I don't really know any more what Elon Musk has to do to prove that he might know a thing or two about what he's doing. But ask a pundit like the one here and their first reaction invariably seems to be extreme skepticism. "It doesn't make any sense!" Should be their mating call. The reason why Musk's decisions have always confounded those in the mainstream essentially comes down to the fact that they're, well, good.

If it was easy to create two billion-dollar companies, everyone would do it including the pundits who attempt to follow the breadcrumbs left for them. Instead of jumping to the conclusion that Musk must be making a mistake because his motives are not immediately obvious to us (people who do not have direct knowledge of the inner-workings of these companies) why don't we see what happens if we give him the benefit of the doubt (just for now!) and see if we can find potentially logical explanations for the move.

Tesla: The Future of Energy Storage

Ever since Musk announced the gigafactory I've been trying to explain to people that the company is pivoting away from being a niche automaker and toward being the world's largest energy storage provider and that I suspect this was the plan all along. The math isn't complicated. Despite its rapid growth rate Tesla Motors won't compete with major automakers for decades. At the current rate the gigafactory is being built, in just a couple of years Tesla will be the largest manufacturer of lithium-ion cells .. in the world ... by an order of magnitude. If you want to call the largest producer of batteries in the world a car-maker just because it makes cars too, that's your prerogative. But if you cannot imagine the potential synergies that would result from combining a company that stores energy with a company that generates energy, I kindly request you try to exercise your imagination.

Solar City: A Decentralized Power Plant

Solar City was always intended to be a decentralized power plant. Its customers leased the panels Solar City installed on their roofs while Solar City remained their owners. Technically, Solar City simply deposited a small piece of its own power plant on its customer's homes and charged them for energy consumption just like any other energy provider except for the fact that since the panels were located on the customer's property Solar City doesn't have to own or lease any property and transmission of the energy is highly efficient because the source of the energy (the panels) is extremely close to the final destination (the customer's home).

Arguably the biggest problem with solar panels is energy storage. If the sun isn't shining, you don't have any energy. Clearly this is a place where Tesla can provide massive synergies by providing the cells necessary to store the solar energy. In addition, there would be ample opportunity to cross-promote. Most people interested in owning a Tesla are likely to also be interested in installing solar panels. Who wouldn't want a complete solution made by a single company which would insure that everything worked together nicely, had great design, competitive pricing, and top tier customer service? If in 10 or 20 years we are all going to be driving solar powered electric cars, who do you think is currently positioning themselves the best to dominate that world?

This Is The Tesla Model

Those failing to understand the thought behind the potential acquisition (which Musk said they've been thinking about for years, not exactly a rush-job) fail to understand the company itself. Tesla's innovation was not in car manufacturing, it was in battery-pack design. While everyone else was searching for the Holy Grail of batteries, some new technology that would catapult them into the future, the people at Tesla understood that their most powerful tool was economics. Companies like Panasonic were already mass producing cheap, energy dense, battery cells for use in electronic devices like laptops. Why not bundle them together to create inexpensive and powerful battery packs?

In a sense, the cars were always merely a container for their real technology: low cost, energy dense, battery packs. The cars simply give them a pre-existing customer. If you make batteries, you have to sell them. In order to sell them you have to find customers and then compete for their business. Finally, once you do that, you sacrifice the ability to make the profits your customer is about to make when they use your batteries to make something else.

This is one part of the secret sauce that makes Tesla so valuable. Their product is batteries. They have excess demand for their product because they make other products (called the Model S and Model X) for which there is also a surplus of demand. The more demand there is for their batteries, the more economies of scale they achieve, the cheaper they can make their batteries (and their other products which incorporate them) and the more they can lower their prices to beat their competition.

It is, I believe, this same dynamic which drove them to accelerate their Model 3 timeline. It is my view that this car is already more or less production-ready considering they gave test drives at the unveiling and committed to the $35K price tag. The key bottleneck was achieving sufficient demand for the car to justify producing the cells at sufficient scale to make the economics of the whole thing work. Once they reached 400k pre-orders and realized just how much demand there was going to be for their cars (and so their batteries) they accelerated the timetable. Note how this also makes them incredibly competitive. By accelerating their timetable they are that much earlier to market than their competitors.

If their goal is to dominate the energy storage game, and not just the automobile game, then this goal is even better served. They were always going to be the largest producer of cells in the world, now they're going to be ramping up production faster than anticipated. Who exactly is going to be able to make more cells at a lower price than Tesla in 5 years?

Prediction: This Is A Done Deal

From that perspective Solar City makes all the sense in the world. It provides yet more demand for Tesla cells which enables Tesla to ramp production of cells at an even faster rate thereby achieving even greater economies of scale at an even more rapid pace. Not only that, but Tesla supplies demand for Solar City panels! Don't forget that those massive gigafactories which will be some of the largest buildings in the world by footprint ... ARE COVERED IN SOLAR PANELS. Now let's take a step back and view the big picture. Tesla is a battery maker. Its model involves building products which create demand for their cells. The automotive sector is huge, so going that direction makes sense. Energy is even bigger.

Hell, this might have been the plan all along

That Solar City was Musk's idea, as usual, is being interpreted as proof that his ego is out of control and that this, as opposed to rational thought, is guiding his behavior (facepalm). Tesla fans will be used to this analysis. He thinks he can disrupt the automotive industry? Look at the ego on this guy! He thinks he can do better than NASA and send rockets into space? Look at the ego on this guy! But consider this, "In what context do you think Musk came up with Solar City?" Do you think that in the midst of working 90 hour weeks to build Tesla Motors and SpaceX simultaneously he was day dreaming about innovative energy production models? In that case he would have to be precisely the genius his critics are claiming he is not!

Could it be the case, just maybe, that he came up with the idea for Solar City while thinking about the future of Tesla Motors? Of course that's how he thought of it! But he was obviously in no position to start a power company! How do you think his investors would have taken that? They were already nervous as hell that he was building two incredibly complex businesses with monumentally ambitious goals that were hemorrhaging money!

I'm not saying he knew it would play out like this, but I will say that when he thought up Solar City he was thinking about how it would fit into Tesla Motors, and when he gave it to his cousin to run he no doubt considered the possibility that if everything went according to plan, when Tesla was better situated, the companies would be merged. The fact that Solar City is going through some hardships right now only strengthens the argument. Better to buy it when the price is low because the real value of the company, its "destiny," will only be achieved once it is merged with Tesla. At that time Musk's vision will finally be "made whole." Good luck betting against that!

The future is powered by lithium and by merging with Solar City Tesla might just own it