Short-sellers in Tesla get burned again as Musk floats plan to take firm private

“A very experienced – and successful – hedge fund manager once told me that he never shorted high-flying, popular stocks until they had at least halved, because that was when confidence would finally begin to crack and shareholders would start to sell on the rallies and not buy on the dips. The latest action in Tesla’s share price reinforces the wisdom of these words,” says Russ Mould, AJ Bell Investment Director.

“Tesla’s shares jumped 10% to $380, their highest level since last September, after its chief executive and major shareholder, Elon Musk, floated a plan, via Twitter and then a blog on his company’s website, to take the company private at $420 a share.

“Unconventional as these channels are for such a major announcement, no rules on stock market communication were broken following a ruling five years ago from the Securities and Exchange Commission on the use of social media as a means for updating shareholders.

“However, the share price’s failure to immediately reach the putative $420 offer price speaks loudly of wider scepticism as to the plan and this is understandable for several reasons.

• The proposed price. The $420-a-share offer equates to a total market valuation of $71 billion, given the 170 million shares in issue at the end of the second quarter. Mr Musk already owns 20% of the company, but that still leaves him needing to find $57 billion from somewhere, if he had to buy out every other shareholder (something which admittedly he says he does not want to do). Were Tesla itself to take on that debt, that would be a huge burden for a company which is in loss, consuming cash and has net borrowings of $8.7 billion.

Source: Company accounts

• Funding. Tesla already has substantial debts and is still in loss. Even if Mr Musk is correct in his forecast that Tesla will break into profit in the third quarter of 2018, the firm still operates in a highly capital intensive and competitive industry (where its market share is less than 0.5% worldwide). To fund his ambitions for the firm, Mr Musk will surely be better off tapping public markets for equity and debt than trying to raise funding privately, especially as the Tesla’s 2025 bonds, for example, are rated Caa1 by Moody’s, B- by S&P – in other words, heavily into ‘junk’ territory so new borrowings would be expensive. Why not simply tap eager and supportive shareholders for freely available capital?

• Markets’ short-term outlook. Complaints from Mr Musk about having to dance to Wall Street’s tune and meet quarterly earnings expectations are perfectly understandable, as fitting near-term financial requirements around long-term strategic planning must be a nightmare. However, this argument is weakened by Mr Musk’s penchant for tweeting and public commentary, as well as the publication of self-imposed production targets for the Model 3 vehicle in particular, which Tesla has then consistently failed to meet. He is now at it again, predicting a breakthrough into profit in the second half of 2018, so some of the pressures are self-inflicted, though the cynical might be tempted to argue that Mr Musk has every incentive to goose the share price higher. Two convertible bonds are due to mature in the next nine months and if the shares do not reach a certain level then the bonds will not convert to equity and will instead have to be repaid. That would drain $1.1 billion from Tesla’s already dwindling $2.3 billion cash pile at what could be a pivotal moment in the company’s plans to ramp production. The good news, from Tesla’s point of view, is that yesterday’s surge takes the share price above the $359.9 mark required to encourage holders of the $920 million March 2019 to convert from debt to equity upon maturity of the bond. That would ease a major cash concern for the company.
  

Source : Company accounts

• Mr Musk’s control of the company. Mr Musk insists the move is not about control. Yet the 2016 purchase of Solar City, a firm where he was the lead shareholder and his cousin the chief executive and whose strategic attractions were questionable, and his unwillingness to tap the markets for fresh equity (even though investors would readily hand over fresh cash) suggests that his grip on the company is a firm one and he would like to keep it that way.

“It is unclear how Mr Musk will proceed from here, given the lack of clarity over the timing or funding mechanism for any move to take Tesla private.

“The spike in the share price at least takes Tesla’s stock nearer to one of the trigger points for one of the soon-to-mature convertible bonds but the best thing that the company could do is meet is own targets for production and profitability.

“At the moment, the company’s losses are rising in tandem with its output, which suggests that its manufacturing operations are not as efficient as they could be and even questions whether a $35,000 Model 3 is feasible, at least in the near term, if the $75,000 version is causing so much near-term operational and financial trouble.

“But a switch from making losses to profits and from burning cash to generating it would go a long way to convincing any doubters, and putting short-sellers to the sword, and Mr Musk therefore needs to be careful that he does not fall into the trap of putting as much effort into managing his share price as he does into managing the operational assets and strategy of the company.”

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