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Unit 3: Inventory and Long-term Assets

Merger and Acquisition: Tesla Motors, Inc.- Solar City Corporation

Exhibits can be found on pages 6-10

1. In its Final Prospectus, dated October 12, 2016, Tesla stated:

“If the Merger is completed, SolarCity stockholders will have the right to receive 0.110 shares (the “ Exchange Ratio ”) of Tesla Common Stock for each share of SolarCity Common Stock issued and outstanding (except shares held by SolarCity as treasury stock or shares owned by Tesla or Merger Sub), with cash paid in lieu of fractional shares. This Exchange Ratio is fixed and will not be adjusted to reflect stock price changes prior to the closing of the Merger. Based on the closing price of Tesla Common Stock on the NASDAQ Global Select Stock Market (“ NASDAQ ”) on June 21, 2016, the last full trading day before the public announcement of Tesla’s proposal to acquire SolarCity, the Exchange Ratio represents approximately $24.16 in value for each share of SolarCity Common Stock. Based on the closing price of Tesla Common Stock on NASDAQ on October 10, 2016, the latest practicable date before the date of the enclosed joint proxy statement/prospectus, the Exchange Ratio represents approximately $22.10 in value for each share of SolarCity Common Stock…. We urge you to obtain current market quotations of Tesla and SolarCity Common Stock.”

On Thursday November 10, 2016, the stock price of one share of Tesla is $187.30. What does the Exchange Ratio currently represent as the value of a share of Solar City stock?

2. Also in its final Prospectus, Tesla stated:

“Based on the estimated number of shares of SolarCity Common Stock outstanding on September 23, 2016, the record date for the special meetings, Tesla expects to issue approximately 11,080,333 shares of Tesla Common Stock to SolarCity stockholders in connection with the Merger, which would result in Tesla stockholders owning approximately 93.1% of the Combined Company and former SolarCity stockholders will own approximately 6.9% of the Combined Company upon completion of the Merger.”

a. Calculate the implied value Tesla will pay for 93% of Solar City stock, using a price of $187.30 per share of Tesla. Round to the nearest million.

b. Calculate the implied value of 100% of Solar City based on the $187.30 price.

c. Calculate the implied value of 100% of Solar City based on the Exchange Ratio value of $22.10 per share of SolarCity stock.

3. Notwithstanding its updated page one statement that it would issue 11,080,333 shares to acquire SolarCity, Tesla has presented this calculation of the purchase price on page 147 of the prospectus. Its other exhibits are based on this price, so we will use $2,326 million as the price in the following questions.

The calculation of the estimated purchase price is as follows (in thousands, except for share and per share amounts):


SolarCity outstanding stock at June 30, 2016		100,267,138
Exchange Ratio		0.110

Estimated number of Tesla shares to be issued		11,029,385
Per share price of Tesla common stock as of October 6, 2016	$	201.00

Estimated fair value of Tesla common stock to be issued	$	2,216,906
Estimated fair value of replacement Tesla stock options and restricted stock units (1)		109,100

Preliminary estimated purchase price	$	2,326,006

Why is there $109 million added for replacement Tesla stock options? I am not asking about the value, just about why the options are issued.

4. Refer to Exhibit 1. This is the preliminary purchase price allocation for Solar City’s assets and liabilities.

Summarize this purchase price allocation with a journal entry:

Explain how goodwill will be accounted for going forward.

5. Refer to Exhibit 1. Explain briefly how the following fair values are determined:

Solar energy systems, leased and to be leased :

Intangible assets and liabilities:

Deferred revenue, deferred income and deferred costs :

Debt, including convertible senior notes, solar bonds and solar asset-backed notes:

6. Refer to Exhibit 2, the pro forma balance sheet. Calculate the total write-up or write-down of Solar City’s tangible assets and identifiable intangible assets. This refers to everything but goodwill.

7. Refer to Exhibit 2, the pro forma balance sheet. Calculate the total write-up or write-down of Solar City’s liabilities.

8. Refer to Exhibit 2. The balance sheet indicates that SolarCity’s long term debt is being written down about 10% in the purchase price allocation. Why do you think this is so?

9. Refer to Exhibit 2. Is the historical goodwill on SolarCity’s balance sheet being written up to fair value, or is the historical goodwill eliminated in the merger and new goodwill determined based on the transaction values? In other words, could the historical goodwill have been completely eliminated if the terms of the transaction were different?

