Tesla Inc. (TSLA, Financial) is slipping into a bear mode as the American electric vehicle manufacturer continues to tumble. Its stock is down more than 20% in just over five days.
What started as a tweet from CEO Elon Musk, suggesting Tesla is looking to go private, is turning into a bloodbath as negative developments continue to unfold.
In the days following the tweet, it became increasingly clear that Tesla doesn’t have the financing for a deal. The electric vehicle company was then subpoenaed by the Securities and Exchange Commission, sending shares even lower. Then, over the weekend, the Saudi Public Investment Fund – which was considered to be key in Tesla’s plans to go private – invested in EV startup Lucid Motors, dealing another blow to the stock. The final nail in the coffin of Tesla's bull run was JPMorgan lowering its price target from $308 to $195 today, citing the company’s inability to finance a privatization deal.
What’s the take?
As negative developments continue to unfold, it will become increasingly difficult for Tesla to raise additional financing for operations, let alone for taking the company private. Going to the equity market might be the last-ditch effort to save operations, which will most certainly crater the stock price. As Tesla has no other option but to look for additional financing, the market will react negatively. Given Tesla needs financing to build a factory in order to reach its production target and justify its valuation, the company is in deadlock that can prove to be fatal.
Is there still a possibility of going private?
The chances of Tesla going private are rather bleak, at least at $420 a share. A $70 billion buyout is just wishful thinking given Tesla’s operating cash flow position; it was negative in six of the last eight quarters.
The company's debt position is also far from perfect for it be a candidate of a private buyout valued at $70 billion. Tesla has long-term debt obligations of around $9.5 billion, up an astonishing 33% over the trailing 12 months.
Looking at short-term obligations, Tesla is clearly in trouble and might have to file for chapter 11 bankruptcy if it fails to secure financing. Given that the company has been burning cash, its reserves have fallen down to a level close to its current debt obligations.
It’s also becoming increasingly clear that Tesla won’t be getting the money it needs to go private. It makes little sense to acquire a potentially bankrupt company for a premium of 40% over its stock price when there’s a possibility of acquiring the same company at a deep discount. The bottom line is that no institutional investor can justify acquiring Tesla at $420 a share given the company’s negative operating cash flow, high financial risk and looming risk of bankruptcy.
The problem isn’t just short-term financing
Although the company faces an immediate financing crisis, long-term prospects aren’t reassuring. Tesla faces competition from big global manufactures like Volkswagen (FRA:VOW, Financial), Toyota Motors (TM, Financial) and Diamler (DDAIY, Financial), who are quickly catching up in the electric vehicle arena. Despite rising competition, Tesla trades at a premium to its peers.
The graph shows that the automotive industry is trading at a price-sales ratio of around 0.5, while Tesla trades in excess of 3. To reach the industry’s valuation level, Tesla has to generate $100 billion in revenue; analysts are expecting $20 billion in revenue for 2018. Tesla has to deliver roughly 1 million cars per annum to justify such a valuation. As the company delivered around 40,000 cars during the most recent quarter, producing 1 million cars a year is a long shot in even the most relaxed of scenarios.
In addition, the Fremont Factory— the company's production line – has the capacity to produce around 500,000 cars a year. With the inclusion of a new factory in China, which will be operational in two years, Tesla will have the capacity to produce around 1 million cars a year. But the construction of the new factory requires funding, which the company currently doesn’t have. Overall, Tesla is in no position to produce one million cars in the near future and is extremely overpriced on relative basis.
In summary, institutional investors won’t take Tesla private as the company faces financial risks in the short term while entailing a lofty valuation, which can’t be justified by realistic long-term production targets.
Disclosure: I have no positions in any stocks mentioned and no plans to initiate any positions within the next 72 hours.
