Elon Musk is an entrepreneur in a bubble. Forced to choose between issuing a bit more of Tesla’s turbocharged stock or tapping the overheated junk-bond market to finance the Model 3 ramp-up, the founder opted for the latter. It raises execution risk for the $60 billion electric-car maker, but not by enough to persuade the chief executive to loosen his grip on the wheel.
Tesla has just over $3 billion in cash, but it’s burning through roughly a billion a quarter as it embarks on one of the most daunting gambits in automotive history: taking production of its mass-market vehicle from zero to 400,000 or more a year in just 18 months.
Fortunately for Musk, investors can’t seem to shower his ambitions with too much money. Tesla’s stock has risen by 67 percent so far this year. The company is valued at some 27 times 2020 earnings, implying the kind of growth that even the most bullish of analysts don’t expect, according to Breakingviews calculations.
The textbook financing solution would be to issue more of that high-priced paper. Selling 5 million shares at a 15 percent discount to market would raise the same $1.5 billion and dilute Musk’s 20.4 percent stake by only 3 percent, assuming he didn’t pitch in more himself.
But he doesn’t have to when the high-yield bond market is on a tear. Investors desperate for income have depressed the yield gap between single-B-rated junk bonds and U.S. Treasuries by nearly 2 percentage points over the past year, to 3.59 points, according to Bank of America Merrill Lynch. S&P Global Ratings affirmed its B-minus rating on Tesla, saying the boost to liquidity should offset the company’s “significant execution risks.”
The bond sale will raise debt to a lofty 5.5 times forecast 2017 earnings before interest, taxes, depreciation and amortization. But EBITDA is set to more than double next year to $2.2 billion and then almost treble by 2020, according to Thomson Reuters data. Even if Musk is not as successful as Wall Street estimates, he should sell more than enough cars to make the leverage, and the additional interest bill, easy for bondholders to swallow.
_______________________________________________________________________
Request a free trial of Breakingviews here.
