Tesla Inc Model 3 Junk Fever May Be Its Biggest Win In Months

Tesla Inc isn’t a normal company. CEO Elon Musk has never massaged a profit from its business, and its appetite for expansion is only matched by investors’ desire to be a part of it. If you thought that institutional bond investors were going to be more skeptical of the firm’s stories, however, you should think again.

Tesla debt is reportedly offering its unsecured interest rate at 5.25 percent. That’s a very low rate given the kind of financial state that the company is in. All of the ratings agencies have put the firm’s credit rating firmly in the “junk” sphere. That usually implies an interest rate much higher than 5.25 percent.

Tesla Inc junk rate rumored

The rumored 5.25 percent coupon on the bonds comes from The Wall Street Journal. Sources familiar with the deal relayed that number to the outlet.

Standard & Poor’s analyst Nishit Madlani told the paper that the ordinary rate for firms with a rating like Tesla’s was 6.6 percent to 7 percent. Tesla coming in so much lower than that, assuming it’s able to sell its bonds, is a dramatic statement of confidence in the firm by Wall Street.

When discussing the “irrational” valuation of Tesla Inc stock, bears and skeptics ordinarily make arguments based on the gullibility of the average investor. The more conspiratorial minded even argue that Elon Musk is in fact taking direct advantage of these “rubes.”

These bonds, however, aren’t being sold to the ordinary man on the street. They’re being sold to large institutional investors. They have valuation models and they employ analysts. Despite that, however, they’re going to give Tesla Inc a very inexpensive loan. That’s not the only thing they’re giving up, either.

Elon Musk negotiates easy bond conditions

This debt is organized as “unsecured senior debt.” That means that Tesla Inc isn’t offering any specific collateral for these bonds. If the company isn’t able to pay off its obligations, however, debt holders will be able to come in and seize assets.

Because of the specific structure of this deal, however, Tesla will be able to push investors in this deal down the list. It could do so, for example, by promising certain assets, like the Gigafactory, as security for a future bond deal.

If this were to occur, the investors in this week’s deal would be pushed down the list. This would have the effect of making it less likely that they would be able to recover their investment in the case of a default.

The bond covenants also allow the firm to pay out dividends, offer as much more unsecured debt as it likes, and sell whatever assets it likes. It’s normal for debt with a junk rating to have conditions which make these things impossible, or at the very least restrict them.

That’s because junk bonds are usually sold by firms with spottier financial histories. That’s the case with the books offered up by CFO Deepak Ahuja. Elon Musk’s firm is a poor one financially, but investors appear to be willing to treat it like a much more reliable company.

Tesla Inc keeps cash levels high

The bond offering that it announced this week is part of the firm’s push to get the Tesla Model 3 into mass production before the end of the year. The firm showed that it had around $3 billion cash on hand at the end of June, but it’s burning that fast. In the three months up to the start of July, the firm spent down more than $1.1 billion.

There are also expiry dates coming up on some of the firm’s older loans. It may have to spend down a certain amount of cash in order to close those debt agreements. So this bond offering is, at least in part, about rolling over the firm’s massive debt pile.

Tesla Model 3 Design. Source: Tesla Motors
Tesla Model 3 Design. Source: Tesla Motors

Since it came into existence, Tesla Inc has raised around $10 billion from investors. Through June 2017 it had spent a total of $7 billion of that, leaving it with a bunch of assets and $3 billion in cash. If it manages to sell these bonds quickly, the firm will have somewhere north of $4 billion in cash.

Will Wall Street fund Tesla forever?

It’s clear that Tesla Inc is getting over this particular hurdle. Over one third of the firm’s junk bonds are reported to have been sold already. It’s expected that the remainder will be sold in the coming week or so.

The question for those following Tesla stock, however, is how long that’s going to last. The firm has huge plans for expansion. It seems terribly unlikely that it’s going to be able to generate enough cash to make those investments itself. That means it’s likely that we’ll see Elon Musk return to capital markets again and again.

There’s nothing necessarily wrong with that. Lots of firms, including carmakers, operate under a lot of debt. It’s part of the nature of a highly competitive, capital intensive industry. As Tesla has never really shown an earnings capacity, however, the firm’s story could be different.

Counting Tesla Stock

As anybody holding Tesla stock will know, the shares can be very volatile. The firm’s rise has come in midst of an almost uninterrupted bull market. Money has been pouring into the stock market, and Tesla has benefited from it along with everyone else. The firm’s “story stock” background has helped it to keep a high valuation in the face of grim realities.

If the bull market is interrupted, by real recession or some sort of stock market problem, Tesla Inc could be in trouble. If investors are less willing to go into risky assets in general, they may be much more unlikely to invest in something like Tesla stock. For those betting on the company, questioning the depth of Wall Street’s pockets should be an ongoing concern.

Despite that, however, the firm’s first bond deal appears to be going off without a hitch. This is the best deal the firm has made in months, and a key moment in its financial history. The danger is far from passed, however.

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