Larger Bank Borrowings Won't Save Tesla

| About: Tesla, Inc. (TSLA)
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Summary

Tesla's recently added borrowing capacity led some news outlets to claim the company would use the increased credit lines to finance its enormous capital needs.

Sorry, but that won't happen.

The added borrowing capacity already has been sucked up by operating losses, inventory build, and letters of credit.

In fact, when one considers the entire picture, it's evident Tesla's borrowing capacity is shrinking rather than growing.

Bottom line: Tesla's survival continues to depend upon continued infusions from secondary offerings.

Last week came the news that Tesla (NASDAQ:TSLA) had increased its borrowing capacity under both its warehouse line and its asset-based loan agreement (ABL).

As often happens when stories involve complex lending arrangements, the news accounts were, to put it charitably, imprecise.

Here is the account at electrek.co:

The deals come as Tesla is expected to increase its capital expenditure to prepare for production expansions at its vehicle factory in Fremont and battery factory in Nevada ahead of the Model 3 introduction next year.

The usually more reliable insideevs.com was even more explicit in suggesting Tesla will use the additional funds for expanding its Fremont factory and Gigafactory in anticipation of the Model 3.

The vast majority of the additional credit is expected to be applied to the Gigafactory and to tool up for Model 3 production.

Both these accounts, along with many others that appeared at other outlets, are misleading. So, with a view to the underlying loan agreements and amendments, let's try to get the story straight.

I. The warehouse line is for direct leasing only

The warehouse facility enables Tesla to expand its direct leasing program. In very simplified terms, here is how things work under the warehouse line:

  • A Tesla subsidiary leases cars to retail customers.
  • The warehouse lenders loan money to Tesla and take as collateral the lessor's rights under the leases.
  • The warehouse lenders then typically "securitize" those lessor's rights by bundling them up, creating a new security (perhaps with various tranches), and selling the security to investors.

Tesla established its warehouse loan agreement with Deutsche Bank (NYSE:DB) at the end of last August. Within a month, with its big push to maximize Q3 deliveries, Tesla had used the entire $300 million facility.

On December 15, Citi (NYSE:C) and its consortium of lenders came aboard for another $300 million (Ancillary question: Is Citi the "new leasing partner" that Tesla in its Q3 shareholder letter announced it would add in Q4?).

Doubling the size of the warehouse line is undoubtedly a benefit to Tesla's direct leasing program. Assuming an average sales price of about $105,000, the added warehouse capacity translates to capacity for an additional 3,000 or so Tesla direct leases.

[Author's Note: I mistakenly calculated the additional number of leases on average sales price. In fact, Tesla values inventory at the lower of cost or market. So, the $300 million probably allows for an additional 4,000 or so Tesla direct leases.]

The added warehouse line capacity helps fill the gap created by the shrinking or disappearance of third-party leasing programs that largely relied on Tesla's residual value guarantees.

Plainly, though, the warehouse line is only to facilitate leasing. Its loan proceeds are not, contrary to the reporting at Electrek, Inside EVs and elsewhere, available for investing in capital improvements.

Of course, cash is fungible. Does having the $300 million in additional warehouse credit free up cash Tesla would otherwise have used for direct leasing and allow the cash to be used for capital expenditures instead? Yes, it does.

But, absent the additional warehouse facility, would Tesla have used $300 million of its own cash for leasing? Some of it, surely, but not all of it, and probably not even most of it.

As a final note, the original warehouse line was required to be fully repaid by September 1, 2018. Tesla's leases making use of the first $300 million likely were predominantly two-year leases. What is the duration of the leases Tesla will make with Citi's $300 million? TBD.

To the extent the warehouse line is used to support aggressive leasing, it merely helps Tesla create more problems and push them over the horizon. Eventually, though, a reckoning must come.

2018 could be a time of reckoning. Tesla's remaining $220 million or so of 2018 convertible bonds come due by May.

Then, in the fall, last quarter's two-year leases will expire. Given the high residual values in those leases, exacerbated by the fact the cars have Autopilot hardware that is now obsolete, there likely will be a flood of used cars coming back to Tesla.

Finally, in November, $230 million of SolarCity convertible notes come due.

II. During 2016, Tesla's effective ABL borrowing capacity shrank rather than grew

The ABL is Tesla's most crucial credit lifeline for sustaining its day-to-day operations. Tesla pledges its cash, inventory, accounts receivable, and equipment as collateral, and in exchange receives a large revolving credit line that includes a letter of credit facility.

1. The Borrowing Base, Established Commitment, and Incremental Commitments

The ABL's "Borrowing Base" calculation determines how much Tesla can actually borrow. The Borrowing Base is the sum of the value of the collateral pledged by Tesla. Tesla's Borrowing Base credit is 100% for cash and 85% for the value of the inventory, accounts receivable, and equipment.

As the value of the collateral changes, so too does the Borrowing Base.

Provided it has a large enough Borrowing Base and meets the various loan covenants, Tesla can borrow up to the maximum "Total Revolving Loan Commitment" (let's call that the "Established Commitment"). In June of 2015, when Tesla and the banks signed the ABL, the Established Commitment was pegged at $500 million.

