Should Investors Hit the Brakes on Tesla?

by Ethan Roberts | May 17, 2013 11:07 am

Every investor dreams of buying a stock that doubles or triples in a really short period of time … though few ever achieve that lofty dream.

But what if, three months ago, you were told that if you bought Tesla Motors (TSLA[1]) at $35, that by May it would be worth $90 or more? Would you have believed that and acted on it? Most investors would not.

Nevertheless, Jim Woods wrote in February that a big selloff in TSLA was a buying opportunity[2]. And boy, was he ever right! Since March, Tesla Motors has ridden a wave of favorable reviews and improved sales to a sweet gain of nearly 165%! Interestingly, for most of that time, there were no insider buys and even a few insignificant automatic sales up to $50.

This week, however, the company announced that it is creating a concurrent public offering of 2.7 million new shares and $525 million in five-year convertible notes[3]. CEO Elon Musk is going all-in with a purchase of $45 million of Tesla stock, and he also will purchase an additional $55 million in a private placement, for a total of $100 million.

Talk about putting your money where your mouth is!

Tesla expects to raise $830 million on the deal, and will use part of the money to pay off some debts, including a $452 million Department of Energy loan it received for the development of the Tesla Model S electric car.

A convertible note, or bond, is a financial instrument that provides investors with income and the option to convert the bonds into stock if the company’s share price rises by a preset amount. The Tesla convertible bonds will yield in the 1.5%-to-2% range, and the bonds can be converted into stock if Tesla shares rise another 35% from their current price.

While Musk’s actions show a huge degree of confidence in his company, the question is, should investors follow his lead and buy after a 165% gain over a short time frame? Similarly, is another 35% in price appreciation asking too much for the bonds to be a good deal?

Let’s look at some recent developments.

First-quarter 2013 sales rose 83% from a year ago to $562 million, and the company earned 12 cents per share, exceeding the analysts’ expectations of just $499 million and 4 cents per share. More notably, this was the first time in 10 years that Tesla had produced a profit.

The Tesla S electric car has been the darling of recent media stories. Consumer Reports called it “the best car we’ve ever driven.” The Tesla can go about three times as far on one battery charge as the other electric cars on the road today. Tesla also has started to install its own network of charging stations between Boston and Washington, D.C., as well as in California. It’s not surprising that sales have been so strong.

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But is the stock too hot right now? A look at the accompanying chart shows that TSLA shares have gone downright parabolic. The announcement of the new offering after the bell Wednesday sent the stock up another 8.7% Thursday. Technical indicators — such as the 14-period RSI (green shading) and Stochastics — are now tremendously overbought. Tesla stock is very far extended from its base at $35, and from the 200-day moving average at $36.30.

That suggests that while human emotions could still propel this stock higher, the potential risk has now become greater than the reward. We are likely to see some very volatile days ahead for TSLA, both on the upside and the downside.

I think it’s also asking a lot for the stock to jump another 35% before the bonds can be converted to company stock.

However, given the enormous potential for the Tesla S car to continue bashing the competition, the long-term should prove to be very profitable for this stock. The paying-down of company debt also is a positive for TSLA.

Prudent investing advice says to be a buyer on pullbacks and to not chase the current hype and the excitement, lest you get caught buying at the very top of this move. However, because Tesla stock has run up so far and so fast, it is difficult to predict where pullbacks will take it. The gap up to $70 should act as support, so that is the most likely place, but when investors throw caution to the wind on a hot stock, anything can happen.

For now, try to put the brakes on any impulse to jump in on Tesla, and even if it should go a bit higher, let’s wait for the stock to come back to Earth before we take our money for a test ride.

As of this writing, Ethan Roberts did not hold a position in any of the aforementioned securities.

  1. TSLA:
  2. buying opportunity:
  3. 2.7 million new shares and $525 million in five-year convertible notes:

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