Elon Musk is becoming a leading figure in American mergers and acquisitions. This week he agreed to buy Twitter Inc. in what will probably be the largest leveraged buyout ever done by a guy in his personal account. In 2018 he spent a week pretending he was going to take Tesla Inc. private, in what was perhaps the largest pretend leveraged buyout ever done by a public-company chief executive officer, though I am not sure precisely how one would measure that. And yesterday he won an important Delaware Chancery Court case over his 2016 purchase of SolarCity Corp. Future law students will take courses in Elon Musk M&A, just like future finance students will take courses in the Elon Markets Hypothesis. Everywhere he goes, he creates issues.
The SolarCity deal was not a leveraged buyout; Musk did not buy it for his personal account. Instead, Tesla bought it, for about $2.6 billion of stock. That’s the problem. SolarCity was a public solar company; Musk was the chairman of its board of directors and its largest shareholder, and it had been founded by his cousins. Tesla is a public company that makes electric cars (and now owns SolarCity); Musk was at the time its chairman and chief executive officer and owned 22% of its stock. (He is now its “Technoking” and owns somewhat less of the stock.) Musk decided that Tesla should buy SolarCity. Tesla, a company he ran, then bought SolarCity, a company that he owned a lot of. This raises an obvious conflict of interest, so some Tesla shareholders sued. From Vice Chancellor Joseph Slights’s opinion yesterday:
According to the plaintiffs, as Tesla’s controlling stockholder, Elon caused Tesla’s servile Board to approve the Acquisition of an insolvent SolarCity at a patently unfair price, following a highly flawed process, in order to bail out his (and other family members’) foundering investment in SolarCity. This, say the plaintiffs, was a clear breach of Elon’s fiduciary duty of loyalty.
The competing theory is that Musk had a “Master Plan” for Tesla, that the Master Plan was not about making electric cars but about how to “accelerate the world’s transition to sustainable energy,” that SolarCity fit perfectly into this plan, that Musk wanted Tesla to buy SolarCity because that was the right strategic decision for Tesla, and that the price Tesla paid was fair.
These are hard theories to adjudicate. Elon Musk is very smart and Tesla’s stock has gone up a lot, so it seems silly to assume that he did not have a genuine strategic vision for Tesla or that SolarCity wasn’t part of it. On the other hand, SolarCity absolutely was founded by his cousins and he absolutely did own a lot of its stock, so it seems silly to say that he wasn’t conflicted in telling Tesla to buy SolarCity.
Broadly speaking there are two ways to address this problem. One is that each board of directors — at Tesla and SolarCity — can set up a special committee of independent directors to review the transaction and decide if it is fair for their companies, free from any influence from Musk or other conflicted directors, and then put in place other safeguards — market checks, fairness opinions, majority-of-the-minority shareholder votes, etc. — to make sure that the deal both looks and is fair.
The other way to address the problem is to punt it to a judge. Aggrieved shareholders can sue and say “Tesla should not have bought SolarCity, and certainly should not have paid $2.6 billion, so Elon Musk should have to pay shareholders back,” and they can make their case for why SolarCity was a bad strategic fit and not worth $2.6 billion. And Musk can make his case for why it was a good strategic fit and worth way more than $2.6 billion. And the judge can listen to both sides and decide who is right.
The first approach is obviously preferable, and it is what basically every public company, in situations like this, aims for. Oversimplifying mightily, the way Delaware M&A law generally works is that if you get the process stuff right — if you have the right combination of independent special committees and ratifying shareholder votes and careful free unconflicted negotiations — the court will not second-guess the deal’s price or strategic logic; a properly done deal will be subject to deferential “business judgment” review. If you get the process stuff wrong, you get “entire fairness” review, meaning that the court gets to decide if the price was fair.
The right way to do the process is to set up a special committee of Tesla directors with no ties of personal loyalty to Musk, let them meet regularly without the conflicted board members (like Musk, or his brother Kimbal), give them free rein to hire financial and legal advisers and negotiate the deal, and give them an absolute right to reject a deal with no repercussions. If they accept a deal under those conditions, it’s probably fair. It is a little hard to imagine this working with Elon Musk! You have to kick him out of his own board meetings, and you have to keep open the possibility of saying no to something he really wants.
Still, the Tesla board did okay. Musk proposed buying SolarCity several times, and the board said no a few times because Tesla had other things on its plate. Eventually it agreed to consider a deal and hired financial and legal advisers (Evercore and Wachtell, Lipton, Rosen & Katz to vet it; it also sort of kicked Musk out of the meetings.
