This Is Elon Musk’s Most Easily Overlooked Talent
Elon Musk has already made his mark as an exceptional innovator, but his capital-raising prowess is often overlooked. With Tesla’s seemingly insatiable appetite for cash to fund its ambitious projects, the company has just announced plans to dip into capital markets once again. This time, Tesla plans to issue $1.5 billion in 8-year bonds to help fund the production of its new Model 3 sedan. The bonds will carry a 5.75% coupon and, so far, reports indicate that bond investors are more than happy to fork over cash to purchase them.
Why did Tesla decide to issue straight debt instead of equity or convertible debt, as it has at least seven times in the past five years? Tesla’s announcement this week was almost certainly influenced by bond market investors’ continued search for yield and the current pricing of non-investment-grade debt. Although stock market valuations are at record highs, the spread on high-yield debt—the difference between high-yield bond and Treasury spreads—is currently at a three-year low, making it an attractive time for firms with below-investment-grade ratings to access the debt market.
Surely, Tesla’s announced bond offering—which will carry what some in the industry refer to as “junk bond” status—is also appealing if one of Tesla’s objectives is to minimize further shareholder dilution. However, if new shareholders were willing to provide that equity capital at a sufficiently high price, I suspect that it would have jumped at the opportunity. Investors in equities, straight bonds, and convertible bonds are often different players. This means that it can be costly or take time for investors to move between markets, and pricing opportunities can exist in one market and not others.
A useful example of Tesla’s opportunistic issuance patterns dates back to February 2014. To help finance a $5 billion battery factory, Tesla successfully raised $2 billion in convertible bonds (bonds that can be converted into equity at some point in the future, at terms agreed upon today). It was one of the largest convertible offerings of the time, and occurred precisely when the supply of new convertible debt issues available to investors was relatively low. More than its size, the terms at which Tesla managed to raise capital were headline-worthy: The bonds were issued at a 42.5% conversion premium (making them more “debt-like” than bonds with lower premiums), yet they carried coupon payments of only 0.25% and 1.25%.
Tesla is not only a first mover in its product space, but its financing activities are worthy of being watched as well. After witnessing Tesla’s success, other tech firms such as Twitter, AOL, and Priceline followed with convertible bond issues of their own. When I teach capital structure decision making to my MBAs, I sometimes motivate the discussion of market conditions with a photograph of a shiny bright red Tesla convertible car. Then, in an admittedly shameless attempt at corporate finance humor, I tell the students that the car is not the only impressive Tesla convertible.
Good firms should be keenly aware of capital supply conditions when issuing securities. Indeed, there is substantial evidence that firms attempt to time the market when they issue equity and debt. We often think that the firms able to issue opportunistically are already cash- and profit-rich. They don’t need the money now, and can therefore wait until market conditions are favorable to borrow or sell stock. By contrast, firms that are cash-starved do not always have this kind of timing option. Tesla is an interesting counter-example, because it always needs cash. However, since it can’t issue continuously, it may as well keep its finger on the pulse of capital markets and tap in when whenever and wherever demand is strongest.
Tesla has been a shrewd navigator in today’s capital markets. If it continues along this path, it may create for itself a valuable option to sit and wait it out when the capital market winds shift. Given the ease with which Tesla has moved between equity, convertible, and now straight bond markets when there are differences in investors’ desires to hand over their cash, it seems that there is substantial opportunity for more firms to do the same.
Will doing so lead to excessive leverage and risk in markets? Only if investors, who should always think twice about investing when their bargaining power is low, allow it.
Heather Tookes is a professor of finance at the Yale School of Management and a 2016–17 Public Voices Fellow at The OpEd Project.