Uh oh, it looks like Elon and Tesla may be in hot water yet again, but this time it has nothing to do with the SEC, thankfully. Instead, it’s all about balancing the corporate checkbook, and paying off lenders in the process.
That’s not too big of a deal, right?
Over the next six months, Tesla needs to pay off roughly $1 billion of debt owed to creditors in order to continue running their business operations – again, something a major automaker should be able to handle.
But here’s the problem:
Tesla doesn’t currently have the cash to cover their loan payment, and they’ll have to raise much of the $1 billion owed before the end of 2018.
Regardless of the SEC settlement, continued volatile behavior from Musk, and the Model 3 “production hell”, the fact remains that Tesla is still not a profitable company.And that isn’t an auspicious place to be in when Musk and co. owe a total of $11 billion in long-term debt, while simultaneously trying to scale-up in a hyper-competitive industry.
Margins are razor-thin among automakers, and even ones that are efficient (like Ford) are having a tough time impressing shareholders.
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So Tesla, a company still hemorrhaging cash, has to make some hard decisions if they have any chance of meeting their lofty production (and revenue) goals. Tesla is currently re-negotiating payment schedules with their suppliers and vendors, which is something they’ve done in the past that actually led to one supplier going bankrupt while awaiting payment.
Will Tesla’s business partners play ball this time around? Possibly, but stretching their current cash reserves won’t be enough to pay their short-term debts. In Tesla’s last earnings report (June 30th), their liabilities totaled $9.1 billion (which has increased to $11 billion) while company assets were only worth $6.7 billion. That means that as of last quarter, Tesla was $2.4 billion “in the hole” in terms of working capital.
But most importantly, Musk needs to figure out a solution that will generate a large amount of cash – $1 billion – by year’s end. As of right now he has a few options, and one of them could be very damaging to his company’s success if he’s not careful.
First and foremost, the most obvious choice here would be to simply raise more capital – but it’s something that Musk has said (repeatedly) he’d never do. Even if he does have some sort of ace up his sleeve, it probably wouldn’t be as easy (or low-risk) as simply issuing more shares of Tesla.
Yes, the stock would get diluted, and prices would likely drop short-term. Musk, as the company’s largest shareholder, could potentially be margin called if prices sink far enough – placing him in the company of Worldcom’s Bernie Ebbers, Chesapeake’s Aubrey McLendon, and several other CEOs who were faced with a margin call death-spiral at one time.
Tesla share prices, which are driven more by perceived potential than actual production, are already in a precarious position, and drastic measures to save the company could send the stock tumbling.
However, in this case, issuing more shares would be something that both Musk and Tesla could survive. Die-hard Tesla investors have a cult-like affection for the company, and they haven’t let share prices fall below $240 since February of last year – despite everything that the automaker has endured in recent months.
In the event that more shares are issued, it appears that the damage will be highly mitigated by speculators (and current holders) that feel like they’re picking up a premium stock for discount prices.
On the other hand, Tesla could just issue more debt to pay off what they’ve already got. This is essentially the old “paying off a credit card with a credit card” trick – where debtors utilize cash advances from ATMs to pay off existing debt – but at a much larger scale.
If this happens, Tesla would likely get loans at terrible rates, however, at an estimated range of 8 – 9.5%. This is something that could cause debt issues to snowball out of control down the road, especially as the Fed seems intent on raising interest rates in the future.
And while this wouldn’t put Musk at risk of getting margin called purely through share dilution, it could end up dropping share prices far more long-term as the company becomes further laden with unshakable debt.
Is that a good strategy? Probably not – and it’s the reason why Musk needs to rethink his current stance on raising capital. I’m sure he’s going to share a bunch of crazy, creative ideas to save the company on Twitter over the next few weeks, but none of them will work quite as well as simply issuing more shares of stock.
It’s easy, it’s way cheaper than taking on junk debt, and more than anything else…
Tesla doesn’t have to be profitable for it to work.