Tesla’s Financing Mix

Tesla’s Financing Mix

An optimal financial mix is the best mix of debt and equity in a company’s financing, which maximizes the company’s market value and, at the same time, minimizes the company’s cost of capital. In financing, debt is always cheaper compared to equity. However, debt financing is associated with several risks, like default to lenders, which might cripple a firm. Therefore, finding an optimal point where the benefits associated with debt outweigh the associated risks is significant in a firm’s financing plan. This paper evaluates Tesla’s capital structure and financing options.

Tesla Inc. employs the following techniques in raising funds for its operations: selling ordinary share stock, selling convertible bonds, offering lines of credit, selling sections of the firm, and customer deposits (Deboard, 2017). In the recent past, Tesla has been utilizing the issuance of equity and the sale of convertible bonds to raise finances. Additionally, Tesla adopted a novel approach to raising funds, one that has not been in use by the firm before (boot strapping). The firm undertook this approach after incurring losses in the first quarter. This technique involved assessment and restructuring the firm’s operations in consideration of areas that exhibited the highest financial requirements. As a result, Tesla reduced its workforce by 7%.

Tesla primarily relies on external sources of funding, such as debt and equity. There was an 18 % drop in Tesla’s stock in the past two years after the issuance of the convertible bond (Randewich , 2019). Tesla’s underperforming stock has made the firm more inclined to debt financing, more so convertible bonds. Due to underperforming stock, equity has proven not to be a viable approach to raising finances.

Due to the instability of Tesla’s financial performance, there was an increase in the issued bonds insurance costs.  The increase in insurance costs for Tesla’s debt was significant, indicating the likelihood of default by the firm on its debt. This increase was after the firm exhibited high losses in the first quarter.

Tesla can’t internally fund its operations from retained earnings. The reason is that the firm has been incurring losses since its inception. For instance, in the first quarter of 2019, which ended in March, Tesla made a loss of approximately $700 million, which translated to $2.90 per share (Marshall, 2019). This loss, as stated by the chairman, was attributed to a decline in sales during the quarter. The firm sold fewer units than it had projected. Part of this decline was due to logistic issues. Tesla encountered challenges in transporting its electric cars to other regions, such as China and Europe.  Also, Tesla closed some of the showrooms and increased the prices of some of the models, e.g., Model 3. As a result, some of the cars were returned to the factory due to the increased prices. As a result of the losses made from the sales of electric cars, the firm can only rely on external sources of financing.

Future cash flows by the firm are unpredictable, given the challenges the firm has been encountering. For instance, the launch of the low-cost Model 3 could result in a loss of sales for the high-end models, that is, Model S and X. The loss of sales by the high-end models is a speculation that the firm has denied. Also, the firm has been encountering logistic challenges when delivering the vehicle to distant locations. The challenges posed by the firm make its cash flows unpredictable in the future.  Also, the underperformance of Tesla’s stock and bond makes it difficult to predict its performance.

Tesla has a debt ratio of 7.06, which is significantly high compared to its competitors. As a result, Tesla performs poorly in terms of debt-to-equity ratios compared to more than 94% of the firms in the automobile industry (Gurufocus, n.d). Tesla is highly leveraged and finances its operations by debt sevenfold. As a result, the firm has been incurring high expenses resulting from interest payments on this debt. To make matters worse, the firm has been employing finances raised from equity to repay the debt instead of financing operations. Tesla’s profits have not been adequate to repay the expenses. The Mots optimal debt ratio would be 0.5%, which would imply the firm is raising half of its financial requirements through debt and the other through equity. Given that Tesla is still in the growth stage, the optimal debt ratio would be 2%. Tesla’s debt is much higher than that of its competitors; for instance, Ford’s ratio is only 4%, while that of General Motors is 2%.

Adjusted Net Present Value is calculated by summing up the unlevered firm value and the net effect of debt. Tesla’s market value is $26.52 billion, whilst its net book value of debt is $12.7 billion. The difference between the two is $13.82 billion (Yahoo Finance, n.d). The bankruptcy costs associated with Tesla outweigh the tax benefits associated with the firm. The reason is that Tesla stands a high chance of bankruptcy due to its significantly high leverage. Thus, in the event of continuous poor financial performance in the future, the firm could go bankrupt. The tax benefits Tesla derives from its debt do not compensate for the costs incurred in the event of bankruptcy.

References

Deboard. A (2017). Tesla has 6 ways to raise money — here are the pros and cons of each. Retrieved from https://www.businessinsider.com/how-tesla-can-raise-money-2017-8?IR=T

Forsyth. R (2019). Tesla’s Bonds Are Tumbling Too. Are They Worth a Gamble? Retrieved from https://www.barrons.com/articles/teslas-bonds-are-tumbling-too-are-they-worth-a-gamble-51558711419

Marshall. A (2019). Tesla is losing Money Again as Deliveries Decline. Retrieved from https://www.wired.com/story/tesla-losing-money-again-deliveries-decline/

Randewich (2019). Tesla stock and bonds tumble as investors fret about costs and safety. Retrieved from https://www.reuters.com/article/us-usa-stocks-tesla/tesla-stock-and-bonds-tumble-as-investors-fret-about-costs-and-safety-idUSKCN1SQ1WY

Gurufocus (n.d). Tesla Debt-to-Equity. Retrieved from https://www.gurufocus.com/term/deb2equity/TSLA/Debt-to-Equity/Tesla%2BInc

Yahoo Inc.(n.d) Tesla, Inc. (TSLA).https://finance.yahoo.com/quote/tsla/key-statistics/

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Tesla’s Financing Mix

You are to complete the Live Case Study at the end of Chapter 8. You will be completing the Live Case Studies for the remainder of the term by researching the company that you have selected. In answering the questions in Live Case Study, you are to answer the questions as laid out in the Framework for Analysis, such as 1,2,3,4,5,…..Also, the sub-sections need to be bulleted. If there is an item that is not applicable, you are to clearly state that. After you have submitted your weekly study, I will grade it and make comments that you need to incorporate into your Case Study.

Researching a particular company will help support your weekly readings. I would suggest that you take a look at Yahoo Finance for information on your researched company. You may also want to go to the company’s website and take a look at Investor Relations, which will give you access to the annual financial statement, SEC filings and the prospectus of the company, along with other information that you will find useful in completing the requirements of the Live Study.
When you are working on your case study, I expect that you will be inserting financial statements and other tables to support your research. These are readily available in Yahoo Finance or the company’s website under Investor Relations, where you will also find financial statements.