Once the Tesla Board decided it would pursue an acquisition of SolarCity, following discussions with counsel, it was determined that Elon and [Tesla and SolarCity director Antonio] Gracias should be recused from any vote relating to the transaction given, among other conflicts, their roles on the SolarCity Board. But the Tesla Board believed that Elon and Gracias’ perspectives regarding the solar industry and SolarCity, in particular, would be helpful, so it was agreed that the two could participate in certain high-level strategic discussions regarding the Acquisition.
Evercore presented its analysis of the potential deal to the board and recommended a price of roughly $25 to $27 per share; Musk, who of course was at this meeting, proposed $28.50. The board approved an initial offer at a range between those prices, and despite Musk’s request that Tesla also give SolarCity a bridge loan until the deal closed — SolarCity’s finances were in rough shape — the board said no.
Then they negotiated a deal, and “Evercore’s 10-member team spent thousands of hours reviewing SolarCity’s financial condition, conducting valuation analyses and negotiating with Lazard,” SolarCity’s bankers. With SolarCity running out of cash, “Elon arranged daily meetings with the Evercore team to push along the pace of due diligence” and hurry up the deal. “Given the information discovered in diligence, Evercore decided to recommend that Tesla lower its offer,” and presented this recommendation at a board meeting that of course Musk attended. (He agreed to lower the price.) Eventually they signed a deal, and Evercore gave a fairness opinion saying that the price was fair to Tesla. (Meanwhile SolarCity’s short-term cash needs were met by Musk and his cousins buying $100 million of SolarCity bonds in their personal accounts.) Then Tesla went out and got a shareholder vote; the board required that a majority of non-Musk shareholders vote for the deal, and about 85% of them did.
That process is, you know, okay. Better to have a special committee, better not to have Musk back-channeling with the bankers and attending every important board meeting that he was supposedly recused from. Vice Chancellor Slights gives it like a B-:
The process employed by the Tesla Board to negotiate and ultimately recommend the Acquisition was far from perfect. Elon was more involved in the process than a conflicted fiduciary should be. And conflicts among other Tesla Board members were not completely neutralized. With that said, the Tesla Board meaningfully vetted the Acquisition, and Elon did not stand in its way.
That seems right. Musk was involved, but the board seems to have taken its job seriously and tried to negotiate a fair deal. Still, the judge more or less gives up on answering the question of whether this process was enough, and instead decides to “skip to entire fairness.” Assuming that the process was not good enough, then the way shareholders are protected from conflicts of interest is by going to court and persuading a judge that Tesla should not have bought SolarCity, or that it overpaid.
But he was not persuaded:
The preponderance of the evidence reveals that Tesla paid a fair price—SolarCity was, at a minimum, worth what Tesla paid for it, and the Acquisition otherwise was highly beneficial to Tesla. Indeed, the Acquisition marked a vital step forward for a company that had for years made clear to the market and its stockholders that it intended to expand from an electric car manufacturer to an alternative energy company. The Court’s verdict, therefore, is for the defense.
He goes through the arguments — about SolarCity’s market valuation, its cash flows, its alleged insolvency, potential synergies, the value of Evercore’s fairness opinion, etc. — but ultimately he seems most persuaded by a general sense that Elon Musk is a business genius and Tesla’s stock has gone up a ton since this deal:
While the synergistic effects of the Acquisition are still unfolding, the astronomic rise in Tesla’s stock price post-Acquisition is noteworthy. Although the relevant inquiry in an entire fairness analysis is whether the acquisition target was worth the price paid when the deal was consummated, hindsight suggests that Elon is right when he asserts that, once valued as a car company, Tesla is now valued as “a first-of-its-kind, vertically integrated clean energy company.”Whether the Acquisition played a large or small part in Tesla’s impressive growth is not clear, but there can be no doubt that the combination with SolarCity has allowed Tesla to become what it has for years told the market and its stockholders it strives to be––an agent of change that will “accelerate the world’s transition to sustainable energy” by “help[ing] to expedite the move from a mine-and-burn hydrocarbon economy towards a solar electric economy.”
But he also says: “I cannot help but observe that Elon (and the rest of the Tesla Board members) likely could have avoided this expensive and time-consuming litigation had they just adopted more objectively evident procedural protections.”
Those are the two sides of Elon Musk, aren’t they? On the one hand he infuriatingly refuses to comply with the basic expectations of law and society; on the other hand Tesla’s stock keeps going up. “Elon Musk is a bullshitter who delivers,” Benedict Evans says. He did a deal that was rotten with conflicts of interest, and while he could have followed the proper procedures to do the deal right, he didn’t, because he is too impetuous and doesn’t really believe in rules or social norms. But also the deal worked out great and confirmed his reputation as a business genius. And so the Delaware judge spends some time criticizing him for doing the deal wrong, but his heart isn’t in it. Musk is too much of a lovable business scamp for any judge to stay mad at him. He does all the wrong things but they keep working out right.
Bloomberg
