The time for Tesla Inc. TSLA -1.30% to raise cash is fast approaching, say many analysts and investors, but the company’s fundraising options are fraught with complications.
Led by Chief Executive Elon Musk, the Palo Alto, Calif., firm has built a $50 billion market capitalization out of its promise to lead the way to a world of driverless electric cars. But in recent quarters it has struggled to build its first mass-market sedan, the Model 3, while burning through billions of dollars—a combination that is beginning to test investor patience.
While Mr. Musk has said Tesla won’t need to raise more money this year, not many analysts agree. To generate cash, they say Tesla needs to be able to consistently build around 5,000 Model 3s a week. That’s more than double the pace the company said it reached at the end of the first quarter, and a target the company has twice set back. Tesla now says it expects to make that many cars by the end of the second quarter.
The longer it takes Tesla to meet its production targets, the “greater the financial risk,” said Efraim Levy, a senior equity analyst at CFRA Research. Tesla shares have fallen roughly 2.2% this year.
No fundraising option is without drawbacks. Issuing new shares would dilute shareholders and likely drive down the share price, potentially rattling creditors and pushing up borrowing costs—a chain that could result in further share declines. And the falling price of Tesla’s unsecured bond means new debt could lead to significant added interest expense.
Tesla could also sell convertible bonds, a hybrid of debt and equity that has been the company’s favored means of raising cash in recent years. But that could prove more challenging due to the unique dynamics of the market. Many investors, such as hedge funds, will buy convertible bonds only if they can also bet against, or short, the issuer’s shares—a strategy known as convertible bond arbitrage.
Normally, that isn’t a problem, as investors can easily short shares in many large firms by borrowing in the stock-loan market and then selling, with the expectation of repurchasing at lower prices later. But Tesla is now the most shorted stock in the U.S. by dollar volume, making it increasingly costly and difficult to borrow its shares.
As of Thursday, investors were short roughly 39 million Tesla shares, worth nearly $12 billion, or about 83% of what is likely available in the stock-loan market, according to financial-analytics firm S3 Partners. The increased demand for shares to bet against has pushed the fee required to borrow Tesla’s stock to as high as 6% of the borrowed amount in the past month, from less than 1% at the start of the year. It was 3.6% this past week.
“If there isn’t enough stock available, or the rate is so high, the hedge becomes untenable,” said Ihor Dusaniwsky, managing director of predictive analytics at S3 Partners, who previously worked on the stock-loan desk at Morgan Stanley .
Since the start of 2013, Tesla has issued $3.9 billion of convertible bonds, $3.8 billion of shares and $2.8 billion of unsecured bonds and asset-backed securities, according to Dealogic.
Convertible bonds have been appealing for Tesla because they pay lower interest rates than traditional debt and don’t immediately dilute shares, unlike a stock offering. The securities typically pay out regular coupons and are either repaid at maturity or converted into shares, depending on the stock performance over the specified period
Tesla finished the first quarter with $2.7 billion in cash on hand, compared with $3.4 billion at the end of last year. Analysts surveyed by FactSet predict the company will burn through $1.2 billion in the remainder of the year. It will need to pay down a $230 million convertible bond this November if its stock doesn’t reach a conversion price of $560.64, and a $920 million convertible note next March if the stock doesn’t reach $359.87. Shares closed Friday at $301.06.
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Tesla’s stock, while up in recent sessions, has fallen more than 20% since its peak of $385 in September. Its $1.8 billion unsecured notes due in 2025, issued at par in August with a 5.3% coupon, recently traded at 88 cents on the dollar for a yield of roughly 7.5%.
The terms of Tesla’s bonds allow it to issue at least $3.15 billion of more senior debt secured by collateral, according to Covenant Review, an independent credit-research firm. Such debt would likely save the company in interest expense but could make a future debt sale more difficult by pushing yields higher on its unsecured bonds.
Issuing another $1.8 billion unsecured bond today could require Tesla to pay an interest rate of 8% or higher, based on where its 5.3% notes trade. That would cost the company at least $144 million each year in interest expense, compared with the $95 million expense of its existing bonds.
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