Tesla’s “Impossible” Task #9: Paying Off Debt In 2018 & 2019

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Recently, there was a misinformed article from Linette Lopez of Business Insider titled “Tesla needs over $1 billion in cash over the next 6 months, and Wall Street is going nuts figuring out where it’s going to come from.” I am writing this piece to refute what was said.

Let’s call this Tesla Impossible Goal #9, after Zach’s great piece about 8 supposedly impossible or nearly impossible goals Tesla has achieved.

These debts are listed under Note #10 on page 24 of the latest Form 10-Q. The ones that interest us are the 2.75% Convertible Senior Notes due in November 2018 and the 0.25% Convertible Senior Notes due in March 2019. The Unpaid Principal Balance is $230 million and $920 million, respectively. Here is an SEC 8-K link for the 2019 notes.

5 Ways Tesla Can Pay Off Debt

There are five ways Tesla can pay off debt. I have listed options from most preferable to least preferable, from Tesla’s point of view. Note that this is simply my opinion, not a statement from the company.

1. Convert to equity
2. Cashflow from operations
3. Borrow and repay
4. Sell equity
5. Use existing cash

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Convert to Equity

Tesla can convert the convertible bonds to equity at a price of $359.87 per share and 2.7788 shares per $1,000 principal amount of the 2019 notes. There are three conditions where it can happen.

The first is Tesla’s stock price is trading at 130% of $359.87 for 20 of the last 30 trading days. This may happen but the current price near $250 is not helping. The third way is in specified corporate events, such as mergers, acquisitions, and takeovers.

The second way is our primary interest. If the convertible notes are trading at less than $980 price for $1000 in bonds for five consecutive trading days, followed by another five business days, the convertible debt can be converted into shares. Currently, with a stock price of $258.78 on Oct 14, 2018, multiplying by 2.7788 gives us $719.09, well below the $1000 principal amount.

Pardon the legalese.

Prior to the close of business on the business day immediately preceding December 1, 2018, in the case of the 2019 Notes, and prior to the close of business on the business day immediately preceding December 1, 2020, in the case of the 2021 Notes, the 2019 Notes or 2021 Notes, as applicable, will be convertible only under the following circumstances:

(2) during the five business day period after any five consecutive trading day period in which the trading price per $1,000 principal amount of the 2019 Notes or 2021 Notes, as applicable, for each trading day of such period was less than 98% of the product of the last reported sale price of Common Stock and the applicable conversion rate on each such trading day;

I feel this is the best option. Tesla trades an average of 13.8 million shares a day. Multiplying by the price $258.78 is $3.571 billion traded every day. $1 billion in new shares is not too much for the market to absorb.

There is no guarantee owners of convertible debt will sell new shares right away. They may hold, sell, or hedge. This results in dilution of 2.3% to existing owners (Tesla’s market value is $44.1 billion).

There may be legal language to true up the value to make the bonds whole. That may result in more significant dilution.

Update: The convertible bond rate is currently $97.23.

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Cashflow from Operations in Q3

This is the second best option for Tesla to pay back funds. Here are three scenarios for cashflow from operations in the third quarter.

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Scenario #1

− $700 million in profit
+ $400 million in depreciation
+ $140 million in stock option compensation
+ $187 million reduction in inventory
− $600 million in accounts payable
= −$577 million in cashflow

Let’s say Tesla loses close to $700 million in profits in Q3. Tesla also pays back the $600 million extra in accounts payable. There was an inventory reduction of about $187 million related to moving Model S, X, and 3 vehicles out of inventory and selling the cars. Using Q1 numbers for depreciation and stock option compensation (more conservative than Q2), this results in −$577 million in cashflow from operations.

Rating: Highly unlikely

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Scenario #2

− $400 million in profits
+ $400 million in depreciation
+ $140 million in stock options
+ $187 million reduction in inventory
− $300 million in accounts payable
= +$27 million in cash flow

Here the net loss matches depreciation. Accounts payable is reduced by $300 million. This results in +$27 million in operating cash flow.

Rating: Unlikely

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Scenario #3

$0 million in profits
+ $400 million in depreciation
+ $140 million in stock options
+ $187 million in inventory reduction
− $300 million in accounts payable
= +$427 million in operating cash flow

I believe this is more realistic compared to the final result.

At the least, averaging the last two scenarios is +227 million gain in cash, enough to cover $230 million debt payment in November.

Rating: More realistic

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I make the following assumptions for Q4.

65,560 Model 3 delivered
92,250 total cars delivered
20% gross margin Model 3 — more than 90% AWD or above (estimated)

Using the Long Range SimTesla game, that gives me about $286 million in net profits.

Estimated Fourth Quarter

$286 million in profits
+ $400 million in depreciation
+ $140 million in stock options
+ $0 million in inventory reduction
− $150 million in accounts payable
The result is $676 million in Operating Cashflow

This totals $903 million in operating cash flow for Tesla to make up at end of Q4 to pay $930 million debt. Very doable.

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Borrow & Repay

For individuals, it is easy to borrow at a lower interest rate and repay higher interest rate credit card debt. You can use Home Equity or Credit Card Consolidation loans. For companies, they are subject to more stringent requirements. Depending on the amount Tesla wants to borrow and the conditions, they may need to talk to their existing lenders first and satisfy the bond covenants. This would be option #3.

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Sell Equity

This is always an option and Wall Street’s preferred outcome, and Elon’s least favorite method. This will pay off the debt, no problem. Depending on the amount raised in new equity, Tesla’s credit rating at the time, and any potential discounts to the existing price, the dilution can be quite large. I rate this as option #4.

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Use Existing Cash

Using existing cash, Tesla will need enough to run the business, pay back the debt, and satisfy existing loan conditions. This seems difficult and probably not the preferred way to go, so this is option #5.

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Final Notes

Q1 2019 will add to the cash balance and is not included here. The Model Y unveiling also adds to Tesla’s cash balance. Both will provide some cushion to the amount of cash Tesla has remaining.

It’s very clever to only take out items that need to be paid and not include items that are in your favor when calculating ratios. That’s not accurate and is deceptive.

The above references an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice.

I am currently long Tesla shares and Tesla bull call spreads.

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