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What The Bond Market Is Telling Tesla Shareholders

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Tesla has over $9 billion in debt with maturities ranging from 2018 to 2049 (for Solar asset-back loans). The original interest rates are as low as 0.25% (convertible debt) to as high as 7.7% (Solar asset-backed loans). To get a read on the debt market’s outlook for the company, looking at the $1.8 billion that was raised in August last year gives an indication that creditors and the rating agencies have become incrementally negative on the company.

A recall for 123,000 Model S’ sent Tesla’s shares down $6.63, or 2.5%, in Thursday’s after-market trading to $259.50, which almost erased the $8.35 gain during the day. This is after they were under tremendous pressure the past week and after falling the previous two weeks. For the week the shares were down $35 or 12% to $266 and since its most recent high on February 26 they are down $91 or over 25%.

Equity investors should pay attention to changes in a company’s debt , as it can foreshadow future issues for the company and its stock. While I believe Tesla is far away from debt repayments potentially being a problem, as most investors know secured debt holders are paid back before equity investors.

August 2017 debt trading at a 12% discount

Tesla’s August 2017 5.3% debt that is due in August 2025 is trading at a 12% discount, or 88 cents to the dollar, a new all-time low per FINRA. This means debt that was sold for $1,000 is now worth $880 and its implied interest rate is approximately 7.5%. The bonds had been trading in the low $900’s before Moody's downgraded the company’s credit rating on Tuesday, so they were at a discount already.

It could be that the debt market is warning about potential problems or it could be they are overly concerned and the debt is offering a great buying opportunity. We should have incremental information early next week when Tesla’s provides preliminary March quarter production and delivery results.

FINRA

Moody’s downgraded Tesla’s credit rating

Bruce Clark at Moody’s Investor Service believes that “Tesla continues to benefit from solid market acceptance of Models S and X, which collectively hold over a third of the US luxury market. In addition, third-party evaluations of the Model 3 remain favorable, consumer response to the vehicle is sound, and advance purchase reservations and deposits remain high. Finally, regulatory support for battery electric and zero-emission vehicles continues to grow.”

He added, “The negative outlook reflects the likelihood that Tesla will have to undertake a large, near-term capital raise in order to refund maturing obligations and avoid a liquidity short-fall.”

On Tuesday Clark downgraded Tesla’s credit rating from B2 to B3, which is the lowest rating of Moody’s B category. By taking Tesla’s rating to B3, this means Tesla’s debt is considered “speculative and subject to high credit risk.”

He also downgraded its rating for the company’s unsecured debt from B3 to Caa1. By moving Tesla’s unsecured debt to Caa1 it moves to a lower category. It means Tesla’s unsecured debt is “speculative of poor standing and are subject to very high credit risk.”

Lastly, he changed the outlook for the company from Stable to Negative. Overall these changes may force some bondholders to sell based upon their internal rules.

Burning cash and upcoming debt maturities

Tesla’s free cash flow was about a negative $3.5 billion in 2017 due to its $3.4 billion in capital expenditures, Moody’s is concerned about the company’s large capital expenditures and the $1.15 billion in debt that matures in the next 12 months. There is:

  • $230 million due in November 2018

    • Issued in October 2013 by SolarCity
    • 2.75% convertible notes
    • Conversion price of $560.64
  • $920 million due in March 2019

    • Issued in March 2014
    • 0.25% convertible notes
    • Conversion price of $359.87

It will be extremely difficult for Tesla’s shares to hit the $560.64 conversion price, but the $230 million should be manageable. It is the $920 million a year from now that is more challenging . The company’s shares have traded above $360 so they could get back there. However, management should plan on having to pay it off vs. hoping for the debt to be converted to shares.

Cash outlook

Tesla plans to spend a bit more in capital expenditures in 2018 than the $3.4 billion in 2017. Assuming:

  • $3.6 billion in capital expenditures for 2018
  • $750 million in capital expenditures in the first quarter of 2019
  • And $1.15 billion to refinance the maturing debt
  • Tesla will need about $5.5 billion in cash from the beginning of 2018

Tesla had $3.37 billion in cash at the beginning of the year and Moody’s assumes that it needs to have at least $500 million on hand for normal operations. This means it could use $2.8 billion of its cash, leaving a $2.7 billion shortfall.

So unless the company can generate a lot of cash this year (its operating cash flow was only a negative $61 million in 2017), it will have to either raise around $2.5 billion in debt, tap into its asset backed lending, or ABL, facility or sell more shares.

It also won’t be able to refinance this debt with nearly as favorable of terms. Since the current debt is trading around 7.5%, any additional debt would probably be around a 10% or higher interest rate.

It will be critical for Tesla to demonstrate that it is making substantial progress with its Model 3 production ramp and that it can do so profitably. If it can, then the debt concerns will become a back burner issue and the stock could also rebound. If the company can’t hit its revised production schedule or make investors feel comfortable that any shortfall won’t impact it, then there is further downside to the debt and equity prices.

If you want to understand Elon Musk’s new stock award plan and how it compares to Tim Cook’s, check out my article,How Elon Musk’s Stock Award Compares To Tim Cook’s”.