The board of solar power developer SolarCity approved an offer from energy storage company Tesla to buy out the company for $2.6 billion on 1 August 2016. The merger has the market divided with some excited and others skeptical as to whether it’s really a good deal for either company’s investors. 

The all-stock offer of $25.37 per SolarCity share is about $200 million below the initial amount Tesla announced in June, when it said it would likely offer between $26.50 and $28.50 per share. That would have given SolarCity investors 0.121 to 0.131 shares of Tesla stock rather than the 0.110 shares they’d get through the current offer.

A larger-than-anticipated loss this quarter has been among the detractors for SolarCity, which is down about 63% year-to-date after a growth spurt from 2013 to 2015 – over 5,000% compounded growth according to a statement from Axiom Capital Management managing director Gordon Johnson.

Given SolarCity’s current position, Tesla's offer came in at about half of the company’s value at this time last year. Shrinkage is largely attributable to slowing company growth and uncertainty about the future of government support for on-home solar.

Why now?

With many key watchers of the energy space projecting that the combination of solar plus storage will not reach grid parity in most markets for a good three to five years at minimum, it’s easy to question the logic of a merger today.

Patrick Archambault, equity analyst at Goldman Sachs reportedly asked Elon Musk, CEO of Tesla on a Monday morning conference call, “If you’ve got sort of a half decade until this makes economic sense […] why was the decision made to take this on right away?”

Musk explained that the companies are taking a long view with an understanding that in order for the market to reach the point that solar plus storage begins to make sense in three years, “we need to take action now”.

The impetus for the merger didn’t arise from the rooftop space, but rather in the utility-scale solar-plus-storage market. In February, Tesla and SolarCity teamed up to provide what is among the world’s first dispatchable solar energy projects in the world for the Kauai Island Utility Cooperative, a deal that according to Musk was like moving a mountain to accomplish.

“We had to spend months running it through independent board committee of Tesla and SolarCity getting conflict waivers, and we were like, man, we are going to do dozens and then hundreds, maybe thousands of these deals. There’s no way […] we can have such an unwieldy process,” Musk said. “It’s just crazy, so we’ve got to combine the companies.”

Mutual benefits

At its core, the merger aims to boost both companies by building synergies out of what the businesses already have in hand.

Financially, SolarCity could stand to benefit from being soaked up into Tesla’s much larger balance sheet, giving it access to better cost of capital. Tesla, in turn, would profit from SolarCity’s project finance experience, Tesla chief finance officer Jason Wheeler told analysts on 1 August.

On the product side, Musk said that the companies are already drafting plans for a new combined solar and storage offering to the point that it would be “awkward” if the deal doesn’t go through. While he declined to use a financial call to announce a potential new product line, he says there is ambition to bring an integrated solar plus storage system to market that would wow neighbors and make customers proud to own the product.

From a service perspective, if a potential customer wanted to combine SolarCity’s panels with Tesla’s Powerwall and a Model 3 with a home charging station today, there would be three separate trucks coming to install the three components. SolarCity’s already vertically-integrated installation and service business would be a value add for Tesla here, opening up the potential one truck to deliver all three products in a single trip.

Through the merger, Tesla could also ostensibly add value to existing retail outlets, which are now aimed at selling only two vehicle models and marketing a third. By adding solar and storage products to the sales floor, the usefulness of Tesla’s existing real estate could increase.

The value proposition of these synergies adds up to roughly $150 million in the first year after merger, according to internal estimates. Leadership declined to drill down on line-item specifics, but Musk said that his “gut feel” is that this is on the conservative end.

What next?

Musk and others close to the deal seem convinced it will be approved by investors, meanwhile SolarCity stock fell more than 7% on Monday to $24.72 following the announcement. With Tesla posting losses for its 13th straight quarter, it’s no wonder the market can’t agree on whether combining the businesses will only exacerbate current woes, or put both companies on the path to financial success.

SolarCity is betting that in the next three to five years, nearly all rooftop solar systems will be working in concert with battery storage, and part of its assumption of future growth comes from a potential shift in the emotions that drive consumers to purchase their systems, chief executive Lyndon Rive posited in the analyst call.

“Today the primary customer emotion for going toward solar is [that it is] environmentally a better source of energy, and you can save money,” Rive said. “Once you add storage to the equation, you have backup, so you go from saving money, [being] environmental, and then [adding] reliability or safety. With many of the large climate events that are occurring, blackouts are quite common on the East Coast, and on the West Coast you have earthquakes and this type of insurance or product will appeal to a large base of consumers.”

It will still be several months before the merger is complete, as regulatory and Securities and Exchange Commission approval is pending, and SolarCity still has a 45 go-shop period in which to secure a better offer. But the companies’ boards are publicly confident that it is the right move for their businesses, and for the industry.