It is acquire slowly to acquire outraged past times events closed to you, but I direct maintain learned, through hard experience, that writing when outraged is dangerous. After all, i time y'all direct maintain climbed onto your high horse, it is slowly to observe fault alongside others in addition to wallow inward self-righteousness. It is for that ground that I direct maintain deliberately avoided taking number alongside investment banking valuations of specific companies, much every bit I may disagree alongside the practices used inward many of them. I empathise that bankers prepare coin on transactions in addition to that their valuations are to a greater extent than sales tools than assessments of fair value in addition to that quest them to pay attending to valuation get-go principles may live on quest likewise much. Once inward a while, though, I do come upwards across a valuation in addition to thus egregiously bad that I cannot bound myself in addition to reading through the prospectus filed past times Tesla for their Solar City acquisition/merger was such an occasion. My get-go reaction every bit I read through the descriptions of how the bankers inward this bargain (Evercore for Tesla in addition to Lazard for Solar City) valued the 2 companies was "You must live on kidding me!".
The Tesla/Solar City Deal
In June 2016, Tesla announced that it intended to acquire Solar City in a stock swap, a surprise to almost everyone involved, except for Elon Musk. By August 1, the specifics of the bargain had been ironed out in addition to the wide contours of the bargain are captured inward the moving icon below:
At the fourth dimension of the deal, Mr. Musk contended that the bargain made sense for stockholders inward both companies, contention that it was a "no-brainer" that would allow Tesla to expand its attain in addition to overstep away a prepare clean release energy company. While Mr. Musk has a history of large claims in addition to perchance the smarts in addition to charisma to deliver on them, this bargain attracted attending because of its optics. Mr. Musk was the Pb stockholder inward both companies in addition to CEO of Tesla in addition to his cousin, Lyndon Rive, was the CEO of Solar City. Even Mr. Musk's strongest supporters could non challenger the notion that he was inward effective command at both companies, creating, at the real least. the potential for conflicts of interests. Those questions direct maintain non gone away inward the months since in addition to the marketplace concerns direct maintain been reflected inward the tendency lines inward the stock prices of the 2 companies, alongside Solar City downwards nearly 24% in addition to Tesla's stock toll dropping nearly 8%.
The board of directors at Tesla has recognized the potential for a legal backlash in addition to as this New York Times article suggests, they direct maintain been careful to create at to the lowest degree the appearance of an opened upwards process, alongside Tesla's board hiring Evercore Partners, an investment bank, to review the bargain in addition to Solar City's board calling inward Lazard every bit their bargain assessor. Conspicuously missing is Goldman Sachs, the investment banker on Tesla's recent stock offering, but to a greater extent than nearly that later.
The Banking Challenge inward a Friendly Merger
In whatever friendly merger, the bankers on the 2 sides of the bargain face, what at get-go sight, looks similar an impossible challenge. The banker for the acquiring society has to convince the stockholders of the acquiring society that they are getting a goodness deal, i.e., that they are acquiring the target society at a price, which spell higher that the prevailing marketplace price, is lower than the fair value for the company. At the same time, the banker for the target society has to convince the stockholders of the target society that they likewise are getting a goodness deal, i.e., that they are beingness acquired at is higher than their fair value. If y'all are a reasonably clever banking team, y'all uncovering real speedily that the solely agency y'all tin straddle this dissever is past times bringing inward what I telephone phone the 2 magic merger words, synergy in addition to control. Synergy inward item is magical because it allows both sides to declare victory in addition to command adds to the allure because it comes alongside the hope of unspecified changes that volition live on made at the target society in addition to a 20% premium:
In the Tesla/Solar City deal, the bankers faced a peculiarly hard challenge. Finding synergy inward this merger of an electrical machine society in addition to a solar jail cellular telephone company, i of which (Tesla) has prepare yell depict in addition to potentially high margins in addition to the other of which is a commodity occupation organization (Solar City) alongside pencil sparse margins) is tough to do. Arguing that the companies volition live on ameliorate managed every bit i society is tricky when both companies direct maintain effectively been controlled past times the same person(Musk) earlier the merger. In fact, it is far easier to prepare the representative for contrary synergy here, since adding a debt-laden society alongside a questionable operating occupation organization (Solar City) to i that has hope but volition demand cash to deliver seems to live on quest for trouble. The bankers could of course of educational activity direct maintain come upwards dorsum in addition to told the administration of both companies (or only Elon Musk) that the bargain does non prepare sense in addition to especially in addition to thus for the stockholders of Tesla but who tin blame them for non doing so? After all, they are paid based upon whether the bargain gets done in addition to if asked to justify themselves, they would debate that Musk would direct maintain flora other bankers who would direct maintain gone along. Consequently, I am non surprised that both banks flora value inward the bargain in addition to managed to justify it.
The Valuations
It is alongside this perspective inward hear that I opened upwards the prospectus, expecting to encounter 2 bankers doing what I telephone phone Kabuki valuations, elaborately constructed DCFs where the terminal outcome is never inward doubt, but y'all play alongside the numbers to arrive facial expression similar y'all were valuing the company. Put differently, I was willing to cutting a lot of slack on specifics, but what I flora failed fifty-fifty the minimal tests of adequacy inward valuation. Summarizing what the banks did, at to the lowest degree based upon the prospectus (lest I am defendant of making upwards stuff):
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| difference betwixt pricing an asset/business in addition to valuing it in addition to how mixing the 2 tin yield a incoherent mishmash. Both investment banks motility dorsum in addition to forth betwixt intrinsic valuation (in their usage of cash flows from 2016-2020) in addition to pricing, alongside Lazard estimating the terminal value of Tesla using a multiple of EBITDA. (See my ship on dysfunctional DCFS, inward general, in addition to Trojan Horse DCFs, inward particular). There are 2 aspects of these valuations that are the over-the-top, fifty-fifty past times banking valuation standards:
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