A quick word about Tesla: It is not going bankrupt

Tesla’s bonds tested new all-time lows this week, hovering around 87.75 cents on the dollar as negative headlines continue to shake confidence of investors. To quickly review the updates, JP Morgan has now downgraded the company just after upgrading it up on the now infamous “Funding Secured” tweet from Elon, the Saudi Arabian sovereign wealth fund that was seen as the funding provider has now been reported to actually be in talks with Tesla rival Lucid Motors for investing a material stake, and lastly, Elon had a recent emotional interview in The New York Times.

But now with reports of concern among suppliers related to Tesla and headlines coming out about the company’s bankruptcy, I want to make something very clear…

It is not going bankrupt.

At least not yet, that is. First of all, we need to separate the recourse debt vs. non-recourse debt. The company has ~$3.2BN  of non-recourse debt, mostly related to Solar backed notes and other auto and dealer plan securities in which debtors have no recourse to Tesla, but do have recourse to some certain collateral. A lot of these are asset-backed bonds related to Solar City, which are issued from a bankruptcy remote vehicle, have claim on cash flows from solar assets only and are also very long-dated and not of much concern (2038-2049 maturities).

TSLA Cap Table

 

Second, Tesla has $4.2BN of unsecured convertible notes, some of which the company can settle in stock and some of which are well out of the money. The 0.25% due 2019, the 1.25% due 2021, and the 2.375% due 2022 will be settled in cash. The converts due 2020 are also in the money and will likely be settled in stock and is relatively small. The rest are out of the money. As such, you can subtract ~$1bn off of this number.

Lastly, the bulk of the remaining debt is the unsecured notes quoted above that are trading at ~88 cents on the dollar.

To make one thing clear, just because the bonds are trading at 88 cents DOES NOT IMPLY BANKRUPTCY. It simply reflects the higher risk associated with the bond. As interest rates moved up recently, a lot of longer dated bonds have gotten crushed. Do you think 3M is going bankrupt too? Because their 2026 bonds trade at 92. What about Microsoft? Their 2026 bonds are trading at 93.5. If treasuries move up and credit spreads of the issuer stay the same or widen slightly, then bond prices must fall. Tesla’s credit spreads widen some, sure, but they were issued with a 5.3% coupon when treasuries were super low.

Therefore, while Tesla is funding a lot of its growth with capex that is hurting cash flow that is only one reason why the bonds are where they are. The move in rates had a larger impact, in my view, and the yield on the bonds is still ~7.3%, which is somewhat high, but not implying bankruptcy. (Some companies issue new debt in the high yield market with 10% yields… investors would not buy that if they thought it was a greater than expected chance of bankruptcy than surviving, it just reflects higher chance of it happening or higher credit risk).

Plus, I’ve mentioned it a lot, but this is a 2025 bond. There are no covenants. The company literally doesn’t have to worry about it until August 2025. The thing to also keep in mind is that $1.6BN of debt with banks (at a super low rate of 1% + LIBOR) and this $1.8BN debt due 2025, is $3.4BN in the context of a $54BN equity capitalization.


Let’s say Tesla wanted to reduce its debt TODAY, but needed to take it out with equity issued at an extreme discount to today’s levels. As shown below, it could take out all the convertible debt and all the credit agreement debt by issuing equity at a 25% discount, or $240 / share, and easily take it down. Sure, they would dilute themselves, but the company survives. This is just a simple example and we will show further below how large the equity cap is in relation to the the debt and total capitalization of the company.

TSLA Share Issuance 2

While headlines try to make Tesla’s debt load seem large… $5.8 BILLION or even $11 BILLION (which includes non-recourse debt which is not correct), the amount is simply is not that big compared to the $55 BILLION market cap. If it had this much debt and only a $1BN market cap, then OK, I’ll start to buy the bankruptcy case. Let’s also not forget that they have $2.2BN of unrestricted cash on the balance sheet…

Capitalization of TSLA


Lastly, reports of Tesla suppliers are complaining about Tesla asking for better terms? Well welcome to Auto companies friends! Auto OEMs always pressure their suppliers for better terms. Why? Because the suppliers are beholden to a select few companies (GM, Ford, Honda, etc.) and those select few companies operate in very hard and bad businesses. As such, they are always squeezing their suppliers margins to stay afloat.

Sorry to disappoint — This article has nothing to do with valuing Tesla’s equity.

But since you asked, would I buy it here? No. I’ve always viewed Tesla as just another auto company operating in a space where they are all piling tons and tons of cash into the industry to catch up. Does Tesla have a great competitive advantage? I don’t really think so, they just have the first mover advantage. As Warrant Buffett says,

“ You give me a billion dollars and tell me to go into the chewing gum business and try to make a real dent in Wrigley’s. I can’t do it. That is how I think about businesses. I say to myself, give me a billion dollars and how much can I hurt the guy? Give me $10 billion dollars and how much can I hurt Coca-Cola around the world? I can’t do it. Those are good businesses.”

I think others will put a dent in Tesla because I view auto companies as challenged. The industry is hyper competitive, so I think people will pour cash to chase Tesla, as mentioned. People also have a wide variety of tastes that auto companies must keep up with year-after-year and make sure they stand out against competition.  The companies also must simultaneously manage very complex supply chains on a global scale. Lastly, cars are high-ticket items, so if consumer confidence falls or we enter a recession, its easy to defer a car purchase. Meanwhile, car companies must then eat the fixed costs.

They are just bad businesses. Simple as that.

 

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