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Tesla : Let’s Gamble.

|Includes: Tesla, Inc. (TSLA)

Summary

Tesla is still in dire financial situation and cannot afford to pay its convertible debts using cash.

Forecasted need for cash up until end of Q1 2019 is $2,3 billion.

Probability of Tesla share prices being lower than $359.87, thus being forced to pay its debt using cash remains relatively high despite recent surge in tesla stocks price.

(Monte Carlo)

Both short sellers and long investors know that Tesla is in precarious financial situation. With working capital approaching negative 2.5 billion US dollars, huge (albeit drastically cut) $1,25 billion capex expenditure projection for remaining year and $920 million worth of convertible senior notes which are due in March 2019 with conversion price of $359.87 per share (p94-95) , Tesla cannot afford to pay March 2019 debt back using cash, either due to risking further delays in bringing new models to the market (if you believe in long narrative) or risking default on debt (if you think that financial markets are closed for Tesla). In this article the main task I decided to take is to look at the probability of Tesla’s meeting its share price targets using Monte Carlo Simulation under three different scenarios: Neutral scenario, Optimistic and, of course, Pessimistic too. But before we start to throw dices let’s talk about financials.

Tesla’s needs for cash.

8K SES filling for second quarter 2018 has brought us updated insight into Tesla financials, with CoverDrive’s predictions being close as usual, bringing us total net loss of over 742 million USD. Combining that with 609 million of CapEx, we have got another huge cash burn quarter, soothed by increased negative working capital to circa $2,5 billion and rising the level of debt by over $1,1 billion. As a note of utmost importance, it is interesting to see balance sheet consisting only two periods current quarter and q4 2017, completely omitting comparison with previous quarter, perhaps because increase of long term debt looks much more rosy, when comparing it to Q4 2017 instead to Q1 2018, by whole 650 million USD.

But, since focus of this article is not nit-picking of deliberate or accidental omissions of some financial data, let’s focus on projected future cash need up until end of Q1 2018, when $920 million of convertible bonds are going to be mature. To do this I have used Coverdrive’s modified projection, combined with Tesla guidance for incoming CapEx.

Q4 2018 Q1 2019

In this exercise I took official Tesla projections for model 3 production rate, gross margins and forecasted Capital Expenditures, while using most of other assumptions used by CoverDrive. Some people might take a note that CapEx remains unchanged regardless of ramp in production of model 3. The reason is simple: I am unsure to which extent I shall increase Op Ex, thus decided to leave it unchanged, since the purpose of this article is not precisely forecasting future profitability and cash flow but evaluate probability of Tesla’s need to pay back its debt using cash.

As we can see, if we use optimistic assumptions, Tesla might become profitable in Q1 2019, while using $2.34 billion of cash to get there. Taking into account fact, that Tesla at the end of Q2 2019 had in cash little over $2.2 billion dollars, it is clear that Tesla cannot afford spending over $920 millions on convertible debt due in 1st of March 2019, even if some part of cash needed to keep light on would be acquired from existing credit agreements or by entering into new ones.

Conditions of Convertible senior notes due in March 2019.

In Tesla Q4 SEC 10K filling page 94-95 “In March 2014 Tesla issued $800 million in aggregate principal amount of 0.25% Convertible Notes due in March 2019 […] In April 2014, we issued an additional $120 million in aggregate principal amount of the 2019 Notes.” (Additionally with 1.38 billion due in March 2021, which is not the topic of this article) “Each $1000 of principal of these notes is […] equivalent to an initial conversion price of $ 359.87 per share, subject to adjustment upon the occurrence of specified events” As we can see, the conversion price is clearly mentioned in the SEC filling, however Tesla has opened itself a gate to “adjustments upon the occurrence of specified events” , namely “If a fundamental change occurs prior to the applicable maturity date, holders of these notes may require us to repurchase all or a portion of their notes for cash at repurchase price equal to 100% of the principal amount plus any accrued and unpaid interest. In addition, if specific corporate events occur prior to the applicable maturity date, we would increase the conversion rate for a holder who elects to convert their notes in connection with such an event in certain circumstances.”

