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Tesla Bond Thoughts

8 August 2017 by Mark Holman

It’s August and we are in the depths of the summer doldrums, but an exciting new issuer is coming to the bond market, and at this stage it looks like they will be greeted with open arms. Once again, a good job has been done thus far by the syndicate banks, and also by the borrower itself, as Tesla is after all a terrific story. So far…

However, for those that were around in high yield bond markets during the euphoria of the dot com era fifteen years ago, it is hard to forget the lessons learned as borrowers at that time took advantage of a nascent European high yield bond market that was desperate for diversification following the introduction of the Euro currency. That euphoria allowed companies to obtain debt in order to grow their young businesses, instead of using equity. This ultimately ended in pain for investors as default rates soared in the later part of 2002 to 2003. This is why we always frown when new technology is mentioned in the same sentence as fixed income. Of course some technology sector companies can become incredibly robust and even utility-like, such as Microsoft, which happens to be one of only two non-financial corporates rated AAA in the world today; but for every Microsoft there are many more that fail.

This brings me to Tesla, which is a story that I have watched and admired. As a car lover I have to say the models they have produced to date have style and performance in equal measures. Right now it’s hard to argue that Tesla is not ahead in the race to be the premier producer of electric cars, a view that the stock market has also clearly taken, valuing Tesla’s equity at just under $60bn. However, from the perspective of a fixed income investor, the story, in my view, remains an equity story and not one that should be in bond markets at such an early stage in the company’s development.

The race to win a sizeable share of the electric car market has only really just started, and there are many venerable competitors that Tesla will meet head-on in the years ahead. These are competitors with tremendous history, brand recognition, customer loyalty and market share. Yes Tesla has first mover advantage, but in the world of technology and innovation, the first mover does not always win. Who knows how battery technology will develop in the future? Except perhaps that they will become smaller, more powerful and cheaper. So what of the old technology? Will it be discarded like we currently do with old phones? I hope the car-leasing firms have factored some of this uncertainty in. Now maybe this is a little flippant, but the point is that so much can and will change, and fixed income markets are understandably wary of uncertainty.

As of today Tesla has never made a profit, it has huge negative free cash flow and it is struggling to meet the demands of its customers – hence it needs more cash.

The new issue bond deal that is due to come later this week is an 8 year $ transaction, rumoured to be with a coupon of 5.25% and a size initially targeted at $1.5bn. The rating unsurprisingly is likely to be B3/B- , one notch above CCC.  The target market is naturally the US, but for overseas investors who may hedge the currency that would equate to roughly 4% in £ or 3.25% in €.

The deal is likely to be a success and should initially trade reasonably well, but I would much rather Tesla used its incredible position in the equity markets to fund this early stage of its growth; consequently, we will be watching with interest from the sidelines on this one.

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