In this article, I will explain why traditional models will be inaccurate in estimating the course of events for the share price of Tesla Motors (TSLA) by breaking down the terms of the Tesla's offering. I will also update a few components of the model outlined in my previous article to take into account recent events. A background reading of that article may be necessary to understand the reasoning outlined here.
There has been a lot of effort to value Tesla Motors by traditional methods. The usual approach is to estimate future earnings, then estimate the value that investors would be willing to pay for these earnings. However, the price that investors are willing to pay is an important determinant of future earnings.
The Recent Offering Demonstrates this Phenomenon
Tesla was able to raise more than $1 billion dollars in a stock and bond deal. This sum is much larger than what was originally planned (source). The demand for an investment in Tesla was so strong that the company was able to up the size of the offering. Thus, the extra cash raised will be able to grow production beyond Tesla's previous expectations.
Let me repeat: Tesla will be able to produce more cars this year than previously expected. This is why I believe that Tesla will produce more than 20,000 cars in 2013. More importantly, the terms that Tesla got on this offering were incredible.
The Stock Component of the Offering
3.4 million shares went for $92.24 a piece - indicating that the huge buyers gobbling up the stock did not demand a discount from market. In fact, they were willing to pay an 8.7% premium to the market price before the deal - a rare event in secondary stock offerings. This indicates the strength of the positive perception surrounding this company.
The stock component of the deal so far has raised $313 mm, with a possible addition of $46 mm if the underwriters opt to purchase the additional shares they are entitled to. Because the stock is currently above the price of the offer, I believe there is a good chance that Tesla will raise this additional capital.
The Hidden Risk of Insider Ownership
Elon Musk personally grabbed $45 mm worth of the shares of this offering, and has indicated interest to buy another $55 mm from Tesla in an additional offering. As I discussed in the previous article, this actually may be a risk, rather than a benefit to shareholders.
In the section of the 10-K titled "Risks related to the Ownership of Our Common Stock", the company stated that Elon Musk had taken out loans from Goldman Sachs to invest in shares of the company. This means his personal portfolio is vulnerable to a margin call. This can grow dangerous in the event of a decline in the stock, as the prior lessons Chesapeake Energy (CHK)and Green Mountain Coffee Roasters (GMCR) have shown us.
There is no way of knowing the status of the leverage used in a private portfolio. Thus, if Mr. Musk remains highly leveraged, the purchase of an additional $100 mm worth of stock might be increasing the risk of a margin call to his portfolio in the future.
The Bond Component of the Offering
Tesla also raised an additional $600 mm in bonds, with underwriters retaining an option to acquire $60 mm more. These bonds went for an astoundingly low 1.5% interest rate.
For comparison's sake, the U.S. Treasury note for the same time period (5 years) was 0.91% on the day of the offering. This means that investors are in such a hurry to grab Tesla's bonds that they are only charging the company an interest rate slightly above the risk-free rate.
Why Tesla Paid Off its Government Loans
In my previous article, I had explained that the agreement Tesla entered to get the DOE loans stated that it had to stay below a certain ratio of total liabilities to equity. So, I argued, Tesla's only option to raise capital was to issue new shares.
These sorts of restrictions were worth it when the deal from the DOE was better than anything it could get on the market. But the average interest rate on the DOE loans was 1.6%, actually higher than its latest offering. Investors are so eager to invest with Tesla, that they are giving the company better terms than the government did.
When Tesla can get better terms on the market, without the stipulation of a set liabilities to equity ratio, it makes financial sense to pay back these loans early. Thus, Tesla is freed from its restrictions, and can now rely on both equity and debt leverage to increase its capacity and grow its earnings.
The Positive Bias is Strong
The demand for this offering shows that investors still believe in the Tesla story. The company can use this to its advantage to get good terms on financing, and grow its capacity.
The traditional model of stock valuation does not take into account the relationship of perception and fundamentals. I believe that current models are underestimating how rapidly Tesla will be able to scale up its production. Thus, even at these high valuations, Tesla's stock still has room to increase, on the back of a cycle of increasing positive bias leading to increasing earnings, and vice versa.