Tesla’s Mountain of Debt
The chart is from Tesla’s U-turn Puts it Back at Square One on Cash. I added the boxes in blue. The reason will become apparent in a moment.
> With a debt load of about $10.5 billion and the possibility of an impending cash shortfall, Wall Street expects the luxury electric carmaker may need to raise funds before long.
> Tesla, which has had just one quarter of positive free cash flow since the fourth quarter of 2013, has $1.3 billion in debt coming due in the next 12 months. Meanwhile it has just $1.3 billion of cash on hand after backing out $942 million of customer deposits on cars.
> With analysts forecasting a slowed, but continued, cash burn in the second half of 2018, Tesla may need to borrow up to $2 billion by the end of the year to stay afloat.
Convertible Bonds
> The most likely option, according to analysts, is a convertible debt issue. Convertibles give owners the right to trade their debt for equity after shares rise over a certain price. They allow holders to benefit from a rising share price, while also offering bond-like protection if it falls.
> The one challenge of using more convertible debt, however, is “that it drives more short sellers to your stock. And Musk does not want that,” said Jeffrey Osborne, senior research analyst, Cowen Inc.
Straight Debt
> Tesla could issue straight debt akin to the 5.3 percent coupon junk bond coming due in 2025. That bond however, is trading well below par at 87.13 cents on the dollar, and so it would be unlikely that Tesla could get the sort of favorable terms they secured in their last offering.
Equity
> Musk said, on the company’s second-quarter earnings call, that he would not tap them for cash. “We’ll not be raising any equity at any point… I have no expectation of doing so; do not plan to do so.”
[My Comment: Not only would the SEC investigate Musk for selecting that option, Equity solutions would also represent shareholder dilution.]
Lease/Asset-Backed Deal
> Tesla could securitize automotive leases backed by drivers’ monthly payments as it did earlier this year when it sold $546 million of bonds backed by leases on Model S and Model X cars.
> There are two problems with issuing new asset-backed securities.The first is that old vehicles may not sell for as much as expected given the increasing competition Tesla is facing in the electric vehicle space. Second, leases as a percentage of vehicles sold have fallen dramatically as it is not possible to lease a Model 3 sedan. While roughly 20 percent to 30 percent of Model S and Model Xs were leased, the Model 3 must be paid for in cash.
Convertible Bond Arbitrage
Investopedia breaks down Convertible Bond Arbitrage
> Convertible bonds are sometimes priced inefficiently relative to the price of the underlying stock. To take advantage of such price differentials, arbitrageurs will use a convertible bond arbitrage strategy. If the convertible bond is cheap or undervalued relative to the underlying stock, the arbitrageur will take a long position in the convertible bond and a simultaneous short position in the stock. In the event that the price of the stock falls in value, the arbitrageur will profit from its short position.
> Since the short stock position neutralizes the potential downside price move in the convertible bond, the arbitrageur captures the convertible bond yield. On the other hand, if stock prices rise instead, the bonds can be converted into stock which will be sold at the market value, resulting in a profit from the long position and ideally, compensating for any losses on its short position. Thus, the arbitrageur can make a relatively low-risk profit whether the underlying share price rises or falls without speculating as to which direction the underlying share price will move.
Tesla Short Position
I do not know how much of that short position comes from convertible bonds but I am confident it’s a considerable amount.
It’s also a price insensitive position, not subject to a short squeeze as Musk implied.
Meanwhile, unless Musk ramps up sales, which seems highly unlikely do to a parts shortage, he has a decision to make.
Question at Hand
Dear Elon, if you have to raise capital, what’s your poison?
Bonus Question
Dear Elon, please elaborate on what you meant by “Force Majeure”. By any chance are suffering from a severe parts shortage?
Related Articles
- Exploring Tesla Share Price vs Short Interest
- Force Manure: Tesla Way Short of M3 Goals, Silicon Carbide Shortage Explanation
Disclosure: I am short Tesla via staggered PUTs.
Mike “Mish” Shedlock
Great article, Mish. A lot of people don’t understand that convertibles lead to shorts, and that often the shorts don’t care if the price goes up or down. Issuing convertibles is not that much different than issuing stock. You still have to find buyers for all the shares. You need buyers for the shares that will arise from conversion as well, because the bond holders essentially create them by shorting.
According to my calculations the upper ceiling of how many shorts could be CB hedges is only 1/3. This is assuming the unlikley scenario that all $4B of Convertible Bond owners are hedges and not genuine longs.
I got to this number by remarking the last known short position of $10B shorts@$300 to the average CB conversion price @$360. So $4B/$12B = 1/3. For CB hedges to be price insensitive they must be hedged 1:1 between long leg and short leg, hence remarking to 360 is required.
There are no other positions that are short stock and are properly hedged for upside (e.g. short stock+long stock OR short stock+long call option don’t make sense to me as arbitrage oppurtunity because they burn money through short fees or option decay). And short stock+short put is not really hedged for upside. So this particular position is price sensitive in case stock goes up.
Let me know If missed any other positions that are short stock and also properly hedged for upside?
Also, among 4B CB owners some could be “long cb, short call option” positions taking away room from “long cb, short stock” positions.
So, for sure, more than 2/3 of shorts ARE price sensitive in case stock goes up and would have to buy hedge (CB, stock or long call option) in case stock goes up.
Good article except for speculation that a parts shortage is going to prevent a sales ramp for 3rd quarter made at only a month into that quarter. These debt figures have been known to the market for a long time (although nice to see well graphed). We will see what happens to the picture when 3rd quarter financials are released.
There are three possible “funding” sources that are not discussed in this article and could be used to pay off bonds:
Musk on his Mars mission: “People are going to die”. Musk on his EV mission: “Investors are going to die”.
Musk could sell some of his shares and use the proceeds to pay down debt. But his ego won’t allow that.
IF, there comes to be an unexpected need, perhaps Musk makes Tesla a 0% loan with option to convert? Then Tesla does not suffer the straddle short implication. He is dedicated to the success of the company above all else.
1) There WILL come a need.
2) Unlikely Musk has the cash to loan to the company — the uber wealthy are typically asset rich and cash poor so he’d have to borrow the money at a commercial rate and lend at 0% i.e. not happening. In the unlikely event that this did happen it would be a signal to investors that the funding market was shut to Tesla and that would likely be hugely detrimental for the stock.
3) Anyone with a pulse knows that Tesla is in its death throes as a going concern. The only question that remains is whether the brand survives or whether it goes the way of DeLorean.
coming to a theater near you