What The Bond Market Is Telling Tesla Shareholders

&l;p&g;Tesla has over $9 billion in debt with maturities ranging from 2018 to 2049 (for Solar asset-back loans). The original interest rates are as low as 0.25% (convertible debt) to as high as 7.7% (Solar asset-backed loans). To get a read on the debt market&a;rsquo;s outlook for the company, looking at the $1.8 billion that was raised in August last year gives an indication that creditors and the rating agencies have become incrementally.

A recall for 123,000 Model S&a;rsquo; sent Tesla&a;rsquo;s shares down $6.63, or 2.5%, in Thursday&a;rsquo;s after-market trading to $259.50, which almost erased the $8.35 gain during the day. This is after they&a;nbsp;were&a;nbsp;&l;a href=&q;http://www.forbes.com/sites/chuckjones/2018/03/27/teslas-model-3-is-it-time-to-sell-the-news/&q;&g;under tremendous pressure the past week&l;/a&g; and after falling the previous two weeks. For the week the shares were down $35 or 12% to $266 and since its most recent high on February 26 they are down $91 or over 25%.

&l;p class=&q;tweet_line&q;&g;Equity investors should pay attention to changes in a company&a;rsquo;s debt , as it can foreshadow future issues for the company and its stock. While I believe Tesla is far away from debt repayments potentially being a problem, as most investors know secured debt holders are paid back before equity investors.

&l;img class=&q;dam-image ap size-large wp-image-a252b8e1ccca483b9da8e4008a8c4c06&q; src=&q;https://specials-images.forbesimg.com/dam/imageserve/a252b8e1ccca483b9da8e4008a8c4c06/960×0.jpg?fit=scale&q; data-height=&q;639&q; data-width=&q;960&q;&g; Tesla Motors unveils the new lower-priced Model 3 sedan. AP Photo/Justin Pritchard

&l;strong&g;August 2017 debt trading at a 12% discount&l;/strong&g;

Tesla&a;rsquo;s August 2017 5.3% debt that is due in August 2025 is &l;a href=&q;http://finra-markets.morningstar.com/BondCenter/BondTradeActivitySearchResult.jsp?ticker=FTSLA4530907&a;amp;startdate=03%2F28%2F2017&a;amp;enddate=03%2F28%2F2018&q; target=&q;_blank&q;&g;trading at a 12% discount, or 88 cents to the dollar&l;/a&g;, a new all-time low per FINRA. This means debt that was sold for $1,000 is now worth $880 and its implied interest rate is approximately 7.5%. The bonds had been trading in the low $900&a;rsquo;s before &l;a href=&q;https://www.moodys.com/research/Moodys-downgrades-Teslas-corporate-family-rating-to-B3-senior-notes–PR_381481&q; target=&q;_blank&q;&g;Moody&s;s downgraded the company&a;rsquo;s credit rating on Tuesday&l;/a&g;, so they were at a discount already.

It could be that the debt market is warning about potential problems or it could be they are overly concerned and the debt is offering a great buying opportunity. We should have incremental information early next week when Tesla&a;rsquo;s provides preliminary March quarter production and delivery results.

&l;img class=&q;size-full wp-image-11765&q; src=&q;http://blogs-images.forbes.com/chuckjones/files/2018/03/TESLA-BOND-PRICE-FINRA.jpg?width=960&q; alt=&q;Tesla&s;s $1.8 billion 5.3% bond price&q; data-height=&q;525&q; data-width=&q;795&q;&g; Tesla&s;s $1.8 billion 5.3% bond price

&l;strong&g;Moody&a;rsquo;s downgraded Tesla&a;rsquo;s credit rating&l;/strong&g;

Bruce Clark at Moody&a;rsquo;s Investor Service believes that &a;ldquo;Tesla continues to benefit from solid market acceptance of Models S and X, which collectively hold over a third of the US luxury market. In addition, third-party evaluations of the Model 3 remain favorable, consumer response to the vehicle is sound, and advance purchase reservations and deposits remain high. Finally, regulatory support for battery electric and zero-emission vehicles continues to grow.&a;rdquo;

He added, &a;ldquo;The negative outlook reflects the likelihood that Tesla will have to undertake a large, near-term capital raise in order to refund maturing obligations and avoid a liquidity short-fall.&a;rdquo;

