Some Observations On Tesla’s Senior Note Issuance – Tesla Motors (NASDAQ:TSLA)

The Note Issuance

On August 18, Tesla (TSLA) issued $1.8 billion of senior notes, generating net proceeds of about $1.78 bin. after expenses. Per the 8-K regarding the notes with the SEC, which was filed on August 23, 2017:

“The Notes initially will be fully and unconditionally guaranteed on a senior unsecured basis by SolarCity. The Notes will not be guaranteed by any other of Tesla’s subsidiaries, except to the extent Tesla causes any such subsidiary to guarantee the Notes to comply with the covenants applicable to the Notes.”

SolarCity is further defined in the documents as “SolarCity Corporation.” SolarCity’s financial structure is actually quite complex. SolarCity Corporation has multiple subsidiaries where most of its assets, including the bulk of its “Solar energy systems leased and to be leased” as well as most, if not all, of its “MyPower” notes are located. All of SolarCity’s $2.5 billion in non recourse debt is located within these subsidiaries and secured by these assets. SolarCity Corporation simply has equity interests (stock) in these “non recourse” subsidiaries and is only entitled to the residual cash flows after the obligations to those non recourse lenders have been met. It has minimal cash generating operating assets of its own.

SolarCity Corporation has to meet all of its ongoing operating expenses (except for those that are directly related to servicing the assets in the non-recourse subsidiaries, for which they are normally entitled to reimbursement), R&D expenses, and capital investment outlays for such items as its solar roofs and its Buffalo equipment facility. It also has debt for which it is directly responsible. This includes a secured revolving credit facility, three different convertible senior note issues, the solar bonds, and the $100 million due to the Musk clan next February, for a total of more than $1.4 billion at June 30, 2017. Having debt to service both at the subsidiary level and the parent company level is what’s known as double leverage. A subsequent guarantee would be subordinate to all of these direct and indirect obligations. As a result, the SolarCity guarantee most likely does not add much to the credit characteristics of the new notes.

SolarCity Repays its Secured Revolving Credit Facility

There was one very significant sentence in the 8-k:

“On August 17, 2017, SolarCity elected to repay in full all amounts outstanding, and on August 18, 2017, terminated the commitments, under its Amended and Restated Credit Agreement, dated as of November 1, 2013 (as amended, the “SolarCity Credit Agreement”), by and among SolarCity, the subsidiaries of SolarCity party thereto as guarantors, the lenders from time to time party thereto and Bank of America, N.A., as Administrative Agent, Swingline Lender and L/C Issuer, in accordance with the prepayment and termination provisions of the SolarCity Credit Agreement. Prior to the prepayment in full, there was $325.3 million outstanding under the SolarCity Credit Agreement.”

This means that in fact, when viewing these two transactions together, Tesla added net cash of less than $1.5 billion the week of the note issue. Furthermore, the most recent 10-Q indicates the balance outstanding at June 30 was a bit higher, at $359 million.

This has a material impact on the cash projections contained in my August 21, article, Yet Another Capital Rise on the Horizon for Tesla, which contained my estimates of future cash needs. In that article, I had started with Tesla’s cash balance of a bit over $3 billion at June 30, and added the $1.8 billion note issuance proceeds to come up with approximately $4.8 billion for a “starting” balance. I had assumed they would roll over the revolving credit facility at its due date in December. Adjusting for the close to $400 million prepayment and facility cancellation, the revised starting total is about $4.4 billion, and my March 31, 2018, projection would also decrease by almost $400 million, to about $1.2 billion.

SolarCity Corp. Obligations are Being Replaced by Tesla Obligations

SolarCity’s last public filing at December 31, 2016, indicated the company had total recourse debt of more than $1.6 billion. It had decreased to about $1.4 billion by June 30, as referenced above, and is now almost $400 million less, so it a bit over $1 billion at this point. In addition to the revolving credit termination, all of the Solar Bonds due to Space X were repaid at maturity this spring, some other Solar Bonds were prepaid, and $10 million of the zero coupon convertible bonds owned by the Musk clan were converted to Tesla stock.

Paying down debt would be good news if it were being done out of operating cash flow. However, it is clearly not. Even a casual perusal of SolarCity’s financial condition indicates that Tesla must be downstreaming cash to them, increasing the ultimate cost of the SolarCity purchase to Tesla shareholders. If new funding is via equity rather than a loan from Tesla to replace the debt, then it makes SolarCity’s financial performance look better, with the interest expense appearing on Tesla’s books rather than SolarCity’s.

Tesla Bonds May be Available to Individuals Soon

Although these bonds were issued under rule 144A in the U.S. meaning they could only be sold to institutions, some of the bonds also were sold in Europe. According to various bond trading desks, once the bonds sold in Europe “season,” individuals in the U.S. may be able to purchase them. (Something about “Reg F”.) I’ve received various opinions as to when this seasoning period might end, but it could be as short as 40 days and more likely 90 days or more, if ever. In any case, if individuals are so inclined, they may be able to purchase these Tesla bonds in the not too distant future.

Surprisingly, even though I’m justifiably viewed as a TSLA “bear” here, and this article is not exactly positive, I would suggest that Tesla stock investors might want to consider spending $1,000 for a bond. Unlike some other bears here, I have never predicted an imminent implosion of Tesla, just that the stock appears to me to be significantly overvalued based upon its prospects.

The bond market is generally considered “smarter” than the stock market in recognizing when a company’s prospects are deteriorating, so for all stock investors, the price of these bonds should be closely monitored. However, I find that having some money at risk greatly focuses the mind. And if you have a bond in your portfolio, you can easily see the daily price rather than having to search for it. If there is a deterioration in the bond price that is not due to general market conditions such as a rise in interest rates for non investment grade (junk) bonds, it would be a good time to reassess both your bond AND stock positions. If the bond price were to decrease much below 95% of par and it is not due to general market conditions, I would begin to get nervous. As long as you are “paying attention” I can’t imagine a scenario where you would lose more than $100-200 on the bond, and of course you are collecting over $50 annually in interest in the meantime. Even if you were ultimately to experience a modest loss on the bond, this may be a much cheaper way to glean important market information than subscribing to a proprietary newsletter or a website behind a paywall.

Disclosure: I am/we are short TSLA.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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