Burgess COMMENTARY

Peter Burgess

Tesla And SolarCity: The Sting, Part Deux |104 comments | About: Tesla Motors (TSLA), SCTY, Includes: SUNEQ, VSLR Summary

• ESG investors are gluttons for punishment: false environmental claims on top of dubious accounting.

• SolarCity was ahead on 'selling the payments' because their value prop was highly dubious. Maybe Tesla will soon learn.

• The new Tesla will be neither an energy company nor green.

You can fool all the people some of the time, and some of the people all the time, but you cannot fool all the people all the time. - Abraham Lincoln

Whether Lincoln said it or not, Elon Musk was not paying attention in that particular class in any case, and his operating record reminds me of the German word for conman: 'Hochstapler' - translated literally: one who stacks it high - etymologically, it refers to a beggar who makes himself seem like more. In a slight variation, here we have an empire built on harvesting government subsidies to the max, masquerading as an investment, a sort of a medicare mill for green fanboys and girls. In fact, the announcements surrounding the proposed acquisition of SolarCity (NASDAQ:SCTY) by Tesla (NASDAQ:TSLA) were a new high point in demonstrating the alternative universe where Elon Musk lives. He argues that the resulting company will be the largest integrated green energy company in the world. It is easy to solve problems if you get to define them in a way that suits your solution, which is what Elon Musk is doing when he calls Tesla potentially the largest vertically integrated green energy company. If all you have is a hammer, everything looks like a nail, except it isn't.

Tesla Emblem

Unfortunately, the end result will be clunky as all get out, neither vertical, nor integrated, and neither green, nor an energy company. Specifically, SolarCity leases or sells (and one day soon hopes to manufacture) solar panels to its customers, and never gets to own the energy, so it's not an energy company but an installer and/or manufacturer of solar equipment. Tesla, on the other hand, manufactures transportation equipment that uses electricity, so in a way perhaps the two cancel each other out, which is how many equity holders in this misadventure must be feeling about the real merits of the acquisition.

Entropy, not energy is the main issue

For years, NYSERDA (the New York State Energy Research and Development Authority) operated on the unwritten rule that you could use their subsidies to make gas, oil, or electric plant more efficient, but they would not support fuel switching. The energy silos were the sacred cows. More recently, however, it was recognized that the problem of GHG-reduction cannot be solve unless the fungibility of energy, and various forms of combining and recapturing energy were taken into account, and along with that realization, the agency is increasingly paying attention to thermal energy solutions as well, and in general any solutions that cut across the silos in various ways.

Elon Musk still pretends that the problem can be solved by turning electricity green, and the rest will take care of itself. However, we will note that, whereas there actually is one supercharger running on solar, it is the exception, not the rule. Further, within people's houses, the bigger problem is usually thermal, not electrical, and the bigger part of the solution therefore will tend to be passive, including insulation, window treatment, heat recovery, and so on.

In a general sense, electricity is going to be the preferred energy for heating and cooling, driven by the extremely high efficiencies of heat pump technology (up to 250% for ASHP - Air Source Heat Pumps, and 500% for GSHP - Ground Source Heat Pumps). However, in many other cases, Solar Thermal will win the day, as can be seen in some of the most innovative designs (such as zonbak.com, and solartomorrow.com - for hot air and hydronic systems, respectively), as well as the super-efficient modern evacuated tubes. Since solar thermal generates 4-5x more energy per square area as SPV, its value is very high wherever it is easy to integrate. For retrofits, solar thermal represents more integration challenges in some cases, than if it can be designed in from scratch.

In all the cases where the rooftop solar installation usurps other projects that would have added more value to the property, and had greater GHG-reductions, the rooftop SPV choice has negative NPV, but is also regressive from an environmental standpoint. In utility scale projects, on the other hand, the issue is much clearer: If you build a solar plant that displaces generation from coal, gas or oil, that is clearly a beneficial event from a standpoint of GHG-reductions, and there simply are not the number of alternative solutions that compete, though the fact remains that any incentive that handicaps one technology over another as opposed to incentivizing outcomes in a technology agnostic fashion, risks encouraging inferior choices being made. So the government inadvertently created these market distortions, and they have not learned their lesson yet.

In summary, looked at from the side of GHG-emissions for the home, replacing electricity with green electricity without otherwise re-engineering things is not a solution, and if it is the only thing you can possibly do in a household, it is worthwhile only if your payback is acceptably short and the NPV clearly positive. From the standpoint of household GHG-emissions including transportation, given the specific production methods of a Tesla automobile, the green credentials are perhaps dubious, as has been documented extensively in a brilliant research report by Devonshire Research, which documents the impossibly large number of challenges Tesla is trying to tackle all at once, but also the extent to which their green claims are open to challenge, because of the innate carbon footprints and pollution (entropy) of the production processes and technologies used.

