many people and institutions hunting for return around the world. Tesla is one of only a handful of companies that has a compelling vision, huge growth potential, and a founder CEO with a cult-like following. I think many investors will be willing to take a bet on Tesla unless they are way off track operationally or a catastrophic macroeconomic event occurs, and I believe Tesla will only be exposed to this funding risk for the next 2–3 years.

Operational Risk

So much of Tesla’s risk profile hinges on its ability to deliver self-driving capabilities and a network that rents out the cars while not being used by their owner. See my previous article. This is an enormous challenge and Tesla is choosing to do it without LIDAR, which many experts do not believe is possible.

Also, production delays on the Model 3, a significant quality incident, or manufacturing issues with the new solar panels would present challenges that would be tough to overcome.

Assessment of risk: High. Tesla is trying to develop a new-to-Earth technology while expanding its auto production at a rate never before seen while absorbing a solar company. There are a lot of balls in the air and none of them can drop if the company is to deliver outsized returns to shareholders. The good news about this risk is that it is largely within their control, which is different from its exposure to…

Regulatory Risk

An American government that is hostile to sustainable energy and tax credits would undoubtedly hurt Tesla’s sales. Solar growth and the potential for distributed grids could be hampered by state and federal regulation that is not nimble enough to respond to shifts in consumer behavior. Also, regulations that create unreasonably high hurdles to build a self-driving network could significantly delay Tesla’s car sharing service.

Assessment of risk: High. The most concerning thing about this risk is that it is most likely out of Tesla’s control. Tesla could take a few pages from the Uber and Airbnb playbooks and push regulatory boundaries to their limits, but it’s much more difficult to do so when safety is involved. The biggest lever that Tesla has in this regard is consumer demand for EVs. If there is a massive consumer shift to EVs and demand for self-driving cars, and they loudly voice their opinion about barriers limiting grid and EV services, regulators may move along more quickly than if it was just Tesla doing the pushing.

To summarize, Tesla is a risky company to invest in because even if they deliver everything they’ve committed to, there are many other things outside their control that may prevent them from succeeding. The addition of SolarCity certainly adds risk to Tesla, but it may also contribute to delivering a much better financial return than Tesla could as a pure auto manufacturer. I believe if Tesla understands its risks and works hard to minimize them, we could look back at this deal as a stroke of genius that provides a massive competitive advantage for decades to come.

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