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John Engle
John Engle
Articles (529) 

Tesla’s Board Has Woken Up to a Nightmare

Elon Musk may have buried his company with an impulsive tweet

August 17, 2018 | About:

Elon Musk, the embattled CEO of Tesla (NASDAQ:TSLA), has been under a microscope for the past week. He posted a bizarre tweet on Aug. 7 in which he said he was considering taking the upstart electric vehicle maker private at $420 a share – and that he had funding secured to undertake the transaction. The market, unsurprisingly, went wild on the announcement, sending shares soaring upward. Musk also tweeted everything was already in place and all that was required to finish the transaction was a shareholder vote.

As the media, banks and analysts frantically searched for who might be the bidder, it became clear no one knew what was going on. No banks or law firms had been contracted to consider the deal and no deep-pocketed buyer came forward. Some suggested the Saudi sovereign wealth fund, which had announced a 5% stake in Tesla shortly before Musk’s tweet. In a blog post published hours after his initial tweets, Musk said the “funding secured” was built off of a series of conversations with the head of the Saudi fund that left him with the impression that the fund had the resources and will to take Tesla private.

Funding not secured

Then the wheels started coming off the story. The Securities and Exchange Commission began making inquiries, which have since resulted in subpoenas of Tesla and its board. Of course, even the board of directors was in the dark when Musk tweeted his intention. In a public statement on Aug. 8, several board members said Musk had brought up the subject of taking Tesla private a week prior, but that no formal action had been taken. The board was clearly blindsided, and several members obviously feared the legal ramifications of Musk not being honest enough to take separate legal counsel.

As the days passed, it has become increasingly clear that no funding pledge was in place when Musk tweeted. This has led to a collapse in the stock price, with shares trading well down from where they had been by Aug. 16. A raft of class-action lawsuits and a mounting SEC investigation have caused concern. Despite the cold water thrown on the go-private transaction, Tesla’s board has taken the necessary steps to backfill the process in an effort to salvage the situation. Musk has retained his own advisors and the board has established a special committee to review any proposals that may be presented. When the committee was formed on Aug. 14, the board made it abundantly clear Musk had not produced the basics of a buyout structure, nor the source of funding.

Asleep at the wheel

Tesla’s board has long been accused of being more a creature of Musk than a true check on his power. After Musk called a cave diver involved in the heroic rescue of a a trapped Thai soccer team a pedophile on Twitter, the board uttered nary a peep. We pointed out in a research note in the wake of that sad episode that such accusations were highly unprofessional and deleterious to Tesla’s brand.

The board proved to be compliant when Musk moved to merge Tesla with SolarCity, the struggling solar energy business run by his cousins. It went through the motions of objectivity, with Musk recusing himself from the decision-making process. Yet the board was happy to essentially rubberstamp the boss’ desire, bringing SolarCity into the Tesla fold – along with a mountain of debt. That merger has proven disastrous, with installations actually falling in recent quarters even as the company has slashed its solar-focused workforce. In hindsight, it should be crystal clear what critics said at the time, namely that the transaction was a bailout disguised as a merger.

Musk has paid his board very well for their compliance. Members are paid the equivalent of $1.5 million annually, making them the best-paid board in the United States. The board is meant to be a check on the CEO and to be the ultimate source of governance on behalf of shareholders. Until the latest crisis, the board appeared to be far more interested in serving Musk’s interests and keeping their lucrative positions.

I love the smell of litigation in the morning

While the board has been asleep at the wheel for years, it appears to have been jerked awake by Musk’s latest stunt. The spike in the stock price in response to Musk’s tweet opened liability from short sellers damaged by what appears to be deliberate manipulation. They are the obvious victims and, allegedly, the target of Musk’s tweet. But shareholders on the long side will also be a source of potential liability: Many bought on the news of a deal, expecting arbitrage profits as the $420 price was confirmed, only to see the price deteriorate severely in the days after.

The board has been made fully aware of the potential liability, according to reporting by journalist Charles Gasparino. Gasparino has sources within the boardroom providing information on the ongoing issues. He reports that fears over potentially billions of dollars in civil liability could dwarf the penalties of the SEC.

Between a rock and a hard place

Tesla’s board is composed of capable businesspeople. They do not want their reputations tarnished, nor their bank accounts ransacked by liabilities created by Musk’s impulsive tweeting. Currently, there is no easy way out of the situation. They have started to behave like a real corporate board, perhaps for the first time. They are behaving as if Musk could bring forward a go-private proposal and are acting by the book. Of course, that alone cannot save them from sharing the potential liabilities already accrued, but it can at least stanch the bleeding.

The board is clearly in a serious bind. With little prospect of a funder coming forward, there is little chance Musk’s statements can be construed as anything other than misleading. But to impose discipline will do little to fix the damage already done. The liabilities are real and could end up bringing Tesla to its knees.

The question now is clear: What to do about Musk?

Disclosure: We are short TSLA via long-dated put options.

About the author:

John Engle
John Engle is president of Almington Capital Merchant Bankers and chief investment officer of the Cannabis Capital Group. John specializes in value and special situation strategies. He holds a bachelor's degree in economics from Trinity College Dublin, a diploma in finance from the London School of Economics and an MBA from the University of Oxford.

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