Tesla or the Path to and from Privatization

Supercharger
Supercharger with Model S (middle) and two Model X, © Tesla

There came the bombshell: On Aug. 7, Tesla chief Elon Musk tweeted he was considering taking the company off the stock market, a process known as delisting. And he put a price on it – USD 420 per share, which would mean a market value of more than USD 80 billion, including debt. He said funding had been secured. Had it really been? It was said that the suggestion to privatize came from Saudi Arabia’s sovereign wealth fund, which intended to purchase a stake in Tesla too.

Since even Tesla’s board of directors looked taken aback by the announcement, I am not so certain about all of it. Musk then had to act, as this kind of statement has – legal – consequences. His decision to do an about-face in less than three weeks means short sellers now hold all the cards. Costly lawsuits are sure to follow. One organization has already sued Musk: the U.S. Securities and Exchange Commission. The subsequent agreement between him, Tesla and the SEC two days later will force Musk out of the chairman role and make him and the company pay USD 20 million each. Of course, had it been one of his other projects, such as SpaceX, which are not listed, he wouldn’t have had to ask in the first place. Stay tuned.

Big funds such as Fidelity have large unrealized gains. Do these institutional investors wait until the last minute to see a few percentage points added and get to USD 420? Obviously, they would need to sell shares no longer traded on the market. Considering this, it is entirely understandable that major shareholders favored delisting, as they would have received USD 420 per share in cash. At that point, though, they would no longer have been shareholders, as the stock would have needed to be available for revaluation.

Saudi fund ups the game

The Financial Times has reported that the Public Investment Fund of Saudi Arabia had spent USD 1.7 billion to USD 2.9 billion on buying a 3 to 5 percent stake in Tesla (Nasdaq: TSLA). I was left wondering, though, why this hadn’t been done through a capital raise, which could have put up to USD 2.9 billion into the company’s bank accounts. The only reason I could come up with was that Musk had ruled out raising capital another time and was intent on following through with his pledge. However, a raise would have provided much needed liquidity. Plus, let’s be honest, Musk has had to walk back some of his statements before.

As said, Saudi Arabia was allegedly the driver behind the privatization attempt. I seriously doubt it: I have yet to see proof in writing and words alone won’t do it. The next question is whether Musk purchased his two parcels of shares in the amount of USD 9 million and USD 20 million at around the same time as he negotiated with the Saudi Arabian fund. If so, it would be a clear case of insider trading that could have legal repercussions.

Put on a happy face

Previously, on Aug. 2, Musk had announced that Tesla would be cash flow positive starting in the third quarter and would remain that way, even though this doesn’t mean it will generate a profit each time. The corporation would not require fresh capital – so no capital raise – as cash flow would take care of everything and would be able to cover 7,000 weekly orders, that is, 5,000 for Model 3 cars and 2,000 for Model S and Model X, by then. The news sparked a wave of euphoria, catapulting the stock from about USD 300 to USD 350 in just one day of trading. The market cap grew by more than USD 8 billion. Then came the tweet about privatizing the company.

“Everything’s all right” is how you could have summed up the state of business and Musk’s comments after the company published results for the second-quarter ended June 30, 2018. Production would increase to 750,000 units in 2020, it was said. Quite frankly, I will remain skeptical, since the company’s financials paint a different picture. Net loss in the second quarter was USD 718 million. Tesla kept the cash level at USD 2.2 billion, down from USD 2.7 billion on a year-over-year basis but better than the capital drain of up to USD 1 billion that some analysts had expected. Deposits earned the company more than USD 900 million. It’s worth taking a closer look at that liquidity figure. The company’s USD 4 billion in liabilities and outstanding invoices could have risen more than expected, while accounting changes may have also had an impact. Obviously, if you don’t pay the bills, your cash reserves remain untouched or grow. In any case, Musk has again managed to push the stock price to new heights and caused some analysts to change their views to a more positive outlook. Let’s see what’s next.

