Saturday, September 7, 2019

In Re Tesla Motors, Inc. Stockholder Litigation

This case (In Re Tesla Motors, Inc. Stockholder Litigation) is the Delaware shareholder litigation regarding Tesla's acquisition of Solar City. The case was filed in September 2016 (three years ago), depositions have been taking place this summer, and the parties just filed opening briefs in support of summary judgment motions.

Something interesting in the Plaintiffs' motion for partial SJ:

On October 21, 2015, following a “weekly cash meeting,” Bryan Ellis, SolarCity’s Senior Vice President, Finance and Analysis, advised the executive management team that his “updated forecast projects our December monthly average balance at ~$91 million, which is $24 million below our revolver covenant threshold of ~$115 million.”

To address its cash need, SolarCity contacted several investment banks and private equity investors about an equity or convertible bond offering—public or private. The banks told SolarCity that neither was a reasonable option for obtaining the amount of cash it needed. The private equity investors had no interest in equity or convertible bonds in the amount SolarCity needed and would only consider “very high coupon debt” that SolarCity management believed would be very difficult to execute given “tough covenants” with their existing debt.

[...] On February 11, 2016, Rive convened a “cash planning” meeting at his home with Musk and SolarCity management. Rive and Musk discussed measures SolarCity could take to conserve cash and stave off its liquidity crisis, including delaying payments to SolarCity’s vendors. [portion redacted]

On the morning of February 27, 2016, Musk called Tesla CFO Wheeler and ordered him to prepare a presentation pitching an acquisition of SolarCity, to be presented during an “emergency meeting” of the Tesla Board. Wheeler prepared the pitch in under “48 hours.” Musk summoned an “emergency meeting” of the Tesla Board on February 29 for the sole purpose of discussing an acquisition of SolarCity. During this meeting, Tesla’s remaining directors learned about Musk’s proposal for Tesla buying SolarCity for the first time.

Wheeler’s presentation made clear that buying SolarCity would be a financial disaster for Tesla. The transaction was projected to be highly dilutive to Tesla’s earnings per share under all contemplated scenarios and would impose a substantial cash drain on the Company—above and beyond Tesla’s own deeply negative cash flow. The Board did not reject Musk’s proposal, as represented in the Proxy. Instead, the Board “authorized management to gather additional details and to further explore and analyze” a SolarCity acquisition.

In the meantime, SolarCity management began to take drastic measures to preserve cash—including delaying payments to its vendors. In March 2016, SolarCity management developed a “stacked ranking” of payments it owed to vendors to help it decide which payments to prioritize and which to postpone. Management also developed “finance postpone guidelines” dictating whether SolarCity would complete or suspend specific solar system orders because of their cash impact.
So, this is the Musk playbook for financial distress. Try to raise money without letting on that there is a cash crunch. Slow pay vendors. When I asked why Tesla doesn't raise money, the pattern of behavior that I noticed there is like the pattern at Solar City when it was on the verge of failing.

Musk would love for Tesla to raise five billion dollars. Ten billion. One hundred billion. Give him five hundred billion and he could pretend to be running a for-profit Mars colonization company for decades to come. Since money is not coming into his hands in big quantities now, a reasonable inference is that no one is willing to give it to him. Not anymore, not at a valuation anyway that would leave him in control of Tesla. He was able to get $2.7 billion this spring, mostly debt, in conjunction with the "robotaxi" stock promotion campaign. (Utterly preposterous because Tesla autopilot cannot recognize a stopped firetruck in its lane.)

At the current stage of the Delaware case there are two main issues to be adjudicated. First, whether the "entire fairness" standard (and not the far more relaxed business judgment rule) governs the court's review of the purchase of Solar City, which it arguably might because of board conflicts of interest. (Interestingly, Plaintiffs say that the Tesla defendants "did not even contest the issue of demand futility at the pleading stage given the Tesla Board’s conflicts.") And second, that shareholder ratification of the deal is not a defense because the Tesla defendants did not "disclose fully and fairly all material information within their control" about the acquisition.

Plaintiffs' discussion of the second issue sheds more light on how Musk behaves when his enterprises are in trouble:
In a June 22 conference call announcing the Acquisition, a transcript of which was filed by Tesla as a Rule 425 Prospectus, Musk represented that SolarCity was “headed to cash flow positive situation for the next three to six months at the outside” and would therefore be in “a very healthy place from a cash flow standpoint in short order.”

These statements were false. SolarCity internally projected that it would likely be in breach of the liquidity covenant for its revolver numerous times in 2016, which would trigger an event of default on its revolver and cross-defaults on other debt instruments, and SolarCity did not have enough cash to get through the year without raising additional funds.
I think that the pattern here is as follows: Musk is an excellent promoter. He did not come up with the technological innovation in batteries that would have allowed battery electric vehicles to make economic sense. Nor did he come up with a technological innovation in photovoltaic solar panels, balance of solar system, or installation procedures that would allow them to make clear economic sense for residential installation.

But he started companies in those two industries anyway. With his excellent promotion skills he was able to raise a lot of money for them and sell products to tech dorks, albeit at prices that result in the continual consumption of the capital he has raised. Because the capital has been consumed and continued operations would consume more he needs more - but the fundamentals of his businesses do not allow him to raise money if he gives a clear, straightforward presentation of the economics. That is why he depends on promotion and tantalizing sizzle - a promise that he can write now but that will not be cashed for "six months" or more.

It does not really matter whether this Solar City case succeeds or not. It might not - under our law, courts defer to managements to an absurd degree. There is little shareholder remedy for mismanagement (barring extreme cases) except to convince lazy index funds to vote the bums out. (See 1, 2.)

But the case has already had the effect of disclosing the degree to which Musk exhibits honesty and forthrightness when his businesses get in a pickle. 

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