Editor's Note: Below is a complimentary Tesla (TSLA) research note published earlier today (8/8/2018) to our Industrials institutional clients and written by Industrials analyst Jay Van Sciver.
Asymmetry Returns
There is much excitement and confusion regarding Elon Musk’s tweets, and subsequent letter to employees regarding the company going private. Investors must be exhausted by events at Tesla, but here is a clear point: if Tesla does have funding for a take private at $420, the move up is probably mostly done. The market priced it in. If closing takes as long as DELL did, the ~10.5% premium seems tight given the time and extreme uncertainty. Could a deal price go higher than $420? Maybe, but one wonders where that doobie-us number comes from in the first place. Oh, right, 20% above the post-earnings share price.
Did Musk line up what is, we think, the biggest management led take private while sleeping at the factory to ramp Model 3 production? Was he buying stock in the open market for his personal account, while also planning this transaction, or did this really just come together since the 10-Q was filed yesterday? It is unlikely that management has all or even most of the pieces ready, and some of the typical 13D amendments suggest limited Board involvement so far. If Musk is just floating an idea, the public floating of it may be the worst idea of all.
Does Musk really have the funding? It seems unlikely, at least in a traditional sense. If Tesla uses debt, the interest cost would be crushing to private Tesla, a company that already burns cash and posts sizeable losses in a competitive industry known for thin margins. Tesla bonds are yielding ~6.5%; borrowing even $10 or $20 billion at that rate, let alone what they need at the rate that it could be raised, would destroy hope of profitability in a reasonable time frame. Worse, Tesla would be replacing dividend-free equity that is so cheap it is willing to rack up losses. Any debt would require light covenants and, if Tesla can get it, a flexible payment-in-kind provision. Typically, debt buyers would need to see real profits and real earnings to get involved without some sort of collateral or similar backing. We don’t see how Tesla could go private without most of the capital being “loss tolerating” equity.
Who would provide the capital? Some expect that sovereign wealth funds might do it, probably because the Saudi holders showed up on the same day. It is hard to say what any investor might do, but it would be shocking if the Saudi Arabia’s PIF put up, say, $20 billion for a Tesla management led take-private. First, SWFs are not just sitting on cash. SWFs often orient investment to their home country or invest in ways that meet the political goals. The Saudis just can’t be that excited about electric vehicles.. Further, Saudi Arabia’s PIF has said it has a few hundred billion under management, presumably ex-Aramco; a large Tesla stake would make a problematic concentration. Could it be (also oil rich) Norway? Some other SWF? Sure, we guess so. But whoever would fund Tesla is going to need to be ready to do more funding once it exits public equity markets. Most people we have met with from public investment funds are top shelf investors, and may not like the character of a private Tesla.
What if Telsa just keeps current equity holders? Musk suggests that no one will be required to sell, and he hopes they don’t. That could reduce the amount needed to take Tesla private – if everyone comes along with him. However, most of the funds that hold shares of Tesla specialize in liquid, public market investments with daily liquidity. They are often mutual funds with a daily NAV. These funds will often hold private interests, but not with large weightings that can skew returns via illiquidity (hard to re-weight). A loss of access to liquid capital markets would increase the risk profile as well. It also sets a weird precedent, where the holders of a company can just decide to go private at whatever price they want. As we understand it, Tesla will struggle to keep smaller investors involved without similar public company constraints. Tesla goes private and smaller investors don’t stay in the equity, holders should expect capital gains taxes.
What About The Board? The most notable party absent from these discussions is the entity that is supposed to represent shareholders in the transaction – the Board of Directors. The Board has obligations, such as evaluating alternative transactions, that apparently no one expects them to execute. This isn’t a transaction that is supposed to happen because Musk doesn’t think investors are nice enough. The absence of lawyers, bankers, identified financing, and the Board suggest that maybe going private is more of an idea than an actual plan.
Would going private make running Tesla easier? Mr. Musk may not like having public market critics, but he likes having access to public market capital. If Tesla needs billions and billions for the Model Y, a Semi, and a Model S redesign, the public markets are the deep pocketed, reasonably priced funding source. If an expanding company like Tesla isn’t going to use public markets, why have them at all?
Upshot: Going private is a poor move for Tesla, costing ready access to the cheap capital it needs to grow, but it is a terribly frightening nightmare for short sellers, permanent losses and wasted time. Musk has been bashing the shorts and tweeting erratically for months. Whether attacking the press, the Thai diver, or short sellers, Musk’s tweets have not been grounded. Would it be so surprising if this was another problematic tweet – maybe one that finally went too far? If we don’t see a revised 13D that includes his intentions, a press release that includes details on funding, or some other third party confirm that this is a real project, it may well end up marking yet another local peak in Tesla’s share price. That is our take. Given that the deal is largely priced in, it isn’t a bad asymmetry to bet on understanding that key catalysts don’t come until 1H2019 and the brand may prove somewhat resilient.
*https://www.reuters.com/article/us-saudi-economy-pif-management/saudis-pif-says-has-230-billion-worth-of-assets-under-management-bloomberg-interview-idUSKBN1CT1HY