On Tuesday Clark downgraded Tesla&a;rsquo;s credit rating from B2 to B3, which is the &l;a href=&q;https://www.moodys.com/sites/products/ProductAttachments/AP075378_1_1408_KI.pdf&q; target=&q;_blank&q;&g;lowest rating of Moody&a;rsquo;s B category&l;/a&g;. By taking Tesla&a;rsquo;s rating to B3, this means Tesla&a;rsquo;s debt is considered &a;ldquo;speculative and subject to high credit risk.&a;rdquo;

He also downgraded its rating for the company&a;rsquo;s unsecured debt from B3 to Caa1.&a;nbsp;By moving Tesla&a;rsquo;s unsecured debt to Caa1 it moves to a lower category. It means Tesla&a;rsquo;s unsecured debt is &a;ldquo;speculative of poor standing and are subject to very high credit risk.&a;rdquo;

Lastly, he changed the outlook for the company from Stable to Negative. Overall these changes may force some bondholders to sell based upon their internal rules.

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&l;strong&g;Burning cash and upcoming debt maturities&l;/strong&g;

Tesla&a;rsquo;s free cash flow was about a negative $3.5 billion in 2017 due to its $3.4 billion in capital expenditures, Moody&a;rsquo;s is concerned about the company&a;rsquo;s large capital expenditures and the $1.15 billion in debt that matures in the next 12 months. There is:

&l;/p&g;&l;ul&g;&l;li&g;$230 million due in November 2018

&l;ul&g;&l;li&g;Issued in October 2013 by SolarCity&l;/li&g;

&l;li&g;2.75% convertible notes&l;/li&g;

&l;li&g;Conversion price of $560.64&l;/li&g;

&l;/ul&g;&l;/li&g;

&l;/ul&g;&l;ul&g;&l;li&g;$920 million due in March 2019

&l;ul&g;&l;li&g;Issued in March 2014&l;/li&g;

&l;li&g;0.25% convertible notes&l;/li&g;

&l;li&g;Conversion price of $359.87&l;/li&g;

&l;/ul&g;&l;/li&g;

&l;/ul&g;

It will be extremely difficult for Tesla&a;rsquo;s shares to hit the $560.64 conversion price, but the $230 million should be manageable. It is the $920 million a year from now that is more challenging . The company&a;rsquo;s shares have traded above $360 so they could get back there. However, management should plan on having to pay it off vs. hoping for the debt to be converted to shares.

&l;strong&g;Cash outlook&l;/strong&g;

Tesla plans to spend a bit more in capital expenditures in 2018 than the $3.4 billion in 2017. Assuming:

&l;ul&g;&l;li&g;$3.6 billion in capital expenditures for 2018&l;/li&g;

&l;li&g;$750 million in capital expenditures in the first quarter of 2019&l;/li&g;

&l;li&g;And $1.15 billion to refinance the maturing debt&l;/li&g;

&l;li&g;Tesla will need about $5.5 billion in cash from the beginning of 2018&l;/li&g;

&l;/ul&g;

Tesla had $3.37 billion in cash at the beginning of the year and Moody&a;rsquo;s assumes that it needs to have at least $500 million on hand for normal operations. This means it could use $2.8 billion of its cash, leaving a $2.7 billion shortfall.

So unless the company can generate a lot of cash this year (its operating cash flow was only a negative $61 million in 2017), it will have to either raise around $2.5 billion in debt, tap into its asset backed lending, or ABL, facility or sell more shares.

It also won&a;rsquo;t be able to refinance this debt with nearly as favorable of terms. Since the current debt is trading around 7.5%, any additional debt would probably be around a 10% or higher interest rate.

It will be critical for Tesla to &l;a href=&q;http://www.forbes.com/sites/chuckjones/2018/03/13/five-days-in-february-will-it-make-or-break-teslas-model-3-production-guidance/&q;&g;demonstrate that it is making substantial progress with its Model 3 production ramp&l;/a&g; and that it can do so profitably. If it can, then the debt concerns will become a back burner issue and the stock could also rebound. If the company can&a;rsquo;t hit its revised production schedule or make investors feel comfortable that any shortfall won&a;rsquo;t impact it, then there is further downside to the debt and equity prices.

If you want to understand Elon Musk&a;rsquo;s new stock award plan and how it compares to Tim Cook&a;rsquo;s, check out my article,&l;strong&g; &a;ldquo;&l;/strong&g;&l;a href=&q;http://www.forbes.com/sites/chuckjones/2018/03/23/how-elon-musks-stock-award-compares-to-tim-cooks/&q;&g;How Elon Musk&a;rsquo;s Stock Award Compares To Tim Cook&a;rsquo;s&l;/a&g;&a;rdquo;.

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