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Wednesday, 22 November 2017

UPDATE 1-Tesla bond generates interest from alternate market

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Electric-car pioneer Tesla is expected to price its debut unsecured junk bond on Friday, testing fixed-income investors’ appetite for a company that has yet to generate any real cash flow.

The US$1.5bn eight-year non-call three bond has already won plenty of attention, given the strong name recognition of founder Elon Musk and the stellar performance of its stock over recent months.

“All the big bond managers are going to be tripping over themselves to be part of this,” said a buyside strategist.

“This is Elon Musk. Investors will be a little bit starstruck.”

The deal signifies the next step in Tesla’s relationship with the capital markets and helps build a relationship with a new community of investors.

“They’re trying to give the markets a signal that they have access to capital other than equity,” the portfolio manager said.

“There was a worry that it might be a bad signal if they needed to hit the equity market again to cover cash shortfalls.”

The bond trade is expected to be the first of several in coming years as it switches away from equity issuance to fund its ambitious growth plans and perhaps acquisition as well.

Tesla has raised fresh equity every year since going public in June 2010 at a price of US$17 per share. The stock was trading at US$355.31 on Thursday afternoon, up about 64% on the year.

Tesla has issued four convertible bonds to date - it has $3.3bn currently outstanding - but it has never accessed the public unsecured bond market.

The company bought some of those converts back after investors complained that the strong performance of Tesla stock was making it expensive to hedge the convertible bonds.

And while equity investors have clearly bought into CEO Elon Musk’s vision, helping push Tesla’s market cap past Ford’s and General Motors’, many fixed-income accounts are skeptical.

Concerns remain over the company’s ability to make debt payments at a time when it has been burning through cash from heavy capital spending after five straight years of net losses.

“It is still very early stage and nowhere close to generating substantial free cash flow,” said Bill Zox, chief investment officer at Diamond Hill Capital Management.

Tesla is expected to remain cash flow negative into 2019, and will have large cash requirement to fulfill its ambitious capex plans and cover maturities of convertible debt, according to Moody’s.

Without this bond issue, the company would face a stressed liquidity position, even with US$3bn in cash and another US$900m available under a secured revolver, the rating agency said.

S&P and Moody’s rated the bond B- and B3, respectively, six notches below investment grade.

“The credit metrics at this point are very weak, so taking leverage up by US$1.5bn is really not going to move the needle significantly,” Moody’s analyst Bruce Clark IFR.

Musk expects capital expenditures to reach about US$2bn during the second half of this year as he looks to ramp up production of its Model 3 as part of his plan to enter the mass market.

“The big issue is the success of the Model 3 – are you going to have a successful launch, and do you have enough liquidity,” Clark said.

Moody’s reckons the company would break even if it hits a 2018 sales target of 300,000 units with gross margins of about 25%. But it would still be cash flow negative given high capital expenditures of around US$4bn this year.

“Their target of delivering (that many) vehicles next year is pretty aggressive,” said Jon Stanley, a portfolio manager at Newfleet Asset Management.

“For a company that has rarely hit its goals up to this point it doesn’t make sense.”

For many investors talk of 5.25% area on the eight-year non-call three bond fails to compensate them for such risks.

“You are buying venture capital at 5.25%, which makes no sense,” said Newfleet’s Stanley. “We are not playing it.”

Even so, current price talk comes well inside the 6% that was being privately talked in recent weeks, the portfolio manager added.

Indeed, Tesla has timed its debut well given the strength of demand of high yielding assets, though investors are starting to be wary of tight valuations.

“Their bankers know the market is strong,” he said. “You hit the market when you can and not when you want to - that’s the thing about high yield.”

And while certain accounts may prefer to stay clear of the credit, larger funds that remain flush with cash may have little choice but to take a bet on Tesla’s longer-term strategy.

“The big players have so much cash to put to work it will take a lot for them to pass on a deal this size,” said Zox.

 

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