Tesla Raises Small Capital And Large Questions

| About: Tesla, Inc. (TSLA)
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That capital raise Tesla just did – you know, the one a few weeks ago Tesla said it didn’t need. Is it just me, or was it a bit odd?

Equity owners may be gamblers, but bond buyers are more sober sorts. The new convertible notes tell the tale of how much riskier Tesla has become.

And you're impressed Musk is putting $25 million into Tesla when, at the same, SpaceX is taking $165 million out? Because I'm not.

Tesla spent $132 million simply to hedge the new bonds. Question for Tesla longs: why did Tesla pay so dearly for capital it claims it doesn’t need?

Is Tesla really going to sell Model 3 "release candidates"? If so, Tesla must believe the risks it faces are existential. Investor beware.

As The Wall Street Journal wrote last week when Tesla (NASDAQ:TSLA) announced its latest offering, a billion dollars isn't what it used to be.

While a lot of money in an absolute sense, Tesla is an ideal candidate to issue as much stock as it can. It had $3.4 billion in cash and equivalents on its balance sheet to start the year, but that money, along with the cash from the offering, is likely to go quickly; Tesla's operating cash flow was negative $448 million in the fourth quarter.

Count me as among those surprised by how small this offering was. But the small size of the offering wasn't the only surprise. Let's survey the scene.

A. Another promise reaches its expiration date.

From last month's 10-K:

We expect that our current sources of liquidity, including cash and cash equivalents, together with our current projections of cash flow from operating activities, will provide us with adequate liquidity over at least the next 12 months based on our current plans.

As my earlier articles underline (for instance, here and here), I didn't believe that claim. It took Tesla only three weeks to tacitly acknowledge I was right.

(photo from Tesla's web site)

B. Why so small?

The final results appear to be $850 million in convertible notes and another $350 million or so in stock, for total proceeds of $1.2 billion.

Obviously, having unequivocally predicted an imminent capital raise, I'm not surprised Tesla raised money. However, as I remarked earlier, I was stunned at the small amount.

Why didn't Tesla seek more this time? I've seen a few theories.

Let's start with Tesla's explanation: the amount it raised was all it needed. Obviously, for the reasons I've detailed in recent articles, I don't believe that.

It's not just me, of course. UBS sees $35 billion in Tesla capital needs over the next few years, and even if the number is half as small, the difference between what Tesla just raised and what it truly needs is one of magnitude rather than size.

If you still believe Tesla raised all it needed, then ask yourself why Tesla had any over-allotment option at all. Why dilute its shareholders more than was necessary?

And why allow $100 million up-sizing in debt (from $750 million originally announced to the $850 million actually issued)? Debt, after all, requires current interest payments.

The debt service on the new notes will, just by itself, chew up a good portion of Tesla's revenues from its only profitable product: ZEV credits and other regulatory credits.

I've also seen a theory that Tesla's existing shelf registration limits its dollar amount runway, and Tesla wished to avoid filing a new registration statement because of the additional disclosures that would require.

The May 2016 registration statement gives Tesla (which is a "Well Known Seasoned Issuer") all the runway it needs for another two years.

So, I settle on the most obvious theory: the amount Tesla raised was all it could raise. The market just won't bear any more, at least right now. Indeed, the deal was announced Wednesday evening and by Friday's close was "broken" (with the stock trading below the $262 offering price).

Considering the underwriters' over-allotment option ("greenshoe") is only 190,000 shares, it's doubtful the underwriters will be able to support the $262 price for very long.

I feel confident predicting Tesla will be back for more capital, likely before Q3 ends and certainly before the year ends.

Perhaps enthusiasm about the Model 3's production model will stoke the market flames once again, and Tesla will have an easy time raising more capital.

Or perhaps concerns about that model's timing and price, or overall deterioration in the auto market generally, will have the opposite effect.

All TBD. But either way, Tesla will need more capital this year.

C. This deal is getting worse all the time.

Let's compare the terms on which Tesla offered its five-year convertible notes in 2014 with the terms offered this time.

The five-year notes issued in 2014 bore interest at the per annum rate of 0.25%, and their conversion price was 42.5% above the last reported share price at issuance.

By contrast, the five-year notes just issued bear interest at the per annum rate of 2.375% and their conversion price is only 25% above the last reported share price.

The more generous terms for the recent issuance are in part a function of rising interest rates. However, rising interest rates explain only part of the difference. The remainder is attributable to the heightened risk the market is now pricing in.

Like all Tesla (and SolarCity) bondholders, the holders of the just-issued 2022 notes come behind the secured lenders of Tesla and SolarCity. And, it would seem, those secured lines are just about tapped out.

In terms of debt maturity, the buyer of the 2022 notes moves to the back of the line behind the holders of 2019 and 2021 Tesla convertible notes. And behind the ABL lenders (the ABL matures on June 10, 2020). And behind an immense load of high interest SolarCity debt (including three convertible note issues which mature before 2022).

That SolarCity debt, of course, was not Tesla's burden in 2014. It was undertaken only last fall in the great bail-out merger.

