Elon Musk may be certain that Tesla will not need to raise capital again, but this morning Goldman disagreed violently, and in a note by bank analyst David Tamberrino, it sees “Tesla coming back to the debt/equity markets to fund growth”, and forecasts that between Tesla’s current operations, anticipated new product spend, and incremental capacity additions, the electric car company would need over $10bn in external capital raises and debt re-financing by 2020 (and that assumes the NHTSA, which is now probing three separate Tesla incidents, does not enforce a recall).
The good news: according to the Goldman analyst Tesla still has full access to capital markets, and has several options available to fund its growth targets and refinance maturing debt and raise incremental funds, meaning that Musk may fund the massive capital shortfall through multiple avenues, “including new bond issuance (secured and/or unsecured), convertible notes, and equity.”
The not so good news: issuing incremental debt (including priming current creditors with secured debt) may weigh on the credit profile of the company while issuing additional equity or convertibles at lower premiums would dilute current shareholders.
Jumping to Goldman’s candid assessment, which will hardly please Musk, meaning that Tamberrino will find himself in the penalty box on the next few Tesla conference calls, the analysts recemmends that Goldman clients “express long views via the front-end convertible credit” while they “continue to express a bearish view on the equity.“
Now back for some additional details.
First, looking at Tesla’s current capital structure, Goldman notes that TSLA currently has a total of $10.5bn in debt, $3.1bn of which is issued by subsidiaries and classified as non-recourse beyond the specific issuers’ assets, and $7.4bn of which is recourse debt, which primarily consists of the company’s revolving credit facility, convertible bonds and straight bonds.
This is where things get complicated, because according to Tesla’s debt maturity schedule, between 2018 and 2022, the company has $1.5bn in non-recourse debt maturing, on top of $5.5bn in recourse debt.
As the company’s new 5.3% 2025 indenture generally does not limit TSLA from placing liens on Asset Financing Transactions (i.e., accounts receivables, residuals, and vehicle lease agreements) and allows for the refinancing of existing Subsidiary Debt without requiring the 2025 notes to be similarly guaranteed, TSLA should be able to refinance the majority of its non-recourse debt on similar terms as the existing. Therefore Goldman focuses primarily on the company’s recourse debt maturity schedule and the potential avenues the company has to refinance.
Tesla’s debt maturity aside, the biggest drain of cash of course, is the company’s unprecedented CapEx needs. Here’s Goldman’s math:
Based on our model, we forecast Tesla could require approx. $10.5bn in capital transactions between now and 2020 in order to (1) re-finance $3.1bn of out-of-the money convertible notes and revolving debt coming due, (2) fund ongoing operations (where we forecast a continued FCF drag), and (3) put new plant capacity in place in China (note: we presently do not include potential China plant capex in our model).
We believe the debt markets likely would let TSLA lever up to a range of 4.0x to 5.0x gross debt to 2020E EBITDA (similar to NFLX), but this would still require $2bn in equity capital (Exhibit 4). Under an upside scenario where Tesla achieved its targets (i.e., sustainable 5k/week production in 2H18 that increases to 10k/week in 2020 and Model 3 gross margins of 25%), we believe the total capital transaction amount would be approx. $5bn —and the company would likely be able to fund its growth with debt.
In addition to the scenario above, Goldman notes that several other options exist outside the two presented below in Exhibit 4. As a result, the GS analyst provides a sensitivity analysis on the total amount of debt (i.e., incremental debt + refinance amounts) that Tesla may require for growth through 2020 in Exhibit 5.
The analysis takes into account the company’s Model 3 production ramp and sensitizes its sustainable weekly production rate in 2020 (using GSe 5k/week at the bottom end of the range, and the company’s ultimate goal of 10k/week at the top end of the range) vs. the Model 3 gross margins (using 20% at the bottom end — near GSe of 21% Model 3 gross margins in 2020, and the company’s target of 25%).
Putting this together, Goldman currently forecasts $2bn in equity raises through 2020 —in addition to incremental warehouse financing/revolver draws “with multiple avenues of continued business development (Model Y, Semi truck, Solar Roof, Powerwall and Powerpack sales)— in addition to capital needs to continue ramping Model 3 production and at the gigafactory, we believe TSLA’s capital expenditures likely step-up from 2018E $2.9bn in 2019 and 2020 (GSe of $3.6bn each year).”
