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Elon Musk said over the weekend that SolarCity (NASDAQ: SCTY) and Tesla Motors (NASDAQ: TSLA) won't have to raise capital in 2016, which the market certainly saw as a positive sign. After a second quarter when SolarCity burned through $216 million, it was easy to see how combining SolarCity's cash needs with Tesla Motors' could be a bad thing for both companies, resulting in a bearish sentiment on their combination.
Since the end of Q2, SolarCity has raised nearly $1 billion in cash, and that could reduce the need for immediate funds if it is acquired by Tesla Motors by the end of the year.
SolarCity's huge influx of cash
There have been three large funding sources since the end of the third quarter, which will help SolarCity -- and Tesla, if it acquires the residential solar company. On July 18, SolarCity raised $345 million in tax equity financing, which funds the investment tax credit, accelerated depreciation, and a small amount of cash flow from each solar project.
On Sept. 12, a cash equity round, which sells cash flows from solar customers, brought in another $305 million. The interest rate of 7.4% was much higher than the 6% discount rate SolarCity has used to approximate value creation in the past, but the cash was still coming into SolarCity.
The latest capital raise was a $347 million fund with Citi to go toward $284 million of residential solar projects and $63 million of commercial projects.
The money was big for SolarCity as it nears a potential Tesla Motors acquisition. Last quarter alone, $563.5 million was spent on selling, installing, and administrative costs, and those costs have to be financed each and every quarter. If the flow of funds is cut off (as was the worry after Q2), the company will be in real trouble.
Giving some leeway to Tesla Motors
Now, instead of being a cash drain on Tesla Motors, SolarCity could actually be a help. In theory, SolarCity should be able to raise enough in financing each quarter to pay all of its costs to build solar systems. Management calls this cash flow positive, and the financing rounds show that that's possible.
Another potential help is the addition of loan sales. If SolarCity is able to shift a significant amount of business to loans, which are cash flow positive immediately, it could accelerate the positive cash flow situation. And as part of Tesla Motors, that would be a great addition.
The "house of cards" effect
The problem with SolarCity's strategy for the long term is that it's constantly in need of new sources of funding. Month after month, it has to raise money to build solar power systems, and with its cost of capital rising, it's selling off more and more of each system's value just to fund operations.
SolarCity could actually help Tesla Motors from a cash flow perspective in the short term, but that doesn't mean that it will help forever or that it won't become a huge drag on cash flow in the future. Musk may not think Tesla Motors or SolarCity will need to raise funds if they're combined in 2016, but that doesn't change the fact that this is still a risky deal and could implode if financial partners don't have wallets open to fund solar systems in the long term.
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Travis Hoium has no position in any stocks mentioned. The Motley Fool owns shares of and recommends SolarCity and Tesla Motors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.