10. Refer to Exhibit 2. Why is SolarCity’s historical equity eliminated in the pro forma balance sheet?

11. Tesla and SolarCity were required to provide fairness opinions to their shareholders as part of the background for the merger vote. Tesla hired Lazard; SolarCity hired Evercore. Refer to the table below (taken from a blog entry titled “Keystone Kop Valuations: Lazard, Evercore and the TSLA/SCTY Deal “, written by Aswath Damodaran, an NYU finance professor.) Comment on the assumptions used in the valuation.

12. Believe it or not, I own a few shares of Tesla through a retirement account. Tesla posted the following comments about the merger on its website. Should I vote yes or no to the proposal?

Strategic rationale:

The acquisition of SolarCity will create the world’s only integrated sustainable energy company, from energy generation to storage to transportation.

Just as Tesla has demonstrated the superiority of electric vehicles, the solar roof and Powerwall 2 will transform energy generation and storage.

Financial benefits:

The transaction is expected to be additive to Tesla’s cash balance. SolarCity increased its cash from Q2 to Q3 2016 and expects to increase it further in Q4 2016. We expect SolarCity to add more than half a billion dollars in cash to Tesla’s balance sheet over the next 3 years.

Continuing to transition to loans and cash transactions as opposed to leases will significantly improve SolarCity’s GAAP revenue and profitability.

More than half of SolarCity’s debt is project financing; this debt is non-recourse and is more than offset by the cash flows from customer payments.

SolarCity obtained about $1 billion in project financing since July 1, 2016, demonstrating the strength of its financial condition.

Tesla’s execution:

With record quarterly production and deliveries, Tesla achieved GAAP profitability and generated positive free cash flow in Q3 2016, while remaining on track with Model 3 and Gigafactory development.

Tesla also paid down $422 million of convertible debt and expanded its third party leasing capacity by $675 million and its direct leasing capacity by $300 million.

With Tesla executing well on its existing goals, it can successfully integrate SolarCity and realize the financial benefits that come from the acquisition.

Exhibit 1: Purchase Price Allocation

Note 3. Preliminary estimated purchase price allocation

Under the acquisition method of accounting, the total purchase price is allocated to the tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values as of the date of the acquisition. The preliminary allocation of the estimated purchase price is based on the terms of the Merger Agreement and Tesla management’s preliminary estimates of the fair value of SolarCity’s assets and liabilities as of June 30, 2016, derived from the historical balance sheet of SolarCity as of June 30, 2016. As of the date of this document, Tesla management has not finalized the detailed valuation studies necessary to arrive at the required estimates of the fair value of SolarCity’s assets to be acquired and the liabilities to be assumed and the related allocations of purchase price. Additional intangible asset classes may be identified as the valuation process

continues. Therefore, the allocation of the purchase price to assets acquired and liabilities assumed is based on preliminary fair value estimates and is subject to final analysis by Tesla management following the consummation of the Merger.

The following table sets forth a preliminary allocation of the preliminary estimated purchase price to SolarCity’s identifiable tangible and intangible assets acquired and liabilities assumed, with the excess recorded as goodwill (in thousands):


Assets acquired:
Cash and cash equivalents	$	145,714
Accounts and rebates receivable		79,468
Inventory		229,699
Solar energy systems, leased and to be leased		5,249,946
Property, plant and equipment		909,290
Intangible assets		369,125
MyPower customer notes receivable, net of current portion		528,821
Restricted cash, current and non-current		173,252
Prepaid expenses and other assets, current and non-current		134,572

Total assets acquired		7,819,887


Liabilities assumed:
Accrued liabilities and accounts payable		401,574
Debt and capital leases, current and non-current		2,181,534
Deferred revenue, current and long-term		255,185
Solar bonds, current and long-term		218,740
Solar asset-backed notes, current and non-current		667,789
Long-term deferred tax liability		182,550
Other current and long-term liabilities and deferred credits		1,089,877

Total liabilities assumed		4,997,249

Net assets acquired, excluding goodwill (a)		2,822,638

Redeemable non-controlling interests in subsidiaries		268,885
Non-controlling interests in subsidiaries		645,873
Capped call options associated with 2014 convertible notes		(6,180	)

Total other (b)		908,578

Total preliminary estimated purchase price (c)		2,326,006

Estimated goodwill (c-a+b)	$	411,946

The following is a discussion of the valuation methods used to determine the fair value of SolarCity’s significant assets and liabilities in connection with the preparation of these Pro Forma Financial Statements:

Solar energy systems, leased and to be leased : For purposes of these Pro Forma Financial Statements, the fair value of solar energy systems, leased and to be leased, has been determined primarily through the use of discounted cash flow method under the income approach as corroborated with the cost approach. Specifically, the

cash flows utilized in the analysis reflect the current market contract rate for electricity generated from the solar energy systems and recent forecast of energy production, and discounted at a risk adjusted rate of return.