Under the Third Amendment last February, Tesla's lenders agreed to increase the Established Commitment to $1 billion. And just a few weeks ago, by means of the Fifth Amendment, the lenders increased the Established Commitment again, this time to $1.2 billion.

Also, Section 2.14 of the ABL gives Tesla the right to request "Incremental Commitments" from the lenders that would add to the Established Commitment.

The original ABL set the Incremental Commitments at a total $250 million. It went to zero with the Third Amendment, and now has gone to $50 million with the Fifth Amendment.

Thus, over time, here is the maximum credit available under the ABL:

Why not just fold the Incremental Commitments into the Established Commitment?

Because not doing so is a benefit to Tesla. Tesla pays a "Commitment Commission" (in effect, a stand-by fee) of 0.25% per annum on unused loan capacity, but the fee is assessed only against unused Established Commitment and not against unused Incremental Commitments.

With that background, let's examine the recent ABL amendment.

2. Tesla's available credit has not kept pace with its increased Borrowing Base

As noted earlier, as the value of the pledged collateral changes, so too does the Borrowing Base. Has the increase in revolving line credit capacity kept up with the increase in collateral value?

Determining the amount by which the Borrowing Base has changed will require some approximation. Inventory and accounts receivable are easy enough because they are separate line items on the balance sheet.

Equipment is folded into the "property, plant and equipment" line item, but Note 5 to the balance sheet provides a further breakdown. Let's include the subcategories of:

(1) Machinery, equipment and office furniture, and

(2) tooling,

(3) but exclude the others (leasehold improvements, building and building improvements, land, computer equipment and software, and construction in progress).

Also, because Tesla's cash balance varies wildly with each equity raise, and has no correlation to the company's growth in production or revenues, let's exclude cash as well.

OK, with that out of the way, here's how things look at the end of Q1 2015 (the quarter-end closest in time to the original ABL):

We see the combined value of inventory, accounts receivable and equipment was about $2.4 billion. Valuing the total at 85%, as does the ABL Borrowing Base calculation, brings us to $2.0 billion.

Now, let's take a look at the value of that same property at the end of Q3 2016 (closest in time to the Fifth Amendment):

We have a total value of $4.7 billion which works out to a Borrowing Base of $4 billion. Thus, Tesla's Borrowing Base has increased by about $2.0 billion during the time the ABL has been in place. During the same period, however, the ABL lenders' Established Commitment increased by only $700 million, and their total commitment (Established plus Incremental) increased by only $500 million.

So, with a $2 billion increase in the Borrowing Base, Tesla's lenders extended only an additional $500 million in credit. Does that, as Electrek and Inside EVs evidently believe, speak highly of Tesla's creditworthiness?

Admittedly, my calculations are imprecise. The ABL lenders do not have a lien against 100% of Tesla's equipment, and only they and Tesla know the value of excluded equipment.

Also, as noted earlier, I excluded cash because it varies so wildly and is uncorrelated to Tesla's growth. However, Tesla's cash balance (valued at 100% for Borrowing Base purposes) was $1.5 billion higher at our end point than our beginning point.

Thus, including cash in the calculations would only widen the disparity between the growth in the Borrowing Base and the growth in the ABL lenders' total loan commitment.

What's our conclusion? Even considering the inherent inaccuracies, it's clear the amount Tesla's ABL lenders are willing to commit has not come close to keeping pace with the value of collateral Tesla has pledged.

3. Tesla's increased ABL capacity won't be available for capital expenditures

Let's now examine the belief that most of the additional ABL capacity will translate to more capital expenditures on the Gigafactory and Model 3 tooling.

This belief is mistaken for three reasons.

a. 2016 operating losses already have soaked up all of the added loan capacity

First, Tesla's large operating losses consume a great deal of cash. Through Q3 of this year, GAAP losses were $568 million. Tesla's loss during that period alone outstrips the $500 million increase in the total ABL commitment.

Add in the $550 million GAAP loss from just the final two quarters of 2015, and the more than $1 billion in losses completely swamp the $500 million ABL commitment increase.

More than anything else, it is the continued operating losses that preclude Tesla's use of the ABL for badly needed capital expenditures on the Model 3 production line and new Service Centers.

b. Tesla's growing inventory overhang immobilizes a huge chunk of its borrowing capacity

Tesla's growing inventory also hobbles its ability to use ABL advances for capital expenditures.

Using VIN and other data, Bonaire and CoverDrive calculate that, through Q3 of this year, Tesla had built about 9,400 more cars than it had sold. Some of those cars, of course, are demos, loaners and employee vehicles. Others may have been consumed in destructive testing, or lost in accidents.

Some simple math illustrates this point. The built-but-not-sold (BBNS) number increased by 4,200 between Q1 2015 and Q3 2016. Let's deduct 500 cars as demos and loaners, giving us 3,200. At an average sales price of $105,000, that's about $390 million in inventory. Against that, Tesla has borrowed 85%, or about $330 million. (If you disagree with the inventory numbers I've used, feel free to substitute your own).

