Short sellers are eager to squeeze Tesla (TSLA) and CEO Elon Musk further after a big capital raise recently carried the electric-car maker's share price briefly upward.
Shares of Palo Alto-based Tesla have traded in a volatile manner after following the announcement on May 2 of a much-needed $2.7 billion capital raise. Tesla disclosed plans to raise money through a "mixed-shelf" offering of Tesla shares and convertible senior notes.
The news initially sent Tesla shares up some 9% over just two days, although they've since given back all of the gains and more. Shorts weren't shaken by the brief price surge, as terms of the deal and the underlying thesis about brand deterioration have stoked skepticism about Tesla ever reaching profitability regardless of the new loans. That's led to an increase in short interest, not a decrease that many expected.
"We have a negative view toward Tesla," Greenlight Capital CEO David Einhorn said Tuesday during first-quarter earnings call for Greenlight Capital Re, the Bermudian reinsurer tied to his hedge fund. "We think the stock is overvalued and risk/reward on the long side is exceedingly poor. The company's business has deteriorated remarkably."
He added that the response from Tesla that has included a capital raise, head-count reductions, price cuts and retail-store closures won't be sufficient to keep the ship afloat.
"In recent weeks, the CEO has all but abandoned the narrative of the last few years that profit from selling cars would prove the company's value," Einhorn noted. "I think that they now face a stream of almost unending losses. So, with the market cap the way that it is, I think as the market absorbs that and some of the disappointments prove out in the coming quarters, we expect to do well in our short position from here."
Parsing the Print
Many investors looking to profit off Musk's pain are following Einhorn's lead as details of Tesla's capital-raising deal with Goldman Sachs (GS) and other banks gets a read-through.
$TSLA short int is $9.2 bn; 37.08 mm shares shorted; 28.29% of float; 0.76% borrow cost. 1.01 mm new shares shorted, +2.8%, over the last week even as #Tesla 's stock price rose 4.4%. Shorts are down $396 mm in mark-to-market losses in May,but still up $2.4 billion for the year pic.twitter.com/dogNNgT51g— Ihor Dusaniwsky (@ihors3) May 8, 2019
One aspect drawing short-sellers' attention is the fact that the convertible bonds that Tesla is issuing come with a myriad of caveats that make their initial 2% interest rate actually far less attractive than that low rate would normally indicate. And while Tesla analysts welcome the much-needed capital raise, there's plenty concern about the dilution and reciprocal-hedging programs in place under the deal's terms.
"We applaud Tesla's decision to raise capital, but believe at the same time it should serve to highlight the potential ongoing dilution risk should the firm not prove more successful in stanching free-cash outflow," J.P. Morgan analyst Ryan Brinkman wrote in a recent research note. "Our estimates tick down slightly, given the impact of higher interest expense and equity dilution." He retained his "Underweight" rating for the stock.
Much less diplomatically, shorts noted that the deal's details make it more expensive than many initially realized.
"The 2% convert really costs 4%-5% cash effectively when you factor in the upfront cash spent by Tesla from the deal proceeds to buy options to hedge dilution," said noted Tesla short-seller Gabe Hoffman, general partner at Accipiter Capital.
Less Than Electrifying
Short sellers have many qualms about the deal, which is divided into two parts debt and one part equity that entails upfront costs to Tesla. According to filings, Tesla paid $475.8 million on Wednesday to close out a green-shoe underwriting agreement in order to reduce potential dilution, already cutting into the cash raise after options exercised by underwriters increased the fee.
According to company calculations, the $475.8 million raised provided a benefit to Tesla of $174.8 million, bringing the net payment to $301 million for warrants attached to the deal. That means the initial $2.7 billion headline number of how much Tesla is raising has in reality already come down to about $2.4 billion.
However, the number will fall even lower after a $566 million bond payment for Tesla's SolarCity business of $566 million comes due in November. That brings the total down to $1.9 billion.
It also adds an interesting wrinkle in the form of call options offered to counter parties. "The warrants allow the hedge counter parties to acquire, subject to anti-dilution adjustments, up to approximately 10.3 million shares of common stock at a strike price of $607.50 per share in respect of warrants, which is also subject to adjustment," a company filing states.
Glenn Tongue, a general partner of Deerhaven Capital Management, wrote recently in a newsletter that if you factor in these equity hedges, the price of Tesla's new debt goes up significantly. Tongue's analysis puts the yield on the total basis close to that of Tesla's 2025 bonds, which ticked above 8% this week.
