The news that Tesla Motors (NASDAQ: TSLA) will attempt to acquire SolarCity (NASDAQ: SCTY) in a deal valuing SolarCity for $2.8 billion is a major development in the renewable energy industry. This is one of the biggest potential deals to come along in the renewable energy industry in many years, and it could be a permanent game-changer in the sector. If Tesla’s bid for SolarCity is successful, it will represent a major step forward not just for Elon Musk, who is the Chairman and largest shareholder of both companies, but also for the renewable energy sector as a whole. That is because it will facilitate the consumer purchase process much easier, and can bring renewable energy to the consumer on a much larger scale.

Elon Musk turning a dream into reality

On the surface, it may seem strange for an electric car company to acquire a solar panel company. But looking deeper, there are a number of potential combinations that many are under-estimating. In an ensuing conference call after Tesla’s offer, Elon Musk said “in order to solve the sustainable energy question, we need sustainable energy production, which is going to come primarily in the form of solar, overwhelmingly in the form of solar in my view and combine that with stationary storage and electric vehicles, and you have a complete solution to a sustainable energy future.”

For example, imagine that a household with SolarCity solar panels capturing energy from the sun during the day. Overnight, this energy is then transmitted to a panel on the wall of the garage, where it can be used to charge up a Tesla electric car for the following morning’s commute to work. The combination of the two companies’ products would utilize Tesla’s Powerwall battery system and leverage SolarCity’s existing technology. As Tesla started developing its Powerwall technology, Musk realized that it is only natural to manufacture the solar panels under the same roof. Otherwise, it results in a number of inefficiencies; consumers would have to purchase the Powerwall and the solar panels from different companies, which would result in unnecessary duplicated costs, and also the likelihood that the hardware would not work as well as it would if it came from one company.

Essentially, the acquisition boils down to making solar power and electric cars more accessible to the consumer than ever before. A consumer can now obtain both sides of the renewable energy equation—solar panels and the vehicle—in one visit. That is the revolutionary aspect of this deal. This is just one scenario in which Tesla and SolarCity can, together, become a consumer-oriented powerhouse that combines the automotive and energy markets like never before.

Synergy is the name of the game

In addition to the operational synergies that a combination of Tesla and SolarCity would offer, there are a number of financial synergies available as well. Tesla and SolarCity are both classic examples of high-growth companies at early stages of their development. Both companies are growing at high rates, but struggle with turning profits.

Tesla’s revenue soared 27 percent last year to over $4 billion, but the company reported an $888 million loss, far exceeding the $294 million net loss in 2014. Similarly, SolarCity’s revenue soared 61 percent in the fourth quarter, and then by 82 percent in the first quarter 2016. The company is enjoying accelerating revenue growth, which is a great sign. But SolarCity suffers from the same woes as most other high-growth businesses. That is, it isn’t steadily profitable. SolarCity lost $56 million in 2015, and losses are still going in the wrong direction. In the first quarter 2016, SolarCity lost $25 million, worse than the $21 million net loss in the first quarter 2015.

Although both companies have been very successful growing sales at a rapid pace, Tesla and SolarCity both have to spend increasing amounts of money to obtain those sales, contributing to their continued losses. As a small company still in its infancy, SolarCity does not yet have the benefits of economies of scale that larger companies enjoy. There are not many cost efficiencies available yet, either in its production or distribution, which would meaningfully help the company achieve consistent profitability.

This is where Tesla’s takeover offers a helping hand. Tesla is offering an all-stock deal that values SolarCity at $2.8 billion. Importantly, the offer does not include cash. This is a wise move by Musk, because Tesla’s stock price has rallied in recent years and now sits above $200 per share. By not offering cash or taking on additional debt, Tesla’s balance sheet is not damaged. And, Tesla would be able to leverage efficiencies of its own, particularly in the sales process. Imagine a consumer paying $35,000 for a Model 3, and then Tesla being able to sell them a similar dollar amount of solar panels, all under the Tesla brand. Since consumers who buy one will very likely need or want the other, Tesla can procure significant cost savings in the production, distribution, and sales process, which would help it reach profitability sooner as well.  

Tesla buying out SolarCity would give the latter company the financing it needs to make Elon Musk’s dream a reality. With SolarCity’s stock price down over 60 percent in the past year, the timing is right from both operational and financial perspectives.

Companies to watch

Now that a major takeout offer has been made for a leading solar panel company, investors are wondering if further consolidation will follow. The solar industry is still highly fractured, with a number of small players including SunPower (NASDAQ: SPWR), Trina Solar (NASDAQ: TSL), and JA Solar Holdings (NASDAQ: JASO), which have market capitalizations below the offering price for SolarCity. As a result, they could be bolt-on additions for utilities looking to diversify into solar electricity generation, or perhaps as a broader industry consolidation for a larger competitor like First Solar (NASDAQ: FSLR).

Bob Ciura is an independent equity analyst. Since 2012, his work has focused on fundamental investment analysis of publicly-traded companies in the energy, technology, and consumer goods industries. Bob has a Bachelor's degree in Finance and an MBA in Finance.