Intangible assets and liabilities : For purposes of these Pro Forma Financial Statements, preliminary identifiable intangible assets consist of anticipated intangibles derived from developed technology, trade name and unfavorable power purchase agreements and leases, net. The preliminary identification of these intangible assets are based on consideration of historical experience and a market participant’s view. The intangible assets and liabilities are valued primarily through the use of the discounted cash flow method under the income approach.

These identifiable intangible assets are finite-lived intangible assets and the estimated amortization related to these intangible assets is reflected as a pro forma adjustment in the Pro Forma Statements of Operations, as further described in Note 4 and Note 5. The actual amortization may differ significantly between periods based upon the final value assigned and the amortization period used for each identifiable intangible asset.

Deferred revenue, deferred income and deferred costs : Deferred revenue in the context of a business combination represents an obligation to provide future products or services to a customer when payment for such products or services has been made prior to the products being delivered or services being rendered. The fair value is primarily estimated using either the discounted cash flow method under the income approach, or the expected fulfillment obligation plus a reasonable profit component under the cost approach. Any related deferred costs associated with deferred revenue that do not have a future performance obligation will also be eliminated upon purchase accounting.

Debt, including convertible senior notes, solar bonds and solar asset-backed notes : The fair value of SolarCity’s debt has been estimated based on available market information and rates currently offered for instruments with similar maturities and terms. The fair value is determined using various models including a discounted cash flows model using inputs including market yield and projected interest and principal payments over the remaining contractual terms of the instrument. The convertible senior notes are priced using market traded prices when available or pricing models, such as the binomial model, using market inputs including stock price, dividend yield and implied volatility.

Deferred tax liability : As of the effective time of the Merger, Tesla will provide deferred taxes and other tax adjustments as part of the accounting for the acquisition, primarily related to the estimated fair value adjustments for deferred revenue, deferred U.S. Treasury grant income and acquired intangible assets. Preliminarily Tesla expects to recognize deferred tax liabilities as part of purchase accounting which is expected to trigger an offsetting release of a portion of Tesla’s valuation allowance provided for deferred taxes.

Other assets and liabilities : Tesla also made certain adjustments to other assets and liabilities, such as deferred income and credits and income tax related prepaid assets, to reflect the anticipated fair value at the Merger date.

Non-controlling interest s: The fair value of non-controlling interests, or third-party investors’ equity interests in various financing funds with SolarCity, is primarily determined based on the income approach. Forecasted cash flows employed in the income approach may, depending on the vintage and the terms of the financing funds, consist of the following forecast: (i) taxable income allocated to investors; (ii) cash distributions to investors; and (iii) investment tax credits allocated to investors.

Goodwill : Goodwill is calculated as the difference between the acquisition date fair value of the consideration expected to be transferred and the values assigned to the assets acquired and liabilities assumed. Goodwill is not amortized but is tested for impairment at least annually, or more frequently if circumstances indicate potential impairment.

Exhibit 2:

Unaudited Pro Forma Condensed Combined Balance Sheet as of June 30, 2016

(in thousands)


	Historical		Pro Forma Adjustments (Note 4)				Pro Forma Combined
	Tesla		SolarCity
Assets
Current Assets
Cash and cash equivalents	$	3,246,301		$	145,714	$	—			$	3,392,015
Restricted cash and marketable securities		24,525			99,477		—				124,002
Accounts receivable		178,594			63,682		(960	)	(a)		241,316
Rebates receivable		—			15,786		—				15,786
Inventory		1,609,607			229,699		—				1,839,306
Prepaid expenses and other current assets		144,678			56,954		(6,061	)	(b), (c)		195,571

Total current assets		5,203,705			611,312		(7,021	)			5,807,996

Operating lease vehicles, net		2,533,726			—		—				2,533,726
Solar energy systems, leased and to be leased, net		—			5,173,624		76,322		(d)		5,249,946
Property, plant and equipment, net		3,993,250			909,290		—				4,902,540
Intangible assets, net		—			163,406		205,719		(e)		369,125
Goodwill		—			321,865		90,081		(f)		411,946
MyPower customer notes receivable, net of current portion		—			529,852		(1,031	)	(g)		528,821
MyPower deferred costs		—			237,460		(237,460	)	(b)		—
Restricted cash, net of current portion		71,621			73,775		—				145,396
Other assets		66,650			203,496		(119,817	)	(b), (c)		150,329

Total assets	$	11,868,952		$	8,224,080	$	6,793			$	20,099,825

Tesla Motors, Inc.

