Technically speaking, Tesla Inc (NASDAQ:TSLA) CEO Elon Musk was completely honest a few days ago when he said he wouldn’t be issuing more TSLA stock to raise some much-needed cash; no new shares are being sold. The company is issuing $1.8 billion worth of bonds instead of selling newly minted shares of Tesla stock.
These aren’t your garden variety bonds, however. This latest round of debt qualifies as high-yield bonds, which is the more polite way of calling them “junk bonds.”
Is it just a coincidental, circumstantial classification bond investors don’t need to worry about, or is the weak safety rating from Moody’s as well as Standard & Poor’s a message the market — including fans and followers of TSLA stock — would be wise to heed?
One Man’s Junk…
Few have argued that Elon Musk didn’t bring mainstream legitimacy to the idea of electric cars. But, one of the chief criticisms of Tesla since it went public in mid-2010 was the organization’s never-ending need for new funding with nary a (GAAP) profit to show for it.
Tesla’s appetite has been getting ever bigger too, with the company now raising a total of nearly $10 billion since the beginning of 2013 through the issuance of new TSLA stock and bonds; $3.8 billion of that funding has materialized this year alone. And as has been the case with Tesla stock from its inception, the latest batch of debt has not only spurred cheers as well as jeers, it has been highly polarizing.
The nay-saying first points out key shortcoming of the bonds themselves. That is, they’re unsecured debt without any guarantee that Tesla won’t issue more senior debt in the future. In other words, should the company proverbially hit the skids, owners of these particular bonds would be last in line to collect on the value of its remaining assets (if there are any).
In the meantime, there’s no built-in guarantee that Tesla has to make interest payments to these bondholders before it uses its cash for any other purpose.
The biggest impasse on the horizon, of course, is what bond-rating outfit Moody’s described as the “sizable near-term credit risks” of the Model 3 production ramp-up that was a “make or break” event for Tesla.
The end result: Standard & Poor’s rates this debt a B-, and Moody’s has categorized it as B3… classifications reserved for junk bonds, and not even the top tier of junk bonds at that. That’s why the bonds are paying a very robust 5.5% of their face value — to reflect their high level of risk. For perspective, the average yield on investment-grade corporate bonds right now is closer to 3.6%.
On the other hand, supporters of the company were quick to point out the bond market didn’t even flinch at the weak terms of the bond. In fact, demand was so strong, the company revised its initial plan to only issue $1.5 billion worth of the bonds to a total of $1.8 billion. It’s the market’s tacit way of saying it believes in the Tesla story, and will buy into it any way it can … especially with the recent runup from TSLA stock making it the less desirable way of doing so right now.
Bottom Line for TSLA Stock
The bonds in question in and of themselves aren’t likely to end up going bust; Musk knows the fallout of doing so would severely damage Tesla’s ability to raise any funds in the future. He’s not going to let that happen.
On the other hand, by wading into junk bond waters, Musk has inadvertently sent a message of weakness to all investors. That is, he knows the fiscal outlook — at least in the near-term — isn’t so pretty, and he had to do what he had to do in order to ramp up production of the Model 3. It’s not a stretch to say he issued the not-so-good unsecured debt because he knew he’d have to offer higher-quality bonds in the foreseeable future to finish the ramp-up of the Model 3’s production.
There’s also the not-so-crazy theory that Musk has switched to debt rather than issuing stock because he doesn’t want to further dilute his personal, controlling stake in the company. Augmenting that theory is the simple fact that now, while its price is so high, is the ideal time to issue more Tesla stock.
Whatever the case, though the market has interpreted the debt-based fund-raising as a glass-half-full affair, this chapter of the Tesla story is actually a glass-half-empty turn of events.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
