Tesla Model 3 Junk Debt Ended Up Paying For Solar City Mistakes

tesla model 3

tesla model 3Tesla, Inc. made headlines in recent weeks after the firm’s attempt to take on new debt went even better than expected. The firm managed to secure around $1.8 billion in funding at an interest rate of just 5.3 percent. For a firm with “junk” debt ratings across the board that’s a very good showing. Those who were expecting the firm to spend the surplus on the Tesla Model 3, however, may be a bit disappointed.

On Wednesday evening Tesla made a filing with the SEC that showed it decided to use the new cash to pay off old debts. Those debts weren’t originated at the firm, however. Instead they came from Solar City, the Elon Musk driven solar installer that the executive convinced Tesla to acquire last year. The payment amounted to $325 million.

Tesla pays down old debts

According to the filing the debt that Tesla paid down appears to be pretty similar, in interest rate at least, to that which the firm took on in August. The date on the repayment was August 17th. That’s just a week after the firm managed to sell the $1.8 billion in bonds.

The debts that Tesla paid off were non-recourse loans with collateral. “Non-recourse” means that the creditor can not pursue anything other than the collateral in the case of a default. Tesla’s new money came in the form of unsecured debt. That means that there was no specific collateral involved. The nature of the covenants on the new debt meant that those who bought the bonds had very little protection in the case of a default.

That may be good enough reason for Tesla, Inc. to have used the new money to pay down Solar City debt. Because of agreements with other banks, the company isn’t allowed to guarantee the debts of that unit. It can, however, use cash on hand to pay back the creditors.

When the new bonds were issued the firm said that its priority was the Tesla Model 3 as well as other operating costs. Now Deepak Ahuja is sitting on $325 million less in cash. It may be no coincidence that that’s about the size of the surplus that the firm had over its original bond sale expectations. The firm went to Wall Street asking for $1.5 billion, but it came back with $1.8 billion in cash.

Critics slam Tesla, Inc.

The repayment of the debt caused quite the reaction from Tesla, Inc. bears on Twitter. Almost anything will drive that particular crowd wild with claims of malfeasance by Musk, of course. And the presentation of the claims here is far from an endorsement of them.

Mark Spiegel, an analyst who has been writing about Musk for quite a while, reckons that the debt deal proves that the CEO is just like pyramid schemer Bernie Madoff.

There were another few people that chimed in on the topic, though none of them seemed particularly well informed.

Mark Spiegel and co. may have reacted extremely to the news, but it wasn’t all that unexpected. Over at Seeking Alpha before the debt deal was done Montana Skeptic predicted that Tesla, Inc. would use the cash to pay off Solar City’s debt.

What the analyst questions, however, is whether Solar City would have been able to afford these payments had it not been acquired. According to the piece, “It’s a fair assumption that, had the merger not occurred, SolarCity would have been unable to pay much, if any, of the Solar Bond debt that has been repaid since the merger.”

Don’t worry about Tesla debt, at least for now

Despite what some of the bears might have you believe, the actions by Tesla, Inc. are entirely above board. The firm must have decided that there was some advantage in paying off the debts it chose to. Those advantages could range from wanting more control over the collateral to any other number of covenants and agreements that could have made it inflexible.

As a company Tesla isn’t all that heavily indebted. Because of its cash burning business model, there’s a strong likelihood that it will need to go back to the markets for cash some time over the next year. If the firm keeps avoiding issuing shares and instead decides to get deeper and deeper into debt, it might be time to start getting worried.

What you should really be worried about is the future of the firms products. The Tesla Model 3 is truly the make or break moment for the concern.

Tesla Model 3 is the only thing that matters

Elon Musk built a storied dream for investors, and they have followed him graciously. The CEO says that he can build a mass market car with a 25 percent gross margin. He also says that is just one of the many revolutionary businesses that his team is working on dominating. It’s a seductive promise, but now they need to follow through on it.

The Tesla Model 3 should be in mass production by the end of the year. Nobody is expecting the margins to be that high to begin with, but Mr. Musk has promised a quick ramp up to profitability. The first thing to watch, if you’re interested in Tesla stock that is, will be the production numbers.

If it looks like those figures are set to undershoot the forecasts, those holding Tesla stock could be in trouble. Once mass production is on track, however, focus will quickly switch to the margins. If the company can’t follow through on the second part of that profitability equation, there’s gong to be rough times ahead.

Tesla, with little or no issue, has gotten over its latest capital raise. The firm has proved an adept spender of money, but its spendthrift ways are matched by Wall Street’s willingness to fund it. The firm’s cash position will once again make headlines next year, but for now the Tesla Model 3 has to be the focus for investors. Let Elon Musk and Deepak Ahuja worry about the firm’s debt position.

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Adrian Smith

Adrian Smith is a finance and tech writer and currently working on a Masters in Business Information. He has developed a keen interest in all things finance and technology and loves to write about it.


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