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SolarCity-Tesla merger deal takes a winding route in choppy waters

Elon Musk, CEO of Tesla Motors, first told his cousin Lyndon Rive, CEO at SolarCity, in February that a merger between the electric vehicle maker and the rooftop solar energy installer deserved “serious consideration.”

But it took four months and several twists along the way before the two companies reached a preliminary agreement on the $2.4 billion combination.

While the companies considered the merger, three other firms expressed interest in buying or making an investment in the solar energy company, according to a regulatory filing by Tesla on Wednesday. And as the year unfolded, SolarCity’s financial position weakened because its installations fell short of targets, and the company finished June with less cash on its books than analysts expected. That is when it explored a handful of alternatives beyond Tesla’s merger bid to shore up its business and give the company access to the capital it needed to continue installing rooftop solar systems.

For instance, the filing also disclosed that a committee of SolarCity directors briefly looked into the possible sale of its solar manufacturing venture, which will be based in South Buffalo at a factory that New York State is building with $750 million in taxpayer money at RiverBend. The plant, expected to open by the end of June 2017, is the centerpiece of Gov. Andrew Cuomo’s Buffalo Billion economic-development initiative, which promises to bring 1,460 jobs to the region.

But the SolarCity directors and their advisers concluded that a quick sale of the solar panel manufacturing venture on South Park Avenue, while easing the company’s cash drain, wouldn’t provide a lucrative return for its shareholders.

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In the end, none of the three potential buyers or investors decided to make an offer for SolarCity or provide an investment. And Tesla lowered its purchase price to reflect SolarCity’s disappointing installation forecast and its smaller hoard of cash, according to the filing that Tesla made with the Securities and Exchange Commission.

SolarCity also asked Tesla in late June whether it would be willing to buy just the Buffalo-based manufacturing business, which will be located in the biggest solar panel factory in the Western Hemisphere, in a stand-alone deal.

Two days later, Tesla said no.

Both Rive and Musk have said the Buffalo factory will play an important role in the new products that SolarCity is developing, especially one that integrates solar power into a roofing system. Musk also sees the high-efficiency solar panels the company expects to make in Buffalo helping SolarCity as an important long-term move to reduce its costs and help make solar energy more competitive with utility-generated electricity.

But getting the factory operating will be expensive, draining cash from SolarCity at a time when its financing costs have increased and the company is trying to make changes to its business so it only uses as much cash as its operations generate.

SolarCity must constantly raise money from investors and the debt markets to fund its operations, which rely heavily on a business model that allows most of its customers to install rooftop solar with no upfront costs. SolarCity needs to raise about $2.6 billion to fund its operations this year and is expected to need about $3.3 billion in 2017, the filing said.

Since SolarCity has no experience in manufacturing, beyond a pilot plant that it runs in Fremont, Calif., executives from both companies have said tapping into Tesla’s experience making electric vehicles and batteries could lead to improvements in the production of solar panels in Buffalo and ultimately lower SolarCity’s costs.

The merger “will help reduce its cost per watt and offers greater access to financing for future installations,” said Angelo Zino, an analyst for S&P Capital IQ, in a report this week. “We also see benefits from a combined solar/storage offering and manufacturing efficiencies.”

In the short term, however, the Buffalo factory is expected to add to SolarCity’s operating costs. The 1.2 million-square-foot factory could cut into SolarCity’s cash flow by as much as $90 million during the second half of this year and reduce its cash flow next year by an estimated $220 million, according to a SolarCity forecast included in the filing. The Buffalo factory is not expected to generate more cash than it uses until 2019, the forecast said.

The filing indicates that the merger between SolarCity and Tesla moved in fits and starts after Musk, who has long held a vision of pushing Tesla into the renewable energy market, first told Rive that a merger deserved serious consideration in February. The two companies finalized their merger agreement at the end of July.

While Musk’s conversation with Rive in February focused on how a merger would help the companies create new products by combining Tesla’s batteries with SolarCity’s solar panels, it set the stage for Tesla to begin looking more seriously at making a deal to expand into the renewable energy market.

In late February, Tesla held a special board meeting to discuss the merits of acquiring SolarCity or another solar energy company, but directors decided not to look any further into a potential acquisition because the electric vehicle maker already was focused on the ramp up in production of its Model X electric vehicle and other initiatives, including the construction of a battery gigafactory in Nevada.

