Stock of the week: Tesla

Summary:

• Elon Musk sends Tesla (TSLA.US) shares sharply higher with a single tweet

• A possible delisting of the electric vehicle producer may be on the way

• Company’s production rates and delivery times start to bode well for the future

• Tesla dominated the US electric vehicle market in the first quarter of the year

• Technically a correction is possible

Tesla (TSLA.US) has always drawn market interest but this week it came with a magnitude we have not seen for a long time. Did something particular happen? Definitely. Namely, Elon Musk, Tesla CEO, announced via Twitter that he is considering taking Tesla private at price of $420 per share (at the time of tweet publication Tesla stood at around $342/share).

Elon Musk stunned investment world with his tweet. Source: Twitter

What does it mean in practice? It means that Elon Musk considers unlisting the company from stock exchanges. While for some such decision may be looking a bit weird Musk actually has a point. In a Tesla blogpost he explained that being a public company is often a setback for the enterprise as it is forced to disclose some particular information (mostly financial) on the regular basis (usually quarterly). This means that public company often provides its competitors with crucial information regarding the condition of a business and therefore risks a possibility of other industry members using such an information to their advantage at the cost of company that discloses it. Moreover, Musk claimed that leading a public company is often a hurdle for executives as there is incentive to focus on the quarterly earnings in order not to disappoint shareholders rather than long term goals of the company. Apart from that, many of the Tesla employees are granted bonuses in form of stock options and because of that the volatility of the company’s share price exerts unwanted pressure on them as well.

As we have already explained reasons behind such decision we can move forward to the ways in which Elon Musk can make this happen. There are two approaches in which Musk can take Tesla private. First one is to convince shareholders to support him in this idea. In such a situation not a single dollar would be needed to conduct this operation. However, this might be hard to do as shares of private companies are much harder to liquidate therefore a withdrawal from such investment could be difficult. The second option seems to be more probable. Namely, Musk could conduct a leveraged buyout (LBO) of Tesla. What is a LBO? It is an operation of acquiring the company using significant amount of debt. Given that in typical LBO debt accounts to as much as 90% of the transaction value the assets of the acquired company (and often part of assets of acquiring company) are used as collateral in the capital raising process. However, because such a big part of the transaction is financed using debt the bonds issued in the process are rarely investment grade thus attracting investors is often a hurdle. Nevertheless, as we can see on the picture above Elon Musk claims that the funding of the transaction has been already secured. The source of funding has not been made public yet.

So, do the market participants believe he can pull this off? Not really. On Tuesday, when the tweet was published, Tesla shares in fact surged over 10% but they have also closed trading at $379.57, what is way below $420 proposed by Musk.

Tesla has gone a long way with its Model 3 production rates and the latest figures suggest the goal of 5,000 units/week was finally met. Moreover, the pace of production should accelerate further. Source: Bloomberg

Tesla (TSLA.US) was founded in 2003 and specializes in production of not just electric cars but also batteries for such vehicles as well as solar panels. However, despite 15 year history the company still did not manage to show any net profit on the annual basis. That is quite interesting as its Model 3 car is hailed as one of the best electric vehicles (EV) ever made and what’s more, with price starting of $35,000, it is also affordable one in comparison with other EVs available on the market. Since its launch in July 2017 the interest with this car was so big that the company encountered an unusual problem for car makers… it was unable to produce enough units to meet the demand. Elon Musk set a production goal of 5,000 a week and continuously ensured investors that it would be met while the company kept failing to do so. However, one year after the sale of Model 3 was launched Tesla finally reported on the 2 July that it managed to produce 5,031 units in one week. If this rate of production is to be maintained we may finally see company climbing above the break-even point. Estimate consensus provided by Bloomberg agency suggests that the company will fail to show profit in the third quarter of 2018 but later on it is expected to generate positive earnings on a regular basis. Another issue that customers disliked - the delivery time - seems to be sorted out already as the company reported in July that an average time the US customer has to wait for his car declined from 3-5 months to just one month.

Tesla’s Model 3 was not only the best selling electric car in the Q 2018 in the US but also its two other models made it to the top4. Source: Bloomberg, InsideEVs

It is hard to find a company of a similar size to Tesla that focuses only on the production of electric vehicles. Because of that we have used some major car makers, that also produce EVs, in order to compare Tesla with the sector. As we have stated previously, the company has not worked out a single dollar of net profit so far therefore it is impossible to confront its valuation metrics with the ones of its peers in terms of EPS ratio (the ratio for Tesla would be negative). Having said that, we can take a look at the number of EVs delivered by its peers on the US market (the biggest market for Tesla). On the chart above we can see that Tesla dominated the US electric vehicle market in the first quarter of 2018. Tesla’s Model 3, Model S and Model X made it to the top7 of the EVs delivered in that period. Do notice that it was prior to the company announcing its delivery times dropping to one month therefore we may assume that such a good performance was achieved despite longer deliveries. Last but not least, the engineering firm Munro & Associates estimated that the Model 3 profit margin may be as big as 30%, the highest among all electric vehicle types produced at the moment. Given that the production rates are picking-up, delivery times are declining and the profit margin is so high Tesla has a potential to outperform its industry peers and turn to be a really profitable company in the long run.

Finally let’s explain the consequences for the shareholders of Tesla unlisting. According to Elon Musk the negative consequence will be marginal. If shareholders are to be offered a possibility to sell their shares at $420 they are free to do so but Musk hopes that they will stay with the company as private shareholders. Same rules apply with the only difference being the fact that in case a shareholder wants to sell his stake he will have to do it via OTC transaction rather than on the organized market. Apart from that, private shareholders still have a possibility to vote on shareholders meetings as well as the right to receive dividend payments.

Tesla (TSLA.US) has been a subject to some wild price swings as of late. Thanks to Musk’s tweet the price surged as high as $382 but bulls have failed to maintain this gain. In turn the price pulled back to the upper bound ($370) of the support zone where also the previous local high can be found. Do notice that since the stock has painted a falling star  pattern a risk of a corrective move is present. Source: xStation5