Elon Musk Is On The Hook For Billions If He Loses Lawsuit Over Tesla’s SolarCity Deal

2022-05-14 23:05:45 By : Ms. Kitty Chu

What—he worry? Tesla CEO Elon Musk is due in court in Delaware on July 12 to defend the company’s 2016 acquisition of SolarCity.

(Updates reference to start of the solar roof program in 16th paragraph.)

Five years ago, Elon Musk gushed to investors about Tesla’s acquisition of SolarCity, then the top U.S. solar panel installer. “I’m pretty optimistic about how it’s going to turn out. It’s pretty transformational,” he said on a November 1, 2016, call with analysts. “It’s been extremely well received at the consumer level,” said Musk of the estimated $2.2 billion deal. During the same call, he batted down concerns about SolarCity’s faltering financial health. “There are quite a few naysayers on the financial front, some of the big hedge funds, whatnot,” said the billionaire, “I see no chance of SolarCity going bankrupt. Zero.”  

Musk heads to Delaware’s Court of Chancery on July 12 to defend the deal. He’s the sole remaining defendant in a case brought by shareholders alleging that the SolarCity purchase was a bailout of a troubled company founded by his cousins in which he was the biggest investor and chairman. The suit had also accused Tesla’s board of lax corporate governance. Board members, led by chair Robyn Denholm, settled for $60 million last year, admitting no fault. But Musk opted to defend the purchase. A loss in the case could cost him more than $2 billion, the full cost of the acquisition, which would be one of the largest judgments ever against an individual corporate executive. While companies such as Bank of America and BP have faced damage awards in the billions for their roles in events such as the mortgage-backed security collapse and disastrous Deepwater Horizon oil spill, individual executives are seldom solely liable for such large amounts. 

A home outfitted with a Tesla Solar Roof

It’s the latest legal twist for the 50-year-old centibillionaire founder of the world’s top electric vehicle brand and rocket maker SpaceX. Musk enjoys a cultlike fan base and 58 million Twitter followers, but his track record defending himself over comments that landed him in tricky legal straits is mixed. In 2018, he lost his role as Tesla chairman and had to pay a $20 million fine to the SEC over claims he made about taking the carmaker private that turned out to be bogus. A later case brought by the SEC over Twitter comments Musk made about Tesla production goals ended with no additional punishment for the executive. In December 2019 he won a defamation case brought against him by Vernon Unsworth, an advisor to Thai rescuers aiding a youth soccer team trapped in a cave whom Musk called “Pedo Guy.”

“When Tesla bought them, supposedly they were going to recapitalize the business and revamp.”

Underpinning the SolarCity case are deep concerns about why Tesla needed to buy it in the first place. Musk argued that it would be a transformational deal that could dominate the solar industry with low-cost panels, Tesla’s battery storage and high-tech solar roofs. Not only did little of that materialize but there were obvious concerns about conflict of interest. Musk’s cousins Lyndon and Peter Rive founded SolarCity in 2006, at Musk’s suggestion. Their rich cousin bankrolled it, owned 22.2% of it when Tesla acquired it and had been its chairman.

“When Tesla bought them, supposedly they were going to recapitalize the business and revamp. Instead, it really declined significantly, I think because they weren't paying that much attention to it and had other things going on,” says Joseph Osha, senior research analyst for Guggenheim Securities who tracks the solar power industry, but doesn’t cover Tesla. 

SolarCity’s business was based on enlisting customers who paid no up-front costs, but signed 20-year agreements to purchase electricity produced by solar panels the company installed. It became the biggest residential solar installer, posting record revenue in 2016 of $730 million, but also had a massive $820 million net loss that year and racked up more than $1.5 billion of debt at the time of the purchase.

Elon Musk debuting Tesla's solar roof at Universal Studios in Hollywood in October 2016

Much of the company’s growth—and debt—was tied to its marketing. Under the Rive brothers, the solar company had grown rapidly by relying on expensive promotion, including heavy advertising and door-to-door sales and offering low-cost, long-term leases for its solar power systems. It was also posting quarter after quarter of red ink as it raced to increase installations.