When combined with our expectation for a slower-than-targeted production ramp of the Model 3, we believe that Tesla may issue equity (in addition to borrowing on its revolving lines) in order to fund operations and maintain minimum cash balances above $2bn (Exhibit 3). Within our forecast, we assume two equity raises of $1bn each to occur in 4Q18 and in 3Q19 —one quarter ahead of our forecast for minimum cash levels to fall below $2bn.
But the biggest cash drain, according to Goldman, would be any “new capacity additions abroad” which would drive the bulk of incremental cash needs:
Tesla has publicly noted that it is exploring the possibility of adding production capacity (both vehicle manufacturing and battery cell/module production) in China — and we believe the likelihood of an announcement in the near term has increased as the company recently registered a new wholly-owned subsidiary in Shanghai. As we have detailed previously, we believe this would likely require $4bn to $5bn of investment from Tesla — with the company funding vehicle manufacturing at approx. $2.5bn (i.e., 500k units of capacity annually at historical precedents of $5k per unit of capacity) and also fund half the investment of a new gigafactory (similar to its existing agreement with its partner Panasonic, where Tesla communicated investing approx. half the total $4bn to $5bn investment).
Looking ahead, Goldman next lays out the potential avenues to raise capital, listing:
- Secured debt: TSLA’s ability to incur additional debt is restricted by both the 5.3% 2025 straight bonds (no liens restrictions in the convertible bond indentures) and the company’s revolving credit facility. The 2025s restrict the company from putting liens on material domestic assets and property (“Principal Property”) without ratably securing the notes, with several key carveouts.
- Unsecured Debt: The 2025s do not limit the company’s ability to incur additional unsecured debt, though the company’s restricted subsidiaries cannot incur/guarantee any additional debt (existing subsidiary debt allowed) unless the notes are guaranteed on an unsecured, non-subordinated basis, with substantially similar carveouts for the company’s liens restrictions. As a result, the company could look to issue additional unsecured bonds to refinance upcoming maturities and/or raise liquidity. The 5.3% 2025s have traded lower over the past several months along with the equity, pushing yields – the implied cost of debt – higher. The bonds are currently quoted at $87/88, or 7.6% YTW (mid), >200bp wide to the 5.3% initial yield.
- Convertible Bonds: TSLA has been a frequent issuer in the convertible bond space and given the wider yield on its recently issued straight bonds and focus on improving cash flow, we think the company may return to the convertible market to refinance and raise additional capital.
Last, but certainly not least, equity:
The company historically has been active each of the past few years with equity raises to fund incremental growth (approx. $3bn in equity raised across three issuances in March 2017, May 2016, and August 2015). Based on our model we believe the company likely will use this avenue again given the total amount of cash needed and potential leverage ratios. In conjunction with our credit team, we believe the debt markets would fund incremental capital needs up to approx. 4.0x to 5.0x gross debt leverage on 2020 EBITDA, with net leverage of approx. 3.9x — similar to NFLX which has gross leverage of 5.0x and net leverage of 3.0x on LTM EBITDA, and given the current equity value coverage above the debt. We note this is a higher level than traditional auto peers (Ford and GM have gross debt leverage of 2.1x and 1.2x, which increases to 3.9x and 2.7x, respectively, when including Pension + OPEB obligations, but also nets down to 0.3x and 1.4x when the company’s sizeable cash balances are considered). With our 2020 EBITDA forecast of $3.7bn for TSLA, this implies over $5bn of total incremental debt capacity —leaving potential for approx. $2bn in equity capital raises
Putting it all together, Goldman has the following trade recos, the key of which is to go long the converts:
we see a compelling opportunity to express a view on the company’s liquidity levels through buying the TSLA 0.25% 2019 convertible bonds and selling a March 2019 call option to isolate the credit value; as detailed within, we believe selling a lower strike $330 call against the convertible creates a 9.2% annualized yield if the stock ends the period below $330 (+15% from current) at maturity while only losing a maximum of 2.0% (annualized) if the stock reaches $359.87/share at maturity.
Or simpler, just short the stock:
Sell Equity: We continue to see downside to TSLA shares as we believe the company will continue to be challenged in its manufacturing process — likely missing its target to sustainably produce 5k/week Model 3’s this year. Further, we believe automotive gross margins will be under pressure — resulting from the incremental labor required in the Model 3 production and for the Model S/X where we expect US demand to subside with the phase-out of the US Federal Tax credit for Tesla vehicles in combination with incremental competition launching in the next 18 months. Altogether, we see 32% downside to our $195 6-month price target.
And now, cue Elon Musk’s outraged twitter account, slamming the vampire squid for suggesting the company is $10BN underwater.