Unaudited Pro Forma Condensed Combined Balance Sheet as of June 30, 2016

(in thousands)


	Historical			Pro Forma Adjustments (Note 4)					Pro Forma Combined
	Tesla			SolarCity
Liabilities and Stockholders’ Equity
Current Liabilities
Accounts payable	$	1,114,878			$	214,145		$	(960	)	(a)	$	1,328,063
Accrued liabilities		558,212				215,341			12,794		(c), (h), (l)		786,347
Deferred revenue		558,816				120,506			(47,378	)	(i)		631,944
Deferred U.S. Treasury grant income		—				14,913			(14,913	)	(j)		—
Resale value guarantees		227,838				—			—				227,838
Customer deposits		679,834				5,775			—				685,609
Solar bonds		—				184,296			773		(k)		185,069
Solar asset-backed notes		—				18,275			1,312		(k)		19,587
Financing obligation		—				42,862			—				42,862
Current portion of long-term debt and capital leases		626,826				275,438			1,823		(k)		904,087
Distributions payable to non-controlling interests and redeemable non-controlling interests		—				9,396			—				9,396

Total current liabilities		3,766,404				1,100,947			(46,549	)			4,820,802

Long-term debt and capital leases, net of current portion		2,620,002				2,109,743			(205,470	)	(k)		4,524,275
Deferred revenue, net of current portion		533,253				1,082,241			(900,184	)	(i)		715,310
Deferred U.S. Treasury grant income, net of current portion		—				364,247			(364,247	)	(j)		—
Resale value guarantees, net of current portion		1,779,509				—			—				1,779,509
Solar bonds, net of current portion		—				33,530			141		(k)		33,671
Solar asset-backed notes, net of current portion		—				604,783			43,419		(k)		648,202
Financing obligation, net of current portion		—				77,268			—				77,268
Other long-term liabilities and deferred credits		612,344				979,946			(25,303	)	(c), (e), (l)		1,566,987

Total liabilities		9,311,512				6,352,705			(1,498,193	)			14,166,024

Redeemable non-controlling interests in subsidiaries		—				344,932			(76,047	)	(m)		268,885
Convertible senior notes		37,146				—			—				37,146
Stockholders’ equity
Common stock		148				10			1		(n)		159
Additional paid-in capital		5,383,731				1,287,960			1,031,855		(n), (o)		7,703,546
Accumulated other comprehensive income		34,193				—			—				34,193
Accumulated deficit		(2,897,778	)			(397,167	)		538,944		(h), (n), (p)		(2,756,001	)

Total stockholders’ equity		2,520,294				890,803			1,570,800				4,981,897

Non-controlling interests in subsidiaries		—				635,640			10,233		(m)		645,873

Total liabilities and stockholders’ equity	$	11,868,952			$	8,224,080		$	6,793			$	20,099,825

See accompanying notes to the Unaudited Pro Forma Condensed Combined Financial Information

Notes to Unaudited Pro Forma Condensed Combined Financial Information

Note 4. Adjustments to the Pro Forma Balance Sheet

(a)

Reflects the elimination of historical transactions and balances between Tesla and SolarCity prior to the Merger. (Refer to Note 7 below).

(b)

Reflects the elimination of SolarCity’s deferred costs related to MyPower loans of $3 million included in prepaid expenses and other current assets, $237 million included in MyPower deferred costs, and $25 million of deferred leased assets included in other assets.

(c)

Reflects the elimination of income tax related prepaid assets of $97 million ($3 million included in prepaid expenses and other current assets and $94 million included in other assets), the reduction of income tax related payables of $24 million included in accrued liabilities and the elimination of income tax reserve balances of $7 million included in other long-term liabilities and deferred credits. These balances were reduced or eliminated for pro forma reporting purposes to reflect the ability of the combined group to use Tesla losses to reduce or eliminate SolarCity income tax liabilities.

(d)

To record the difference between the historical book value and preliminary estimated fair value of solar energy systems, leased and to be leased, acquired in the Merger.