A few weeks before the acquisition closed, Tesla held a splashy media event at Universal Studios in Hollywood on the set used for Desperate Housewives to show off solar roofs made using high-tech glass shingles. Musk said at the time that the product would be a game changer because the roofs would both generate clean power and eliminate the aesthetic shortcomings of traditional photovoltaic panels that greatly irritate the world’s third-richest man. “The key is it needs to be beautiful, affordable and seamlessly integrated,” he said.

After the acquisition, Tesla eliminated SolarCity’s steep marketing costs by shifting sales directly to its website and network of stores. It scrapped a sales partnership with Home Depot. The Rive brothers had both resigned by July 2017, months after the sale of their company was finalized. “There were some of the sales channels that we thought were not consistent with the Tesla brand, such as door-to-door, sort of knocking on people's doors, so we wanted to transition that to sales to the Tesla stores instead. It makes more sense, which I think we've mentioned as one of the rationales for the SolarCity acquisition,” Musk said in a June 2019 deposition in the investor lawsuit. 

Tesla’s energy unit, which contains what’s left of SolarCity’s operations, posted $1.99 billion of revenue last year, up from just $178 million in 2016. That growth hasn’t been driven by panel installations, but rather by fast-growing sales of “Powerwall” batteries that store electricity from solar panels—a product Tesla began selling more than a year before the deal was announced. At the same time, panel installations, SolarCity’s core business, cratered to 205 megawatts in 2020, a quarter of the 803 megawatts it posted as a stand-alone company in 2016.

Tesla reported a jump in solar installations to 92 megawatts in the first quarter of 2021, without specifying whether those were for residential or commercial projects. It also said the solar roof business rose by nine times from a year earlier, without providing specific numbers. Despite those gains, the battery business Musk had before the acquisition “is the tail wagging the dog,” Guggenheim’s Osha says. “Powerwall is such a good brand they can sell Powerwalls all day long.”

Tesla Powerwall battery units hang on a wall inside the garage of a home in San Ramon, California.

In the 2019 deposition, Musk said production challenges with the Tesla Model 3 electric vehicle in 2017 led to the redeployment of staff and engineers from SolarCity to help beef up vehicle production operations. Under questioning from attorney Randall Baron, he wasn’t able to say exactly what portion of SolarCity staff was shifted to Model 3 production efforts and confirmed the move hadn’t been mentioned in Tesla’s annual report.

Tesla didn’t respond to a request for comment on the upcoming trial, though in its most recent annual report said, “We believe that claims challenging the SolarCity acquisition are without merit and intend to defend against them vigorously.” 

Baron, the attorney for San Diego-based Robbins Geller Rudman & Dowd who is leading the case against Musk on behalf of investors, also declined to comment on the trial. 

SolarCity never installed unique solar panel tech, but instead relied on conventional commodity panels sourced from the top manufacturers. Its business was built on installing them, getting lease payments from customers and monetizing the value of the energy generated from all the systems it was installing. 

The company had begun developing the solar roof concept that Musk hoped would displace its conventional panel business and wrapped work on it into Tesla’s R&D efforts after the acquisition. Five years later, it isn’t yet being delivered at a level close to the mass scale Musk hinted at in 2016. In part, that’s because the company has since learned that, unlike cars that can be mass-produced, every rooftop is different and needs to be custom designed. More recently, Tesla has said it’s focused only on installing solar roofs for new construction, walking away from the vastly larger market of retrofitting existing homes. 

“The SolarCity acquisition was a deal to forget for Tesla investors.”

As part of the SolarCity acquisition, Tesla also inherited a large-scale solar panel factory in Buffalo, New York. The company promised that output at the facility would grow to 1 gigawatt a year of solar production, in partnership with its longtime industrial partner Panasonic, the main supplier of lithium-ion battery cells throughout the company’s history. Panasonic abandoned the project last year and it’s unclear how many panels or solar roof tiles Tesla currently produces at the plant. Tesla doesn’t include details of that production in SEC filings.

For all the headlines and attention Musk and Tesla get, companies including Sunrun, now the biggest installer of residential solar power systems in the U.S., Sunnova and SunPower are more consequential players in their industry.

“The SolarCity acquisition was a deal to forget for Tesla investors as it’s a crowded space with minimal traction since the acquisition,” says Wedbush analyst Dan Ives. “The Street assigns minimal value until they really hit scale and execute on the broader vision.”

Tesla's solar power products factory in Buffalo, New York.