The only riskier things in Tesla's capital structure than its just-issued 2022 convertible bonds are (1) some SolarCity debt with even later maturity dates, and (2) Tesla stock.

Tesla shareholders, of course, will receive no coupon payments (or dividends, or other distributions) to partially compensate them for the risk they are taking.

D. Tesla's hedges make the deal even smaller than it appears.

As disclosed in its Prospectus, Tesla will use some of the proceeds from the capital raise to purchase hedges so that, if the holders of the notes eventually exercise their conversion option, Tesla shareholders will not be diluted.

How much did that protection cost? A handsome $131.5 million.

Who will immediately profit from those hedging transactions? Why, Tesla's underwriters, of course. They are acting as brokers, or counterparties, or both.

So, in considering that Tesla just raised about $1.2 billion, you can subtract $131.5 million from the total to get the net proceeds actually available for things such as the Gigafactory, the Model 3 production line, and new Service Centers.

E. Montana Skeptic has a question.

Tesla will pay a much higher interest rate on the just-issued five-year notes than it did in 2014. Indeed, to carry those notes, Tesla will pay a much higher interest rate than it enjoys under the ABL.

And those five-year notes went out at a much lower conversion price than did the notes issued in 2014.

On top of all that, Tesla incurred a huge expense for hedges.

So, tell me, Tesla longs. Why did Tesla just pay so much for capital it claims it doesn't need?

F. Goldman Sachs: "What, you want to pay $262 for stock we believe is worth $187? Be our guest."

The lead underwriter on the latest offering was Goldman Sachs.

At the time of the offering, Goldman Sachs had a TSLA price target of $187.

Reflect on that.

G. Musk chipped in $25 million. But what did SpaceX walk away with?

Musk made quite a show of buying $25 million of the issued Tesla stock. But, considering his related company, SpaceX, what is his actual net position in the capital raise?

SpaceX holds $90 million of SolarBonds (issued by SolarCity) coming due in March. Has Tesla repaid those bonds, or did SpaceX agree to roll the debt?

SpaceX holds another $75 million of SolarBonds coming due in June. Will Tesla, in effect, use the proceeds just raised to repay its affiliate?

In undertaking its latest capital raise, Tesla did not disclose the answers to these questions.

Consider whether Tesla is being transparent with investors if it trumpets a Musk $25 million stock buy, but is quiet about having Tesla repay $165 million of related debt.

There's more similar drama ahead. Next January, $100 million of SolarBonds come due to Elon Musk and the Rive brothers.

Does anyone believe a "business reporter" from electrek or insideevs or Motley Fool or CNBC might trouble themselves to inquire, at the next conference call, about the SolarBonds held by SpaceX, or by Musk, or by the Rive brothers?

H. Is Tesla rushing the Model 3 out the door?

Last Thursday, as it launched the capital raise, Tesla arranged a private conference call with select analysts and investors. Out of that call came the rumor Tesla is going to dispense with testing a "beta" (Tesla terminology) version of the Model 3:

Anton Wahlman has the goods on the private call in a terrific piece here.

Surveying reports about the call posted at Reddit, followed by articles at insideevs and electrek.co, Wahlman writes:

Now Tesla says - allegedly, on this call - that it's skipping the Beta Prototype stage and going directly to "release candidates."

The idea, evidently, is that Tesla is confident it has learned so much about auto manufacturing that it can safely dispense with the year or so of intensive testing that typically would occur for a new model, and instead soon begin selling the "release candidates."

If indeed such is Tesla's plan, then for all the reasons detailed by Wahlman in his article (and by me and others many times in the past), it sounds like risky business indeed.

EnerTuition lays it on the line in his recent article: if reports of the phone call are accurate, Tesla has just materially increased the prospects of its insolvency.

Why, with such risks, such an extraordinary rush?

I'll offer a theory: Tesla deliveries in Q1 are as good as it's going to get this year. Tesla demand is highly dependent on subsidies. But subsidies and tax breaks are now shutting down in several key markets including Norway, Hong Kong, Germany, and the U.K.

The problem of disappearing subsidies is compounded by growing cannibalization of Model S demand by Model 3 anticipation. Why pay $80K for a low-end Model S when you can pay $35K for a Model 3 that is only 20% smaller?

(And, no, obviously, I don't believe the Model 3 in anything like a desirable configuration will cost only $35K. But many deposit holders do believe that, having been endlessly assured by Tesla and its fawning press agents that such is the case.)

Tesla appreciates the huge risk of placing the Model 3 into consumer hands before the car has undergone proper testing. But Tesla may feel it's a risk it simply must take.

Why? Because Tesla already sees a significant drop-off in demand for its Model S and Model X. Tesla simply cannot afford for its growth narrative to collapse. Without the growth narrative, the stock price also collapses.

The risks are great but, to Tesla, the dangers of not taking the risk are existential.

I never attempt to predict the direction of the Tesla share price. As I have written before, Tesla is where finance meets religion. The share price has been and remains completely divorced from fundamentals.

But if Tesla truly is determined to rush the Model 3 into consumer hands, then I think one needs to be brave indeed to continue to hold this stock.

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.