Crayola Time pic.twitter.com/6pKdJdi6nk— This writing business. Overrated if you ask me. (@ScouseView) May 8, 2019
Tesla has eschewed this style of accounting for the deal's two separate portions (debt and equity) as if they were one, and explained at length in its prospectus the fund raising's benefits as opposed to a simple debt offering. However, shorts are standing steadfast by their bearishness on the deal's structure.
"Raising 2/3 debt and 1/3 equity, roughly, will prove to be incredibly stupid of Tesla," Accipiter's Hoffman said. "On the other hand, perhaps it was all the equity Tesla was able to raise!"
He argued that Tesla's cash raise was done out of necessity rather than hope for the future, as sales numbers should continue to lag the overly bullish estimates that Musk has set.
"Tesla was almost literally out of money before this raise," Hoffman reasoned. "Remember, [of] the $2.2 billion of cash, only $1.45 billion belonged to Tesla. They owed suppliers over $3 billion against only about $1 billion in accounts receivable."
It's worth noting Tesla has rejected this notion, noting that the company wouldn't have pursued its fund-raising strategy had it not been attractive. Further, the latest offering is somewhat similar to previous capital raises that Tesla has pursued and dealt with in the past, most notably a hefty $920 million bond payment made in March, that the company comfortably paid.
In fact, the latest deal's terms are actually more favorable than a previous offering that came before the company's massive share growth in recent years. Still, the sizable debt pile is provoking more-pessimistic investors to take interest in the company.
"Our and our subsidiaries' outstanding indebtedness was approximately $10.3 billion as of March 31, 2019, without giving effect to the notes to be issued in this offering," the deal prospectus acknowledges, recognizing this issue. "Of our total outstanding indebtedness, $1.1 billion is due to mature in 2019 and $819.8 million is due to mature in 2020."
The filing added that alternative methods of drawing down debt -- such as reducing or delaying investments or capital expenditures (something the company has already done), selling assets, refinancing or obtaining additional equity capital "on terms that may be onerous or highly dilutive" -- could be pursued if the company's outstanding debt becomes too large.
"For Tesla, 'Winter Is Coming,'" Hoffman concluded amid his compilation of a hefty list of bearish indicators. "The stock is heading into a permanent deep freeze."
But Tesla counters that its balance sheet is doing just fine, despite looming debt.
Chief Financial Officer Zachary Kirkhorn painted a picture of an improving cash trend during the company's first-quarter earnings call, citing company optimism around sales of its new Model 3 car.
"The balance to the $1.5 billion reduction is more than explained by the working capital impact of expanding Model 3 operations overseas," he said. "We do not expect to repeat in [the second quarter], and we expect our quarter-ending cash balance to continue to increase going forward. I will also note that we are tracking in April to the largest amount of deliveries from Month 1 in the history of the company."
An increase in deliveries and better cash position could make the capital raise more amenable in this light, but at the very least, analysts wonder about the timing of Tesla's new debt offering.
"Some question whether the timing so early in the quarter sends a less confident message around the second-quarter pace of deliveries, which some sources suggest is off to a sluggish start," Morgan Stanley analyst Adam Jonas recently wrote in a note. "Our forecast is 348,000 units. In our opinion, an investor in Tesla shares must be comfortable with full-year unit volume that could test the 300,000 to 320,000 mark as a realistic downside scenario." That forecast would fall well below management's expectation of 360,000 to 400,000 sales.
Jonas added that the most bullish Tesla thesis pertains to increased sales opportunities in China, which the company's new financing could serve as a bridge to. However, increased China sales remain uncertain, so Jonas retained his "Equal Weight" rating on Tesla based on what he sees as a questionable risk/reward profile. Of course, analysts are likely to get only more bearish if the U.S.-Chinese trade war makes Beijing regulators more adversarial toward an American-based company operating in their country.
Tesla has, of course, countered this on the basis of its estimated $500 billion valuation being achievable mainly on the back of autonomous-driving initiatives that will seek to differentiate the company in an ever-more-crowded electric-vehicle space.
"Our ultimate goal is an autonomously driven future that improves safety for everyone on the road and provides our customers with convenience and additional income through participation in an autonomous Tesla ride-hailing network, which we will also operate with our own vehicles," the company's latest 10-Q filing states.
Considering Tesla is already putting in protection for a stock price surge to $607.50 through call options, the battleground on the stock couldn't be more dichotomous at this point.
But given Musk's dodgy track record on production timelines, bears aren't moved by the autonomous driving statements despite the adulation of Tesla's loyal fan base and bullish outlook for the option hedges.
As such, that "battleground" status is likely to persist for quite some time.