Addicted to Twitter, just like Trump

In the meantime, even major investors have become annoyed by Musk’s sheer endless stream of tweets, some of which have absolutely nothing to do with company operations and look more like a strategy to distract from the issues at hand. One tweet, which sounded almost like an ultimatum, was supposed to put short sellers in a bind within three weeks. The one about privatization did that after five. Its style and tone could remind one of tweets put out by U.S. President Donald Trump. Plus, they contain statements I believe chief executives aren’t allowed to make due to stock market regulations, most of all during trading hours when they can have an effect on stock prices.

Messages to tout the 5,000-per-week milestone in Model 3 production capacity seem harmless in comparison. But plans to establish new battery and vehicle factories in China and Europe, or, more specifically, in Shanghai and Germany, don’t engender trust. Those would need loads of cash, which Tesla couldn’t provide at present, even though Panasonic has indicated that it would stay on as a partner.

Many Model 3 buyers are faced with a cut in the USD 7,500 tax incentive for Tesla vehicles, as the company has surpassed the 200,000-unit mark. The incentive is currently half the amount but will be gone in several months. The USD 35,000 base model is unavailable anyway. Tesla is offering premium versions only, as they have higher price tags and thus greater margins. What is more disconcerting is the situation surrounding former employee Martin Tripp, whom Musk has accused of sabotage. Tripp has claimed that Tesla had been using both defective parts and defective batteries in some Model 3 cars to meet the ambitious production targets set by Musk. Even marketing and consumer protection agencies have begun to recommend not being among the first to receive a Model 3.

The aggressive pricing strategies of competitors could have a negative impact as well, some analysts have said. Investment banking firm Needham recently downgraded the corporation’s stock to Underperform, saying that USD 1,000 deposits were being cancelled at a faster rate than new ones were made. Likewise, Tesla is now asking for another but non-refundable USD 2,500 deposit for Model 3 cars. I share the opinion of the sell-side analysts and will remain a skeptic. My cautious stance has little to do with those handsome electric cars that the company is putting on the market. Rather, a worrying financial situation, growing competition and the attempt to privatize business could have serious legal and financial consequences for Musk himself and for Tesla. Additionally, other automakers may soon put on the pressure by presenting new electric and, in time, hydrogen-powered vehicles and fuel cell hybrids.

My prediction is that the reduced cash reserves of USD 2.2 billion and the loss of USD 718 million will inevitably lead to a request for a larger amount of capital. Though Tesla has repeatedly denied that possibility, it wouldn’t be the first time the company has said one thing but done another. Musk could take advantage of current stock price highs and a bright outlook to justify a capital raise. The company will certainly need cash to implement all those plans for new production facilities. But a raise would mean it will need to be very upfront about the aims, reasons, the price and terms of it. The renewed hype over Tesla could quickly grind to a halt. There were analysts that recommended gradually selling shares when prices exceed a certain limit and realizing profits. It is time to act, since a market capitalization of USD 50 billion will, at some point, require matching revenues. The company could soon find itself in a tight spot, considering several manufacturers of long-distance fuel cell cars could be on their way to disrupt the market by then.

The grandiose claims by Musk clearly illustrate to what lengths the company will go to bring about positive cash flow at the end of the third quarter. For example, the second quarter didn’t feature any tax incentives for zero-emission vehicles. Since Tesla can decide when to include them in accounting, I am certain they will show up in the third. Some estimates put the figure between USD 200 million and USD 300 million, so this can be noted down as an option to improve financial results. However, this tactic is not sustainable or related to day-to-day business. In my view, the stock price could go even higher until reversing later this year and especially in 2019.

Risk warning

Share trading can result in a total loss of your investment. Consider spreading the risk as a sensible precaution. The fuel cell companies mentioned in this article are small and mid-cap ones, i.e., they may experience high stock volatility. This article is not to be taken as a recommendation of what shares to buy or sell – it comes without any explicit or implicit guarantee or warranty. All information is based on publicly available sources and the content of this article reflects the author’s opinion only. This article focuses on mid-term and long-term prospects and not short-term profit. The author may own shares in any of the companies mentioned in it.

Written by Sven Jösting

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