Unless Tesla can reduce the BBNS number, that's $330 million of ABL capacity soaked up by inventory build. And, if the BBNS number continues to grow, then Tesla's effective borrowing capacity will continue to shrink.

(CoverDrive expects the BBNS number to grow rather than shrink in Q4. Indeed, to grow by about 2,000. Of course, he could be wrong. There's a first time for everything).

[Author's Note: I mistakenly based the value of inventory on the average sales price. In fact, it would be based on the lower of cost to produce the inventory or market. Consequently, the 3,200 additional BBNS cars would soak up about $230 million of ABL capacity, not $330 million.]

c. Tesla's need for letters of credit immobilizes another large chunk of ABL borrowing capacity

As noted earlier, the ABL includes a letter of credit facility. The November 2015 First Amendment doubled the facility from $100 million to $200 million.

Tesla does not disclose its outstanding letters of credit. However, it is a fair surmise that at least some Tesla trade creditors have demanded letters of credit to protect themselves from any TSLA payment default.

(Tesla's history of product delays would be enough to make parts vendors wary, and its lawsuit against Hoerbiger Automotive Comfort Systems cannot have helped matters).

The problem with outstanding letters of credit is that so long as they are outstanding, and even if they are never drawn, they soak up ABL loan capacity. If the total amount of outstanding letters of credit has increased since the ABL was put into place, then there is that much less cash available to borrow.

Interestingly, Tesla's balance on the ABL at the end of Q3 was $200 million. Why, with $3 billion of cash on hand, would Tesla have any debt outstanding under the ABL unless it was for letters of credit?

III. Tesla's continued existence is completely dependent on further secondary offerings

Unable to generate a profit, the only thing that has kept Tesla alive so far are continuous infusions of capital. It's doubtful Tesla's history of operating losses will come to an end in 2017 or 2018.

As detailed above, the company's expanded borrowing capacity is at best only a tiny part of the solution to Tesla's need for the billions more in capital it needs to roll out the Model 3.

Indeed, when one considers operating losses, inventory build, and letters of credit, Tesla's borrowing capacity went backward rather than forward this year. The Model 3 needs include not only further research and development, tooling, testing, equipment lines, paint facilities, and Gigafactory expenses, but also an immense outlay for raw materials, work-in-progress, finished goods, and spare parts. And, as well, a huge investment in expanding sales and service staff and distribution facilities.

The idea that the newest additions to Tesla's secured lending will come close to funding these immense capital needs is pure fantasy. Tesla's fate depends upon the public capital markets. While the bond market has become unaccommodating to Tesla since the 2014 convertible bond offerings, the stock market remains fortunately friendly.

If, however, Tesla were to struggle to find buyers at secondary equity offerings, its share price could collapse overnight.

IV. Further Imprecision In Electrek's Reporting

The Electrek story linked to earlier begins:

After market close today, Tesla announced that it closed two deals last week with Deutsche Bank to increase two credit lines by $200 million and $300 million respectively - for a total of $500 million more in available financing.

In a hyper-technical sense, that sentence is accurate. However, the new player in the warehouse line - and the most crucial signatory to the amendment - is Citi, not Deutsche Bank.

Also, Deutsche Bank is only one of the 10 different lenders that signed the ABL's Fifth Amendment.

Eight of those were the existing lenders: Bank of America (NYSE:BAC), Citibank, Credit Suisse , Deutsche Bank, Goldman Sachs (NYSE:GS), JPMorgan Chase (NYSE:JPM), Morgan Stanley Senior Funding (NYSE:MS), and Wells Fargo (NYSE:WFC).

The other two lenders are the source of the additional $200 million in lending availability: Barclays Bank PLC (NYSE:BCS) ($175 million) and Royal Bank of Canada (NYSE:RY) ($25 million).

V. Musk's Subterranean Inspiration

Cloister Research has the goods on Elon Musk's latest deep thought: tunnels. Evidently frustration at being stuck in car traffic prompted staggering neural traffic in the cerebrum of The Inspired One, who suggested that "tunnels (yes tunnels)" are the solution.

(MS goes both to the sun and to the underground).

As usual, CoverDrive, in his wry and dry style, nailed it:

To address the traffic issue, perhaps he envisions a network of tunnels beneath a city. You could operate electrically propelled trains in the tunnels. It's actually an idea that could work.

VI. The Bigger Picture

Many of us here tend to focus on Tesla and only Tesla and ignore the larger forces at work in the financial and investing worlds. And it is those larger forces that may have more influence on Tesla's ultimate destiny (or fate) than, for example, loan lines and inventory builds.

My virtual friend, The Nattering Naybob, wrote an intriguing piece recently about some of those larger forces.

(Special thanks to Art Director, Nathaniel Nabob).

As always, Naybob writes with erudition, humor and stylistic flair. His work is a pleasure to read, even if you disagree with his take.

A Note of Thanks

I received valuable help this time from notasmidgeon, Bonaire and CoverDrive. My thanks to each of them.

As always, I'm 100% responsible for any errors.

Disclosure: I am/we are short VIA OPTIONS.

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.