Autos

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

You might think that when someone issues bonds, it's all about money.

Except Tesla Inc.'s debut in the high-yield bond market means so much more than that. As of Friday afternoon in New York, it was reported to be a $1.8 billion issue.

Don't get me wrong, Tesla does need the cash. It burned through more than $1 billion last quarter for the first time ever, and the high spending required to ramp up production of the Model 3 means more of the same.

The obvious question is, why issue a bond when you've got this going on:

Obvious, No?
With Tesla's share price close to its all-time high, it could theoretically raise $1.5 billion by selling new stock equivalent to just 3 percent of its current total
Source: Bloomberg

Tesla hasn't been shy about issuing equity in the past. And given that the main reason for those infusions is persistent negative free cash flow, issuing a bond that necessitates paying a regular cash coupon seems less ideal than selling equity that doesn't.

Therein lies at least part of the answer. At a reported 5.25 percent, Tesla's incremental interest charge equates to about $24 million a quarter. That's real money, of course, but a rounding error on $1 billion-plus of negative free cash flow.

That helps explain why the company's enthusiastic shareholders -- its core constituency -- don't seem bothered (the stock hasn't reacted since the bond was announced). After all, if things like Tesla's cash burn and rising leverage were really front-of-mind, then they wouldn't be holding shares priced at 74 times 2017 Ebitda in the first place.

One old-fashioned notion that probably does occasionally intrude, however, is liquidity. You can't build half a million Model 3s, a Gigafactory or a supercharger network with a multiple of 74 times. That takes cash -- preferably not one's own cash.

That's where the bond issue comes in; because $24 million a quarter, while an unhelpful obligation, can get somewhat overshadowed by this number: $477 billion.

That's the face value of the bonds included in the Bank of America-Merrill Lynch Single-B U.S. High Yield Index. Tesla's credit rating stews in this motel-grade pool. But in the Tesla dimension, this is one of those instances where, contrary to what you were told at school, quantity is quality.

The pricing of Tesla's bond is, let's be clear, even more ridiculous than its stock. The latter at least has some sort of option value.

Tesla's worth rests almost entirely on a long-term bet that it sparks a transformation of the global vehicle industry (and energy in general) and emerges at the top of the resulting pecking order. This is ambitious. If it pulls it off, shareholders stand to reap the rewards. If not, they'll reap something decidedly unrewarding.

Now consider the buyer of Tesla's newly minted bond. If Tesla succeeds, then the bondholder gets a coupon currently worth about 3 percentage points over Treasurys and their principal back, maybe with a premium if called early. If Tesla doesn't, then they also stand to lose potentially all or part of their principal, especially as the bond's relatively loose covenants provide room for Tesla to raise more debt.

Which makes that 5.25 percent coupon a coup for Tesla: 

Dive In
Despite high leverage and ongoing cash-flow deficits, Tesla's debut bond priced favorably even compared to an already frothy Single-B pool
Source: Bank of America Merrill Lynch, Bloomberg
Note: Weighted effective yield for BofA Merrill Lynch Single-B Index and sub-groups.

For the price of an extra bit of (whatevs) cash burn, Tesla just established the notion that it can tap into a far bigger amount of potential capital at a yield that undercuts even the lax standards of today's high-yield bond market. And don't forget the size of the issue appears to have been expanded from the original $1.5 billion.

For the true believers on the shareholder register, this extra leverage can actually look welcome. To them, all that stands between CEO Elon Musk realizing his vision -- and validating their bet -- is adequate liquidity. The bond market, from that perspective, looks like an infinity pool. And given the make-or-break timetable for Tesla's ambitions over the next couple of years -- particularly regarding the Model 3 -- anything maturing in 2025 may as well be a perpetual bond.

And there's a strange symbiosis, and circularity, at work here.

Like the shareholders, Tesla's bondholders are implicitly playing that long, vision-thing game too. How else do you justify taking 5.25 percent and no upside for a bond that covers maybe four or five months' worth of current cash burn?

They are implicitly banking on the protection of Tesla's dizzying market capitalization or other lenders to fill the inevitable future deficits and potential setbacks -- which will themselves result from the company's push to justify that same market capitalization.

The result is both fascinating and unnerving: a company rated in the sub-basement of junk and burning $1 billion a quarter, yet valued at almost $70 billion and borrowing at a rate similar to where utilities were issuing bonds less than five years ago. How very 2017.

Wired
At just over 5 percent, Tesla's new bond is priced similarly to where U.S. utilities were borrowing money in late 2013
Source: Bloomberg

 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. And that's actually 78 times, pro forma for the bond issue.

To contact the author of this story:
Liam Denning in New York at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net