There is, however, another way to convert tesla 2019 bonds into shares, if “(1) during a quarter in which the closing price of our common stock for at least 20 trading days (whether or not consecutive) during the last consecutive trading days immediately preceding the quarter is greater than or equal to 130% of the conversion price”, which is $467.831 per share. “Upon such a conversion of the 2019 Notes, we would pay or deliver (as applicable) cash, shares of our common stock or a combination thereof, at our election. “

As we can see, SEC filing is quite clear when and how such bonds can be converted into shares, where share price equal to $359.87 is a goal tesla cannot afford to miss, with another price target of $467.831 per share which, if met, can be used to convert tesla 2019 bonds into shares, thus saving Elon Musk headache how to gather $920 million up until March 2019.

Methodology behind the gamble

As I mentioned at the beginning of this piece, the main aim of the article is to perform Monte Carlo simulation, thus evaluating probability of Tesla’s meeting price targets to convert its 2019 notes into shares.

If somebody is not interested with reading boring details about method used to get there, please feel free to skip this part of the article and scroll down to findings.

I have decided look into three scenarios: neutral, optimistic and pessimistic. In Neutral Scenario (which some people might find overly optimistic anyway) I used closing Tesla stocks price data from last five years period to compute mean, daily and annualised standard deviation and variances to establish trend which has been used to perform Monte Carlo with 5000 random samples for each of scenarios. Both other scenarios: Pessimistic and Optimistic also starts from base 5 years trend of Tesla share price history, but additionally incorporate either effect of extremely positive or extremely negative event. In Optimistic evaluation I introduced for last 30 trading days the most positive 30 days long trend from Tesla stocks history, which, I believe can reflect a very positive event such as presentation of Model Y somewhere in February or signing an agreement for building Chinese Gigafactory. In pessimistic version I started from assumption that tesla financial situation is still precarious, and the longer Elon Musk will wait with announcing new capital rise the more risk of default will be priced in Tesla stocks price, thus pushing shares price further down if the price will hoover somewhere below $359.87 per share. Similarly, to optimistic scenario, for pessimistic version I gauged an effect of such negative mood by introducing for last 30 trading days the most negative 30 days long trend from Tesla stock history, which can somehow simulate the effect of such uncertainty.

In each scenario I have tested two situations:

- probability of reaching $359.87 price target

-probability of reaching $467.83 price target

After having the results, the last step was to calculate combined probability of reaching one of those two price targets.

Findings

Perhaps surprisingly for many readers, after publishing of Q2 report causing surge in Tesla stocks price, the probability of reaching the price target equal to $359.87 per share on 1st of March 2019 remains still relatively low, with 58% chances for Normal, and just 15.4% for Pessimistic scenarios, while 78.9% chances for Optimistic scenario puts results in the bracket of relatively high odds. We must remember, however, that chances of NOT REACHING the price target, thus paying $920 million back in principals alone remains still high 42% for Normal Scenario and whooping 84.6% chances for Pessimistic scenario while for optimist there is still 21.1% chances for need to pay the debt in cash.

Scenarios

Chance for reaching

normal

Optimistic

Pessimistic

$359.87

58.0%

78.9%

15.4%

$467.83

34.7%

69.7%

2.7%

$359.87 or $467.83

72.6%

93.6%

17.7%

(Source: Author)

From other hand, if we combine chances for reaching one of two price targets, situation looks much better, relatively from if you have neutral, bearish or bullish view on Tesla stocks, having almost certainty for meeting price target (93.6%) for optimistic scenario, high chances (72.6%, i.e. 27.4 %, quite similar to 24.1 percent of the face value of the 2025 bond on Monday.) for neutral scenario or just 17.7% if you believe in bear thesis.

(distribution for samples for each of the scenario source: author)

Final takings:

As we could see, debt problem which tesla faces is a serious one, where either future growth or survival of the company is at the stake. The Monte Carlo simulation, while useful with evaluating risks depending on different effects of future events this time brings us only more uncertainty. For Bears it is a warning that if Tesla will manage to keep stocks price up, it might just make it through March 2019, thus spiking even higher after that date, for Bulls it should bring a wake-up call, that tesla is still under existential threat and for investors neither long or short, it should remind to do very careful due diligence before investing in Tesla to very high uncertainty of the future.

This evaluation also helps interpret behaviour of Tesla’s CEO Elon Musk, who has not other choice but to “pump” the stock price as much as it is possible, thus acting in the best interest of Tesla shareholders as every responsible Director of a company would do. Shorts (including yours truly) should keep that in mind.

Special thanks for Bill Cunningham, who was extremely kind and helped me with understanding some of accounting nuances. Thank you, sir, once again!

Disclosure: I am/we are short TSLA.

Additional disclosure: I am/we are short TSLA, but might reconsider my position within 72 hours.