Following a surprise announcement about a stock split last month, Tesla capped off its summer with a new capital raise — its biggest ever.
The $5 billion in new equity the company plans to sell is about twice as much as it has ever issued before (it’s an “at the market” raise, meaning the shares will be sold over time, at potentially variable prices). The raise should also even out Tesla’s cash-to-debt position on its balance sheet, at roughly $14 billion on both sides. As far as the cash side is concerned, the new tally is notable: Tesla used to feel pretty good if it had $1 billion on hand.
Ah, those quaint old times, back before Tesla was worth more than any other automaker on the planet, not to mention all but six companies in the country. A rally than commenced late last year has vaulted Elon Musk’s electric automaker to a stunning market cap: $462 billion.
The execs running the traditional car business look at this with slack-jawed astonishment, and not for the reason you might think. Market caps aren’t an especially relevant metric when dealing with companies that have been around for a hundred years. Automakers are far more concerned with how much money is flowing through their operations, metrics calculated through measures such as free cash flow and return on invested capital.
The Tesla envy actually comes from the ease with which Tesla essentially sells itself to investors. Given its wild valuation, Tesla can issue new equity without facing criticism that it’s diluting existing shares. Those $5 billion are a drop in the bucket when you’re talking about a firm that could be valued at 100 times that by the end of 2020.
Equity vs. debt
Traditional automakers lack demand for their equity, so when they need to raise money, they have to tap the debt markets. (Tesla has sold debt, but far less than it has equity.) This isn’t a bad deal for legacy companies, given that a low-interest-rate world means the money comes cheap. Of course, a low-inflation-world also means that debt remains a balance-sheet concern for longer.
Tesla, by contrast, basically sells more of itself today than what existed yesterday. You could call it free money, and you’d nearly be correct. It is nearly riskless, as long as Tesla doesn’t go the convertible-debt route, as it has in the past. In that case, debt that can’t be transformed into equity, because a stock-price milestone hasn’t been met, carries the risk of taking cash off the balance sheet or requiring other forms of fundraising to manage the payoff.
The only worrisome thing for Tesla is that growing its physical capacity and making more cars — by building factories and service centers and so on — requires 2020 money. A company like Ford is using factories that were built and paid for decades ago.
Tesla’s operational costs are also about the same or even higher than a legacy carmaker, so it isn’t as uniformly efficient at the use of its capital. Investors have been more than compensated for that risk by a stock price that’s been tearing ever higher for a year (and that’s ripped northward many times over Tesla’s history). But if Tesla ever slowed down — and as it expands, it might, because global automating operations are challenging to manage — that risk might start to bite.
The traditional automakers also play the equity game
Established carmakers have also ventured into this game. General Motors has capitalized Cruise, a stand-alone self-driving division, as a separate company and undertaken investment rounds that have valued the startup at around $20 billion. Ford has invested in EV-maker Rivian and autonomous-mobility company Argo AI.
But Tesla is far, far out in front with this maneuver. And for the moment, it’s hard to argue against the strategy. If you’d bought shares at Tesla’s 2010 IPO, you’d be sitting on an 8,300% return. I sometimes wonder why Tesla hasn’t raised many billions more, given the inexhaustible demand for its equity.
The incumbents don’t begrudge Tesla its success. Quite to the contrary, they were delighted to watch Tesla take on almost all of the early EV-development and market-validation risk. But they’ve always grumbled about easy it is for Tesla to raise funds, and now that the pandemic has slowed sales with them critical cash flow, prompting carmakers to turn to debt markets to shore up their balance sheets, that grumbling could get louder.