At the end of last quarter, Tesla (NASDAQ:TSLA) was sitting on $3 billion worth of cash. That comes after the electric-car maker spent $959 million in capital expenditures during the quarter, leading to free cash flow burn of $1.16 billion. Tesla guided capital expenditures in the second half of 2017 to $2 billion as it invests heavily in the Model 3 production ramp.
Even before factoring in operating cash flow, those figures would put Tesla a little too close for comfort to its previously stated minimum threshold of $1 billion. Tesla is no stranger to capital raises, with the most recent one being earlier this year. This begs the question: Will Tesla need to tap capital markets in the near future?
Capital markets appear to remain willing
Greenlight Capital's David Einhorn is among Tesla's most vocal critics (Einhorn is short Tesla shares), recently arguing that Tesla risks running out of cash as it attempts to ramp Model 3 production. "The company is expected to burn over $2 billion this year as it begins production of its Model 3," Einhorn said earlier this week. "It is currently only capitalized for the next three quarters. As Tesla attempts to achieve scale for the Model 3, it will depend on the capital markets' willingness to fund it."
Einhorn is correct that Tesla has largely relied upon capital markets to fund its ongoing cash needs, returning every year or two to refill its coffers. However, Einhorn may be underestimating investors' willingness to support Tesla's capital requirements. It's worth pointing out that the most recent offering was oversubscribed, with underwriters exercising options to satisfy investor demand. Initially, Tesla only expected the March offering, which included both common stock and convertible notes, to bring in gross proceeds of $1.15 billion. It ended up raising net proceeds of $1.22 billion, even after covering the cost of hedging the notes ($131.5 million).
The "promised land"
On the earnings call on Wednesday, the company provided some detail regarding its cash flows. One minor item that helps is that Tesla has negotiated more favorable payment terms with its suppliers, effectively stretching out accounts payable. Ideally, that gives Tesla more time to build the car, deliver it to the customer, and collect payment from the customer before having to pay suppliers. To the extent that Tesla can accomplish this, which CEO Elon Musk called the "promised land," it can grow hopefully its cash position. Still, Musk would not rule out the possibility of another capital raise (emphasis added):
Now that said, there may be some wisdom in having a cash cushion for unexpected events. You just never know if there's going to be some significant force majeure events in the world, could be an earthquake in California, for example. And -- but we're not at this point considering an equity raise. We are thinking about debt, but we're not thinking about an equity raise.
Let's look at the pros and cons of a possible debt raise.
The good, the bad, and the capitalized
The good news would be that existing shareholders would avoid further dilution if Tesla goes with debt instead of equity, even though dilution costs would be minimal at current share prices. There is also a higher cost of capital associated with equity compared to debt, so issuing debt would reduce the company's weighted average cost of capital (WACC) relative to issuing equity.
The bad news is that Tesla's balance sheet is already loaded with debt, particularly after absorbing SolarCity's paper. At the end of the second quarter, Tesla had nearly $8 billion in long-term debt and capital leases (including both current and long-term portions). The interest on that debt is substantial: $108.4 million last quarter, although this sum includes $65.7 million of non-cash interest expense associated with convertibles.
Tesla's true interest expenses are also higher than what's reflected on the income statement. In its 10-K, the company notes: "Interest expense on outstanding debt is capitalized during the period of significant capital asset construction. Capitalized interest on construction in progress is included in property, plant and equipment, net and is amortized over the life of the related assets." It is certainly entering a "period of significant capital asset construction" for the Model 3 ramp. Tesla's most recent 10-Q for the second quarter has not yet been filed, but the company capitalized $23.3 million of interest expense in the first quarter and $46.7 million throughout 2016.
Since the proceeds from Tesla's debt issuances often fund capital construction, this seems an appropriate accounting method, but the point is that capitalized interest expense does not show up immediately on the income statement, and is instead accounted for on the balance sheet and subsequently depreciated and amortized over a longer period of time.
It's going to be a tricky balancing act in the months ahead as Tesla tries to maintain its cash position and cash flow while investing heavily in ramping Model 3 production in pursuit of the "promised land."