As most know, the stock of Tesla (TSLA -1.11%) has been on a rocket ship move upward over the past six months, boosted by much-better-than-expected profitability metrics posted in the company's third- and fourth-quarter earnings reports.
While Tesla still hasn't posted a full year of profitability on a generally accepted accounting principles (GAAP) basis, 2019 ended up a very positive year on free cash flow, which surged to roughly $1.1 billion, up from a slight negative free cash flow in 2018. That's the result of the company miraculously reducing operating expenses and capital expenditures, even while growing sales.
In addition, Tesla seems to have put questions about liquidity to rest. By the end of 2019, the company had $6.5 billion in cash and cash equivalents versus $13.4 billion in debt. That is not that much net debt, considering a lot of that debt is either convertible to equity and holds low interest rates or is nonrecourse to the whole company. It's especially manageable for a growing, cash-flow-positive company.
And yet, even with all of these positives, Tesla decided to sell 2.65 million shares to the public last week at a 4.6% discount to its share price, or roughly $767.29 per share, bringing in roughly $2 billion. So, why would Tesla sell shares, especially when cash flow is up and management very recently claimed it didn't need to do so?
The Tesla Model Y. Image source: Tesla.
Changing its tune
As recently as the fourth-quarter conference call with analysts on Jan. 30, Musk and CFO Zachary Kirkhorn claimed Tesla didn't need to raise any money to fund Tesla's growth projects. Current projects include the Model Y launch, the Shanghai plant and Gigafactory, and the construction of the company's European manufacturing plant in Berlin, which has yet to be built.
On the conference call, Musk said:
...if there's any sensible way to spend money, we're spending it. There is no artificial holdback on expenditures. Anything that I see that is what looks like it's got good value for money, the answer is yes immediately. But we're spending money I think efficiently and we're not artificially limiting our progress. And then despite all that we are still generating positive cash. So in light of that, it doesn't make sense to raise money because we expect to generate cash despite this growth level.
So, it didn't seem that Tesla needed cash to support its growth investments, according to Musk.
Of course, Tesla could also use the money from an equity raise to pay down its debt. But even on that front, Musk said on the call, "Diluting the company to pay down debt doesn't sound like a wise move."
And yet, a mere two weeks later, Tesla is doing just that.
What changed?
Tesla may have changed its tune for a couple reasons. The first is that it may have been bluffing on questions regarding a capital raise. Obviously, if the market anticipates that you are going to dilute your existing stock, investors will discount that in the share price, thereby lowering the share price and making the capital raise more dilutive to existing shareholders.
The more likely reason is that Tesla's stock price has rocketed higher over the last two weeks, even from the high levels at which it was trading prior to the earnings call. Prior to the Jan. 30 earnings release, Tesla stock was trading around $580 per share, already up more than 150% from six months earlier. However, since earnings, the stock has rocketed another 37% to $800 per share, increasing Tesla's market capitalization to nearly $150 billion.
That final surge in the share price may have changed management's mind about diluting the company. After all, raising that $2 billion at these elevated prices only diluted Tesla shareholders by roughly 1.5%. That kind of minimal dilution -- especially when the company is still generating losses on a GAAP basis -- may have been too much of an opportunity to pass up.
Finally, it's also possible that management sees potential to ramp up Model Y, battery, cybertruck, and semi-truck production in California, China, and Europe at a faster pace than management previously led on. The auto industry is still very capital-intensive, but Tesla has a lead in electric vehicles, so management may see an opportunity to turbocharge its spending to stay ahead of incoming competition.
Be cautious at these levels
Whatever the reason for the capital raise, it's likely a big caution flag for potential Tesla stock buyers. When past equity raises, such as the smaller $650 million raise in 2019 and the $2.3 billion raise in 2016, occurred, Tesla needed to raise cash, as the company was ramping up production facilities and burning cash in order to reach the level of efficient production it's at today.
Now, however, it doesn't appear that Tesla needed the money, given the improved cost structure and balance sheet at the company. And yet, management thought it was a good idea to sell shares anyway.
That should make interested investors extremely wary about buying shares at these levels. When even reluctant sellers of equity think that issuing shares is a good idea, it may be a sign not to take the other side of the trade.