The frathouse brawl over net-metering

SolarCity was in the forefront of unreasonable demands of the utility industry, without thinking through the fact that within the 'natural monopoly' of utilities, the other customers are subsidizing the solar customers, so there are certain limits to just how obnoxious you can get. Nevada became a real show-down, and the solar industry suffered a serious setback, the first one of many.

Clearly, one of the greatest successes of SolarCity to date was the efficiency with which some of the insiders cashed in their stock options. Clearly, the founders felt they had something to celebrate, where as for investors all they did was move the goal posts repeatedly. The current state of affairs is reminiscent of Vivint Solar (NYSE:VSLR), where business was slowing down before the takeover attempt by SunEdison (OTCPK:SUNEQ), but then they blamed the rest of it on the acquisition. The same pattern now exists for SolarCity - it was slowing down into the takeover, and the likelihood is great it may drag Tesla down if this transaction is ever completed.

Just now the Musk/Rive clan is acquiring $100 million of a $124 million SolarCity bond offering, signaling a near total lack of interest in the market. This arrangement is only marginally less inelegant than having Tesla provide a bridge loan pending the acquisition. Various analysts have already dissected this new piece of skullduggery here on SA, and I see no need to add more - the incident speaks for itself. This is an SOS signal that increasingly calls into question how any Tesla shareholders could in good conscience approve the said acquisition.

The re-invention of BIPV, and the future of SPV technology

Thin film solar - materia.nl

Amidst the recent flap over the SolarCity acquisition, a lot was made of an announcement about Building Integrated PV, as if it were something new. The announcement was reminiscent of Al Gore's 'invention' of the Internet. While Dow Corning and many others have exited this market, SolarCity claims to have something new to contribute, though no details were provided, but it certainly is not as new as it was made out to be, as can be seen from the Stillwell Avenue train terminal in NYC, which was built in 2001-2005 with what was and possibly still is the largest BIPV roof in the world - based on thin film solar. It should be noted that while New York State in its kindness is helping SolarCity build another gigafactory in Binghamton, based on the Silevo Crystalline Silicon technology, the future almost certainly belongs to thin film, where manufacturing costs are getting to $0.30/watt or less, while c-Si is at $0.40-$0.50 for comparable efficiencies, and the new fab is now coming on-line amid a new glut of solar panels. All at the same time the technology runway for thin film may stretch all the way to 45% efficiency over time, whereas c-Si is out of runway at the present level of 25-26%.

Amateur hour is over for ESG investing

The province of Ontario recently introduced the most comprehensive Climate Change Action Plan anywhere in our part of the world, which makes it clear that every technology option must be taken seriously, it is no longer good enough to have a good green story, this is about results now. Just a short while later, New York State followed suit by committing to 50% renewable power by 2050. Again, these types of commitments mean that half measures, and good-sounding stories won't help much. Real engineering will have to come to the rescue.

Socially responsible investing, and intentional investing, the so-called ESG (Environmental, Social, Governance) investment sector, needs to find itself clear objective measures, so it no longer falls prey to story telling by various environmental conmen. Various attempts have been made, and a site like True Value Metrics is worth exploring, because it has been at the center of this dialog, and very critical of many fashionable, but usually very superficial, attempts that have been made in this area in recent years. It represents at least an attempt at 'impact accounting' that could provide more objectivity to the 'impact investing' field. The time is over when just because you had 'solar' in the name, you were a green investment.

The sales methods of SolarCity have made sure that many homeowners signed on, who would have been better off with other energy upgrades that would have done more for GHG-reductions as well as the value of their properties. In other words, the actual GHG-reductions claimed by SolarCity are grossly overstated, if the projects usurped better solutions, just because home owners did not know any better.

Solar Freakonomics

Any readers of Freakonomics will realize that perverse incentives can, sometimes quite unintentionally, do more harm than good. Solar is no exception. The construction of the ITC (Investment Tax Credit) is so poor that it leads to lousy, and often counter productive project selections, and in a way the government only has itself to blame for the very mixed result, and the minimal impact on GHG-emissions. The ITC subsidizes tax shelters, and not GHG-reductions, as solar leases and PPAs have become vehicles for financiers to abscond with equity from the customer's real property.

