Tesla Motors is getting baked in 2018. The company struck a new high in the second quarter with the build of 5,000 Model 3s, and its founder Musk got high on Joe Rogan.
And that was only the second time that they got stoned this year. Earlier the company struck a new high with 500,000 Model 3s on order. Musk then sent the stock high by tweeting that he intended to take the company private at $420 a share with secure funding.
However alas Musk and Tesla have come down from these highs and they must now detox. Model 3 production has declined again and there is the issue of cancelled orders. The Department of Justice is also launching an investigation into the $420 tweet. They are concerned that Tesla might be using shady accounting practices.
All of this negative press would be cool if Tesla wasn’t a real company. Wait. I’m getting word that they are real. Tesla is so real-life that they have $10 billion dollars in debt. $920 million of the debt is convertible. This equates to options for its creditors and a real headache for the company. The debt is risky provided that Tesla continues to trade above a preset stock price. Should the stock fall below that price, then you get what is known as a margin call. In the financial world, a margin call works like when you take a loan out on your house and then default on the loan. Their creditors could demand all $920 million in cash. Since Tesla Motors is strapped for cash, Musk would be compelled to raise cash. Morgan Stanley has estimated that they need to raise another billion this year to stay in business even without a margin call. Should a margin call occur and new investors are too startled to step up, Musk would be compelled to sell off much of his stock to cover the debt. Depending on the financial situation and ongoing investigations, he might even be necessitated to resign.
Musk could still play his 🃏 and still come out on top.
Don’t take me as a conjurer of cheap tricks!
You see it works like this. The market is engineered to profit off gambling. You buy a stock on the expectation that its value will rise. Then when you sell the stock, you recoup a profit that is the difference in price. On the contrary, you could also bet that the stock will sink. This could be at the expected valuation where the creditors demand a margin call, but any value that reduces the price to junk could work. Executing the transaction is marginally more complicated, but you don’t have to own the security. The task is typically accomplished through a broker who is holding the security for another investor, but the broker rarely owns the security. Since Musk is already a majority owner of Tesla, he probably wouldn’t need a broker to hedge his own firm. Instead he could sell 15 million shares, for example. That is $4.7 billion dollars at an average share price of $318. For the moment let’s assume that an unfavorable DOJ investigation sends the stock tumbling. The business could be in dire straits at $100 a share. At this point Musk buys back 15 million shares for the price of $1.5 billion dollars. That equates to a net profit of $3.2 billion dollars.
Don’t get me wrong. I’m not saying that Musk intends to short his own enterprise. Much of his billions are tied to Tesla and could evaporate in a market crash. There are however many investors that are concerned about the hulking debt Tesla is pulling with no end in sight. They could be onto something by shorting the stock. At the same time Musk is a brilliant engineer and knows everything about the stock that they do. It is beyond a doubt that he has the resources to insulate himself against a crash.
In full disclosure I do own some stock within a mutual fund.
What would you do with your shares ❓