Tesla's Recent Financing May Bite Back

Mar. 3.14 | About: Tesla Motors (TSLA)

Tesla (NASDAQ:TSLA) just announced a $2 billion bond financing as a first step in putting together an approximately $5 billion package to fund a "gigafactory" to produce batteries for up to 500,000 vehicles annually. The battery capacity is a key part of Tesla's planned growth and without the factory or some other large scale source, battery supply would limit Tesla.

Notwithstanding the need, I don't like the financing terms. The 0.25% bonds are cheap enough and the conversion rate of 2.8 Tesla shares for every $1,000 bond is favorable to existing shareholders.

So why don't I like it? I have three reasons, all very critical.

First, the deal does not completely fund the new battery factory which will very likely take a couple of years to build. Reports that Panasonic and some suppliers might put up another $1 billion is encouraging, but it will still leave $2 billion to be found. The time taken to fund the project could delay it.

Second, the financing apparently has appeal to short sellers who can buy the bond and sell short the stock, with the bond providing a cap on losses if the short bet does not work out. The Wall Street Journal commented:

Encouraging short sellers is a dangerous path for a growing company, in my view.

Finally, and perhaps most importantly, the bonds come due in 5 years. A five year term is very short in the automotive world. Car markets are cyclical and do not grow monotonically, even for Tesla.

A sharp downturn in the market could occur at some point and possibly just as Tesla needs to refinance the bonds. If the market conditions are adverse, Tesla will face some challenges in getting the money it will need.

The financing was an important step for Tesla. It is pretty clear that operations will not generate enough cash to repay the bonds in a short five years, with cash flows today just able to keep up with spending on fixed assets and research and development. As a Tesla bull I would have preferred it if Tesla had raised straight equity leaving its balance sheet open for bank debt if the balance of the funding need did not come from partners and suppliers.

Longer term if Tesla avoids refinancing issues, the battery initiative should pay off. Volume of 500,000 vehicles a year will necessitate 2 assembly plants and very likely capital costs of another $1 to $2 billion for assembly capacity over and above the gigafactory outlays.

The payoff at annual volumes of 500,000 or so is considerable.

My crude Tesla model at 500,000 vehicles a year produces annual revenues of $40 billion more or less and net income approaching $6 billion, almost $50 a share. I have used 2019 as a target date but reaching a scale this great could easily take a year or two longer and to an extent depends on how long it takes to build and start up the gigafactory.

I assumed two assembly plants and two car models and used the Model S and proposed Model X as representative, using average selling prices of $90,000 for the more expensive car and $65,000 for the mid-tier vehicle with a 60:40 split of volumes; put R&D spending at $1 billion and bumped SG&A to $1.2 billion in coming up with ball park figures.

Source: Michael Blair analysis

The numbers for this 2 plant operation look very high at first blush but do not surprise me. As a long time CEO in the automotive parts industry, I have reasonable belief that hidden in General Motors and Ford there are high volume plants that have impressive economics.

Readers should interpret my very crude Tesla calculations as order of magnitude figures and not put too much reliance on them. They are intended to simply make the point that if Tesla can expand without running into a liquidity crisis and reach volumes on the order of the capacity of the planned gigafactory, very solid financial results should follow.

I do not own Tesla shares at present and prefer to wait for a market sell off to consider buying. I like the company but a lot of its growth is already in the stock price and I can see plenty of speed bumps that might impede growth at such a high rate for a 5 year period.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.