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Tesla's Model 3 production strategy: Junk bonds on offer

Tesla Model 3 cars are seen as Tesla holds an event at the factory handing over its first 30 Model 3 vehicles to employee buyers at the company?s Fremont facility in California, U.S. July 28, 2017. (Tesla/Handout via REUTERS/File Photo) Photograph: (Reuters)

WION Web Team New Delhi, India Aug 08, 2017, 05.00 AM (IST)

American automaker company Tesla Inc declared on Monday that it would raise $1.5 billion through its first-ever offering of junk bonds. The luxury electric car maker is seeking fresh resources to ramp up manufacturing of its new Model 3 sedanThe highly anticipated Model 3 was launched with a lucky-draw competition on July 28.

Junk bonds are lower-quality investments that offer higher yields. The strategy by Tesla Chief Executive Elon Musk represents that bond investors will be as keen as stock investors to back the company, expecting that Model 3 will be a hit.

"Bond investors, who typically don't love companies that don't make money, will be far more forgiving when it comes to Tesla," said bond expert Robbie Goffin, managing director of FTI Consulting, citing the company's stellar stock market value.

Tesla was to start pitching potential investors on Monday, IFR reported, citing lead bankers on the deal. Tesla is counting on the Model 3, its least pricey car, to become a profitable, high-volume manufacturer of electric cars.

Tesla's market shares are up by a whopping 67 per cent this year, pushing the company's value to around $60 billion, above that of top U.S. automakers General Motors Co and Ford Motor Co. However, shares of Tesla closed down 0.5 per cent at $355.17 on Monday. Tesla is yet to make an annual profit. 

So far, Tesla has been raising money to pay its bills with a combination of equity offerings and convertible bonds, which eventually convert into shares. In March, the company raised $1.4 billion through a convertible debt offering.

Following the announcement, Standard & Poor's reaffirmed its negative outlook for the automaker and assigned a "B-" rating for the bond issue - deep into junk credit territory. S&P also maintained its "B-" long-term corporate credit rating on Tesla.

"We could lower our ratings on Tesla if execution issues related to the Model 3 launch later this year or the ongoing expansion of its Models S and X production lead to significant cost overruns," S&P said in a statement on the bonds.

Moody's assigned a junk "B3" rating to the bond issue and said the company's rating outlook was stable.

The rating agency said the overall company's "B2" rating was justified by the fact that if Tesla ends up in severe financial turmoil, its brand name, products, and physical assets would be of "considerable value" to other automakers. During the quarterly earnings call of the company, Musk revealed that about 63,000 people have cancelled their Model 3 pre-orders.

Tesla's debt load increased significantly in 2016 when it took over solar panel maker SolarCity.

CFRA equity analyst Efraim Levy said the bonds will provide Tesla with funds to survive till "at least into mid-2018."

"There is a risk they could still run out of money," he said. "Then you’d go back to the equity markets and hope it’s not too late" to raise more money.

The latest effective yield on single-B rated bonds, maturing in seven to eight years--the class for a Tesla issue, is around 5.5 per cent, according to Bank of America/Merrill Lynch Fixed Income Index data.

The price of the bond will be determined later in this week after several days of brainstorming sessions with credit investors. They will keep ion account factors including the absence of a borrowing history, its lack of profit and its high cash-burn rate against its growth potential and its attractiveness as an environmentally friendly “green” issuer.

Ultimately, the depth of investor interest will determine the bond's interest rate.

Tesla said last week that it had 455,000 net pre-orders for the Model 3, which has a $35,000 base price, and that the sedan was averaging 1,800 reservations per day since its launch in the late last month.

At the launch, Musk, however, warned that Tesla would face months of "manufacturing hell" as it increases production of the sedan.

Tesla had over $3 billion in cash on hand at the end of the June quarter, compared with $4 billion on March 31.

The company expects capital expenditures of $2 billion in the second half of this year to boost production at its Fremont, California assembly plant and a battery plant in Reno, Nevada.

Tesla's cash burning strategy has prompted short-sellers like Greenlight Capital's David Einhorn to bet against Californian competitor Palo Alto.

Goldman Sachs, Morgan Stanley, Barclays, Bank of America Merrill Lynch, Citigroup, Deutsche Bank and RBC are the book-runners on the bond offering, IFR reported.

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