UPDATE: Tesla's junk bonds are trading under water -- and it could spell trouble for Elon Musk

11/15/17 08:00 AM EST

By Claudia Assis and Ciara Linnane, MarketWatch

Tesla may struggle to get good terms if it attempts to issue more junk bonds, experts say

Tesla Inc. first-ever pure corporate bonds are trading under water, boding ill for the Silicon Valley car maker's next attempt to tap capital markets.

Tesla(TSLA)sold $1.8 billion in the senior notes in August at a yield of 5.300%, at the height of excitement about the Model 3 and expectations the sedan's production ramp would run as smoothly as Chief Executive Elon Musk had predicted.

That same month, Tesla shares rose 10% to mark their last monthly gain this year so far. The stock lost 4.2% in September and 2.8% in October.

The stock is down 9% so far in November, on the heels of a quarterly miss earlier in the month and news that the company has further pushed out its Model 3 production targets (http://www.marketwatch.com/story/buy-the-dip-on-tesla-as-it-has-the-talent-to-fix-its-manufacturing-issues-analysts-say-2017-11-02).

"Third-quarter results put some pressure on the cash flow needs," said Efraim Levy, an analyst with CFRA Research. The wider-than-expected quarterly loss and production delays "makes it harder for them to get a sweeter deal than they had in the past," on capital raising, be it when selling bonds or equity, he said.

The 5.300% notes, which mature in 2025, were trading at 93.81 cents on the dollar on Friday to yield 6.320%, according to trading platform MarketAxess. On a spread basis, they were trading at 393 basis points above comparable Treasurys. The bonds fell under par within a week of issuance, but were holding above 97 cents for much of October.

Wall Street has long seemed to accept that Tesla's high capital expenses and negative free cash flow will be the reality for the company at least in the short term.

But the weak performance of the bonds may be a sign that bond investors, at least, are starting to disbelieve Tesla's growth story and will be looking for higher premiums to take on higher risk, said Trip Miller, a managing partner at hedge fund, Gullane Capital LLC. That higher cost of borrowing will have its own negative implications, he said.

"Maybe the dam is starting to break for Tesla," Miller said. Gullane does not have a position in Tesla because "their balance sheet is very, very troublesome for us," he said.

Related:Tech to kill car dealerships, in one chart (http://www.marketwatch.com/story/how-technology-could-kill-car-dealerships-in-one-chart-2017-11-06)

While bulls mostly contend Tesla will hold on to its early-mover advantage in the electric-car space and to the appeal of its design and its leadership, others point to increasing competition from rivals with bigger pockets as well as the company's inexperience in mass-market production.

At the time of the company's roadshow, the bonds raised some eyebrows for offering fewer-than-usual protections for bondholders, including weaker covenants (http://www.marketwatch.com/story/mind-the-hype-teslas-15-billion-in-new-bonds-are-riskier-than-usual-2017-08-10). Fund managers said the pricing was aggressive for a high-yield, or "junk" deal, with the notes rated in the single B category by Moody's and S&P Global Ratings.

The deal was the first pure bond deal by Tesla, which has in past issued convertible bonds, which can be converted into equity and benefit from stock gains. Still, the deal went smoothly, and Tesla increased the size to $1.8 billion from an original $1.5 billion, after meeting strong demand.

Don't miss: Why stock-market investors should be worried about the junk-bond market (http://www.marketwatch.com/story/why-stock-market-investors-should-be-worried-about-the-junk-bond-market-2017-11-10)

The delays with the Model 3 are likely to weigh on Tesla's gross margins through at least the first quarter of next year, analysts at Goldman Sachs said in a note last week after Tesla's results.

See also:Morgan Stanley keeps Goodyear its top pick in cars, shared mobility (http://www.marketwatch.com/story/morgan-stanley-keeps-goodyear-its-top-pick-in-cars-shared-mobility-2017-11-07)

The company's goal for positive operating cash flow generation "should remain elusive until the middle of 2018 -- though we still forecast significant (free cash flow) burn," the analysts said.

"On that front, we now believe (Tesla) will need to raise capital sooner," likely around the second quarter of 2018 rather than third quarter, they said.

Tesla shares have gained 42% this year, in contrast with a 15% rise for the S&P 500 index. That outperformance has disappeared in the last three months, however, with Tesla stock down nearly 17% to the S&P's 4.2% gain in that period. The Dow Jones Industrial as gained 7% in the same time frame.

See also:Top Tesla investor: The stock could triple in five years (http://www.marketwatch.com/story/top-tesla-investor-the-stock-could-triple-in-five-years-2017-11-02)

-Claudia Assis; 415-439-6400; AskNewswires@dowjones.com

 

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11-15-17 0800ET

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