Tesla 'Going Private' Story Does Not Make Sense

|
About: Tesla, Inc. (TSLA)
by: EnerTuition
Summary

Tesla's going private story does not add up at many levels - it is difficult to see a way to make this deal work.

We explain why the transaction does not make sense and potential rationale for promoting this unlikely transaction.

We believe Tesla is far more troubled than investors realize.

Tesla (TSLA) CEO Elon Musk caused quite a stir on Tuesday by announcing on Twitter that he is intending on a going private transaction at $420 a share. After a chaotic day, the stock ended up 11% at about $380.

Will Tesla go private at $420?

Call us skeptical. The logic is simple. At $420 a share, Tesla's market cap would be over $70B. On top of that, Tesla has about $20B of debt and working capital deficit that would likely need to be refinanced in the event that it goes private. In effect, we are looking at about $90B deal.

Elon Musk is suggesting that public stockholders will have an option to convert to private Tesla stock. However, this is not possible for many funds because the rules governing them may not allow for investments in private companies. Similarly, in case of individual investors, many investors would likely not be able to, or not choose to, invest in private instruments. Depending on the number of shareholders that convert, Tesla could be looking at somewhere in the neighborhood of $30 to $50B in funding requirements in a best-case scenario.

Given the sheer size of the transaction, it is extremely unlikely that funding for this transaction was secured without Wall Street Investment Banker involvement. As of the writing of this note, financial reporters are unable to find any Wall Street IB house involved in such a transaction.

The Transaction Does Not Make Much Sense

In private placements (also referred to as Private Investment In Public Equity or PIPE), investors routinely get a discount to the current stock trading price. In this deal, if Elon Musk’s tweets are to be believed, Tesla will be asking these investors to pay more than the market rate.

For what? It is unlikely that the new investors are going to gain control.

So, what exactly is it that the investors are getting? Will this offering be some form of preferred equity or include warrants? If so, it is kind of silly to say the takeout price is $420.

Debt is possible but makes even less sense as the company is already heavily burdened and has no positive cash flow. Doing a tens of billion dollars of debt driven deal for an EBITDA negative company does not pass the smell test and is highly questionable to say the least.

So, what could be the rationale behind Elon Musk going this route?

Possible Motivations Behind The Deal

Note that there was no discussion of the “going private” transaction in the Q2 earnings report last week. Also, there was no hint of any such development in the 10-Q filed on Monday. How is that Elon Musk has drawn up the offer and made so much progress with funding with nary a disclosure?

And, what has changed within the last few days for Elon Musk to introduce this new Hail Mary scheme into the capital markets?

We have a theory:

Firstly, it is increasingly likely that Tesla does not have access to the public markets for unknown reasons. Otherwise, it would make very little sense for Tesla to be not raising equity with such a precarious balance sheet.

Secondly, we suspect that CEO Musk increasingly realizes the gravity of the situation at Tesla and wants to avoid the probing eyes of the public markets as the company makes hard decisions about the future.

Let us look at this from implications of “going private” offer well above the current stock price and see what it means.

  • The immediate impact of the offer is an elevated stock price. This may help in many ways including convert conversion. For example, the much talked about Tesla converts need stock price to stay above $360. This could be one of the many key liquidity events for the company. A conversion here would be necessary – especially if Tesla does not access the capital markets.
  • High stock price is valuable in many subtle and not-so-subtle ways, including acquiring talent, stock option exercise proceeds, supplier settlements, talent acquisitions, etc.
  • Going forward, much of Tesla related discussion will be about the going private offer instead of other issues at Tesla such as production, quality, demand, cash flow, profitability, etc. This “going private” makes for a nice distraction from the core issues that trouble Tesla.
  • Time frame wise, it is probably 6 months to a year before any deal can get done. In the meantime, Tesla can bypass certain investor questions about Tesla's future because of "pending sale" and corresponding strategy changes.
  • Ongoing negative results may not impact the stock as much since the stock price will be supported by the going private offer.

Looking Forward

However, if Mr. Musk has overplayed his hand with respect to this going private PR, he could be in some significant legal and regulatory trouble.

According to former SEC Chair Harvey Pitt, quoting a specific amount for the takeout offer and saying “funding secured” would constitute fraud if those proclamations are not true. As such, we wonder if there is basis for the quoted “going private” price and if funding has been secured. If there are problems on this front, it is for the regulators to determine if CEO Musk’s “going private” tweets constitute a fraud. However, whether it is fraud or not, news of no real funding for the deal would likely be a negative for the stock.

For the time being, we remain very skeptical that this is legitimate offer that can be executed.

Disclosure: I/we 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. I have no business relationship with any company whose stock is mentioned in this article.