Even though the DOE has been reporting on this issue as far back as 2014 with the Banking On Solar report, the problem was perhaps best quantified by a study from Arizona State University, documenting what amounted to a difference of 10% of a home's value between owning or leasing solar panels. A 10% difference is often easily worth more than the cost of the installation itself.

If incentives were simply based on documented reductions in GHG-emissions, or better yet on an assessment of optimal GHG-reductions along with maximal improvement in property values, then the technology choices would be left to the engineers instead of the accountants, and much better results would ensue.

The Ponzi scheme

The research from Devonshire on Tesla, at least so far, is in two pieces, and whereas the first report brilliantly lays out how Tesla straddles so many industries that the mind soon boggles how they could think they could do anything well with any kind of consistency. It also gives a pretty thorough accounting of why the green claims don't add up. The follow-on report, Tesla Motors, Inc., Part II, published at the time of the Model 3 Deposit surge lays out the case for comparing Tesla to Enron and WorldCom, as well as pyramid, and Ponzi schemes, and not undeservedly so. The Model 3 deposits were immediately leveraged into the next equity raise, famously without disclosing the first autopilot fatality, which is now being looked into by the SEC.

The Ponzi structure of the financials should get the SEC keenly interested, and Devonshire for its part called for: 'it is an experimental financial services company, and should be regulated as such.' To describe these courageous financial innovations, the report resorts to new definitions, including 'Future-Earning Pyramidal Financing (FEPF) on page 11:

Future-earning pyramidal financing (FEPF) is a business dynamic characterized by the act of raising capital to finance future losses rather than future returns. The assumption in this dynamic is that the future losses will be covered by a second capital raise (similarly pyramidal) which will allow some investors to exit profitably, although many will reinvest and/or accept losses.

When properly recognized, managed, and regulated, FEPF can be a sustainable arrangement that operates within both the spirit and the letter of the law. Examples may be found in the realm of public services, non-profits, and social service programs. However, when performed maliciously with intend to defraud, FEPF forms the dynamic underlying illegal Ponzi, pyramid, and matrix schemes.

Aggressive cash-negative growth ventures that rely entirely on profitability at scale occupy a dangerous middle ground where delusion often substitutes for malice.

The problem in Tesla's case has been and continues to be a constant moving of the goal posts, covered over by empty promises and vaporous green claims, while in the meantime reality is catching up and quickly overtaking the company. Anyone who has looked at the Chevy Bolt lately, would have to assume that as the Model 3 slips, some of those vaunted deposits might be revoked, and forwarded to Chevrolet, since they can deliver in 2017, when mass market delivery of the Model 3 is increasingly likely to be a 2018 event.

The path forward for Tesla is increasingly navigating between Scylla and Charybdis, and the outlook is not encouraging. The window between Q3 sales and Q3 financials might be the last shot at an equity raise, but current reports on sales, discussed by Bill Maurer, here, do not instill much confidence. In short, absent a realistic growth model, the company is increasingly unlikely to outgrow its Ponzi-style financing, and investors must look forward to more equity raises and dilution, if the market lets them. The introduction of Tesla in Korea and South Africa is more reminiscent of Herbalife (NYSE:HLF) entering the market in Zimbabwe than of any credible business expansion.

Conclusion

Every reasonable analysis would suggest that the only possible way this deal is a positive for Tesla is if it could be argued that a failure for Elon Musk in SolarCity now would drag the whole thing down the drain. If there is any merit to that line of reasoning, common sense would still suggest that this sort of plugging of the dikes is usually a precursor to bigger failures later. Be prepared for the vaunted synergies to disappear from the reports without explanation as the deterioration continues.

The more obvious rationale, behind all the rationalizations and PR stunts, is simply Elon Musk bailing out his cousins, and possibly SpaceX in the process. If SolarCity was one of the overloaded lifeboats on the Titanic, there was no time to launch it, and it's likely to go down with the ship anyway.

Tesla vs SolarCity - 3 months Yahoo Finance

Tesla vs. SolarCity, 3 months, from Yahoo finance

The physical reality as any kind of a credible solution for our energy problems is conspicuously absent from the story, and what remains is a patchwork of hopes and dreams that may limp across the finish line some day, but more likely will start coming unglued as interest rates in the world around it begin to rise, and the Musk currency ends up being devalued as the financial structure unravels. If MLM companies like Herbalife are product-masked pyramid schemes, Tesla is a product-masked Ponzi scheme, which further uses unsubstantiated green credentials for cover. The trend-line in the market should make shareholders voting for this deal uneasy, but it ain't over till its over, and it would appear that Mr. Musk still has goodwill capital that may once more tide him over. For how long?

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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