Case Study: Tesla’s High-Yield Bond Sale

Over the past few years, futuristic car-maker Tesla has grown into arguably the market
leader in energy-efficient auto-manufacturing. The group’s equity market capitalisation
reached US$45.5 billion earlier this year in March, surpassing Ford’s US$45.4 billion for
the first time. However, given the latter boasts revenue and assets of US$151.8 billion
and US$238 billion respectively versus Tesla’s US$7 billion and US$22.7 billion in
FY16, equity investors are clearly pricing the company’s significant growth expectations

Investors high expectations of company performance in the not-to-distant-future is

largely based on the growing number of people transitioning towards eco-friendly
products in response to (not least) climate change concerns. For the auto industry, this
clearly means a higher adoption of high-tech hybrid and electric vehicles as battery prices
decline and governments ban or plan to ban new petrol cars in around 20 years or so
(notably Britain and France but with China recently indicating this too).

The highly likely ultimate replacement of carbon-based fuels with stored electricity
(ignoring the initial electrical generation source) to power the wheels is attracting more
and more investors. In August 2017, Tesla embarked on a capital raising to finance its
“Model 3” product line and create a larger cash buffer for existing investors. Rather than
again tapping equity or hybrid markets, this time Tesla opted to issue an inaugural senior
debt instrument, offering US$1.5 billion of 8-year high-yield bonds.
Interestingly, the initial yield of 5.30% (which is also the coupon rate given that the
security issued at par) appeared to be considerably lower than comparable securities. As
Tesla’s bond was rated B3/B- by the credit rating agencies, the market-based yield for this
risk level should be around 5.8% according to the relevant US high-yield yield curve
(Figure 1). However, the approximate 0.50% yield differential did not compromise
investors’ confidence on the issuer’s prospective performance and the offering was even
upsized to US$1.8 billion due to this high demand. In addition, this

offering has placed Tesla in a similar ballpark to BB rated corporates (the approximate
yield for BB rated corporates is 5.1%) regardless of Tesla’s weaker financial
performances (it has made substantial losses for the past few years).

Tesla’s issue readily demonstrates the differing viewpoints on companies by investors and
credit rating agencies. More specifically, credit rating agencies are very evidence-based
and their thoughts will be more backward loomoking. From a credit rating perspective,
an upgrade (or downgrade) often only occurs when the financial situations of a company
have soundly evidenced improvement (or deterioration). In contrast, investors would
probably consider more prospective factors into the decision making process as they are
the ones who actually bear the risk (and potential loss). This highlights that credit ratings
are only one piece of the credit analysis puzzle and should be utilised as one of many
inputs in the investment process.

Overall, Tesla’s successful high-yield bond sale was attributable to investors being
positive on the corporates’ outlook over a longer-term and its ability to partially address
global concerns on environmental issues.
For our part, we would be concerned about Tesla’s continued lack of profits, high capital
expenditure requirements, significant project risk and substantial cash-burn. And that’s
not even including creditor-protective bond terms normally found in high-yield issues.
We believe that we could very well be revisiting the Tesla bond story in 2018 and perhaps
not in a positive light.