Musk raised the topic again three months later, and this time, the board agreed to hire a financial adviser, Evercore, to evaluate the strategy behind acquiring SolarCity or another solar energy company.

Already, the acquisition winds were swirling around SolarCity. Two days later, SolarCity’s management had an introductory meeting to discuss a potential “business combination transaction” with representatives of an unidentified company while those executives were in the Silicon Valley on other business. That meeting never led to an offer.

But less than three weeks later, on June 20, Tesla’s board, meeting without Musk because he also was SolarCity’s chairman and owned more than 20 percent of the stock in both companies, agreed to make a preliminary offer to buy SolarCity, potentially offering to buy the company for the equivalent of $26.50 to $28.50 per share. That was roughly $5 to $7 per share more than its trading price at the time.

With a preliminary offer in hand, SolarCity’s board set up a special committee of directors to evaluate the Tesla bid and consider other alternatives. One possibility arose just six days after Tesla agreed to make its offer, when another unidentified company contacted director Nancy Pfund, one of the two members of SolarCity’s special board committee, to discuss a possible deal.

SolarCity’s directors then reached out to a third potential buyer, an unidentified private equity firm, about a potential deal. The private equity firm said in early July that it wasn’t interested in buying SolarCity but might be willing to take an equity stake in the company.

By mid-July, though, SolarCity’s directors learned that the company’s financial position was weakening. Its quarterly earnings report, due out in early August, would say that despite scaling back its growth targets significantly last fall, SolarCity was reducing its forecast for how much solar energy generating capacity it would install this year by about 10 percent, and its cash balance at the end of June was much lower than expected.

By late July, the private equity firm pulled out of its discussions, and the other potential suitor decided not to make a merger bid, citing unspecified regulatory issues and its belief that it couldn’t top Tesla’s offer.

So SolarCity tried to get Tesla to sweeten its bid, asking the electric vehicle maker to up its preliminary offer of 0.121 to 0.131 shares of Tesla stock for every SolarCity share to 0.136 Tesla shares.

Tesla said no and came back with its own revised bid that cut its offer to 0.105 Tesla shares, which was worth about $23.31 per share at that time.

SolarCity then countered at 0.1265 Tesla shares, prompting the electric vehicle maker to come back with its “best and final offer” of 0.11 Tesla shares July 28. At today’s prices, that offer is worth about $23.10, about 13 percent less than the low end of Tesla’s preliminary bid in late June.

With no other suitors, SolarCity accepted, although the terms of the deal included a “go-shop” provision that allowed SolarCity to consider other merger offers that might come forward through mid-September. So far, no other offers have been made.

Since then, federal antitrust regulators have cleared the deal to move forward. The next step is for shareholders at both companies to vote on the merger, though neither firm has scheduled a vote. If shareholders approve the deal, the companies are hoping to complete the acquisition by the end of this year.

For that to happen, Tesla, which recently raised $1.7 billion by selling more shares of its stock to investors, probably will need to issue even more shares if the SolarCity merger is approved by shareholders from both companies. Tesla has said that it could issue up to 100.6 million new shares to pay out to SolarCity shareholders in the proposed all-stock purchase.


How the SolarCity-Tesla merger deal took shape

February – Tesla CEO Elon Musk tells his cousin, SolarCity CEO Lyndon Rive, that a merger deserves “more serious consideration.”

Feb. 29 – Tesla holds special board meeting to discuss merger and decides against pursuing one while it ramps up production of its Model X electric vehicle.

May 31 – Tesla board decides to evaluate a possible SolarCity merger.

June 20 – Tesla board makes a preliminary offer for SolarCity, worth $26.50 to $28.50 per share.

June 26 – Unidentified company contacts SolarCity to discuss “a possible business combination.”

June 28 – Tesla says it’s not interested in only buying SolarCity’s solar panel manufacturing business, which will be based in Buffalo.

July 11-12 – SolarCity meets with representatives of unidentified suitor.

July 14 – SolarCity directors learn that the company will lower its financial guidance in its August earnings report.

July 22 – Unidentified company decides not to make an offer to buy SolarCity.

July 23 – SolarCity asks Tesla to raise its bid.

July 24 – Tesla lowers its bid to $23.31 per share.

July 25 – SolarCity makes a counteroffer at midpoint of Tesla’s preliminary offer range.

July 28 – Tesla makes “best and final offer,” worth $25.83 a share at the time.

July 29-30 – SolarCity and Tesla boards approve merger.

Source: Securities and Exchange Commission filing


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