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Tesla Changes Its Mind on Raising Capital

By Evan Niu, CFA - Feb 14, 2020 at 8:30AM

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Elon Musk said last month that the automaker wasn't interested in raising capital.

Just two weeks ago, Tesla (TSLA 4.53%) CEO Elon Musk casually dismissed the idea of raising capital after the electric-car maker reported strong fourth-quarter earnings that included a second consecutive quarter of profits on a GAAP basis. The stock had already started its recent meteoric climb and was approaching $600, and analysts wondered if Tesla should opportunistically raise capital.

Musk said Tesla was "spending money as quickly as we can spend it sensibly," yet was still generating positive cash flow -- including $1 billion in positive free cash flow during the fourth quarter. "So in light of that, it doesn't make sense to raise money because we expect to generate cash despite this growth level," the eccentric billionaire added.

Musk has now changed his mind.

Four Tesla vehicles with mountains in the background

Image source: Tesla.

Strengthening the balance sheet

This week, Tesla announced that it would be raising $2 billion through a public secondary offering, with underwriters having an option to buy another $300 million.

Musk often participates in secondary offerings and is doing so again: He will buy $10 million worth of shares. Musk almost never sells shares, and instead takes out personal loans (backed by his Tesla holdings) worth hundreds of millions of dollars for liquidity. Director Larry Ellison, who is a personal friend of Musk's and one of the richest men in the world, will buy $1 million in stock.

The company expects to raise around $2.3 billion in gross proceeds, assuming the underwriters exercise their options in full, and plans to use the proceeds to "further strengthen its balance sheet." Tesla had $6.3 billion in cash and cash equivalents at the end of 2019, up $930 million sequentially. While Tesla's cash position has already been improving, the company still has a considerable debt load.

Including finance leases, total debt is now $13.4 billion. A $1.4 billion tranche of convertible senior notes is set to mature in March 2021. The conversion price on the 2021 notes, which were initially issued in 2014, is approximately $359.87 -- well below current share prices. Tesla reserves the right to pay cash in lieu of issuing stock upon the conversion of those notes, and frequently enters into convertible note hedge transactions that are designed to mitigate potential dilution while effectively raising the conversion price.

A change of heart

On the earnings conference call, Credit Suisse analyst Dan Levy suggested that Tesla could raise capital to either pay down debt or pursue acquisitions that could accelerate the company's development of autonomous driving or battery technology. Musk replied that he is open to acquisitions but is "not aware" of any companies that he'd want to acquire.

Generally speaking, the cost of equity is higher than the cost of debt, so issuing shares to pay down debt does have the potential to increase a company's weighted average cost of capital (WACC). Convertibles have a higher cost compared to regular debt since the paper has an equity component, but lower costs compared to equity.

Musk had asserted, "Diluting the company to pay down debt doesn't sound like a wise move."

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