(e)

Reflects the estimated fair value of SolarCity’s identified intangible assets. The following table shows a preliminary estimate of the fair value of those intangible assets and their related average estimated useful lives (dollars in thousands):


Intangible Assets	Estimated Useful Life (in Years)		Estimated Fair Value as of June 30, 2016			Net Book Value as of June 30, 2016		Pro Forma Adjustment
Favorable power purchase agreements and leases		18		$	46,825		$	—	$	46,825
Developed technology		9			283,400			132,775		150,625
Trade name and other		Various			38,900			30,631		8,269

Total intangible assets				$	369,125		$	163,406	$	205,719

Intangible Liabilities
Unfavorable power purchase agreements and leases		18		$	(81,211	)	$	—	$	(81,211	)

(f)

Reflects the elimination of SolarCity’s historical goodwill and the preliminary estimate of goodwill recognized as a result of the merger, which represents the amount by which the estimated consideration transferred exceeds the fair value of SolarCity’s assets acquired and the liabilities assumed, as well as the impact of the non-controlling interests assumed.

(g)

Reflects the fair value decrease of $1 million related to MyPower customer notes receivable, net of current portion.

(h)

Reflects estimated transaction costs of $41 million to be incurred by Tesla and SolarCity directly attributable to the Merger. The costs that Tesla and SolarCity may ultimately incur could differ materially from this amount. Transaction costs include fees for investment banking, advisory, legal, valuation, and other professional fees. As the transaction costs will not have a continuing impact, Tesla has not shown the estimated transaction costs in the Pro Forma Statements of Operations. No material transaction costs were incurred by Tesla or SolarCity during the periods covered by the historical financial statements.

(i)

Adjustments to reflect SolarCity’s deferred revenue at fair value. As a result of purchase accounting, deferred revenue is valued based on the remaining performance obligations and therefore deferred revenue with no remaining performance obligations is eliminated.

(j)

Reflects the elimination of SolarCity’s deferred U.S. Treasury grant income as there is no continuing performance obligation by SolarCity.

(k)

Reflects the adjustments of SolarCity’s debt, current and non-current portion, at fair value.

(l)

Reflects the reduction of $4 million in accrued liabilities and $100 million in other long-term liabilities and deferred credits for various SolarCity deferred credits and deferred rent as these liabilities do not represent future performance obligations for the combined entity.

(m)

Reflects the fair value decrease of $76 million related to redeemable non-controlling interests in subsidiaries and the fair value increase of $10 million related to the non-controlling interests in subsidiaries.

(n)

Reflects the elimination of SolarCity’s historical equity and the estimated consideration of $2,326 million, which includes the issuance of $2,217 million of Tesla common stock to SolarCity stockholders, and $109 million in Tesla replacement stock awards. The actual number of shares of Tesla common stock issued to SolarCity stockholders upon closing of the transaction will be based on the actual number of shares of SolarCity common stock outstanding when the transaction closes, and the fair value of those shares will be based on the trading price of Tesla common stock at that time.

(o)

Reflects the fair value of $6 million for the capped call options issued by SolarCity in connection with the 2014 convertible senior notes.

(p)

An income tax benefit of $182 million has been recorded as an adjustment to accumulated deficit in the Pro Forma Balance Sheet as of June 30, 2016 related to the change in fair values in connection with purchase accounting. The following table shows a preliminary estimate of the changes in temporary differences in SolarCity’s deferred taxes (in thousands):


Decrease in net deferred tax assets for an increase in book basis to identifiable intangible assets	$	(81,110	)
Decrease in net deferred tax assets for a decrease in book basis in deferred U.S. Treasury grant income		(149,493	)
Decrease in net deferred tax assets for a decrease in book basis in deferred revenue		(373,599	)
Increase in net deferred tax assets for a decrease in book basis to other net assets and liabilities		3,547

Net decrease to net deferred tax assets		(600,655	)
Pre-existing net deferred tax assets		418,172

Pro forma adjusted net deferred tax liabilities		(182,483	)
Increase to Tesla net deferred tax assets to reflect a reduction in valuation allowance equal to SolarCity’s net deferred tax liabilities on a pro forma basis*		182,483

Net change to deferred taxes to the combined entity	$	—

It is anticipated that the acquisition of SolarCity will enable Tesla to recognize deferred tax assets in an amount approximately equal to the amount of SolarCity net deferred tax liabilities recognized. The income tax benefit associated with the recognition of Tesla deferred tax assets has been excluded from the Pro Forma Statements of Operations as it is not expected to be recurring in nature.