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Commentary: Tesla Showering Musk With Stock Is Good for Bondholders: Gadfly – Liam Denning


January 24, 2018 by Liam Denning

(Bloomberg Gadfly)

Tesla’s proposed new compensation plan for CEO Elon Musk is, like so much else at the company, an intoxicating mixture of big numbers and far horizons. True believers in the stock will no doubt love it. But it has more to offer Tesla’s bondholders.

Musk would continue to draw no salary but could add substantially to his existing stake in Tesla Inc. as and when it hits various milestones related to market capitalization, revenue and Ebitda. The ultimate prize would await him if Tesla reached a valuation of — large numbers alert — $650 billion, plus revenue of $175 (maybe) billion and Ebitda of $14 billion (maybe; more below on these maybes). Here is how they compare to the current picture:

It is debatable as to exactly how much extra motivation is garnered from the promise of raising a CEO’s wealth from $21.5 billion — Bloomberg’s current estimate of Musk’s net worth — to a theoretical level of almost $200 billion. But that’s a question quite literally above my pay grade by at least a few orders of magnitude. Plus, emigrating to Mars wouldn’t come cheap, obviously. So let’s take the rationale for the plan at face value.

The driving force behind the plan is, of course, growth. And the promise of that growth is why shareholders are seemingly fine with the mismatch between Tesla’s soaring valuation and less-soaring financial metrics and missed targets.

So a new pay plan that keeps Musk at the helm in one capacity or another and which is tied to even more ambitious targets almost counts as shareholder populism. That $650 billion figure elevates Tesla, in theory anyway, to the pantheon of Big Tech alongside the likes of Apple Inc. and Alphabet Inc., distancing Musk’s company from its automotive identity.

Yet, as Tesla’s cash burn shows, growth comes at a price. Leaving aside the market-cap milestones in the new package, the operational ones emphasize the top half of the P&L statement.

There are eight revenue ones and eight adjusted-Ebitda ones. The latter excludes stock based compensation — which, at $420 million in the four quarters ending in September, was actually bigger than Tesla’s Ebitda.

Moreover, Tesla needs to hit only 12 of those 16 targets for Musk to get his stock awards. In theory, therefore, he could be paid the full amount if Tesla achieves — alongside that $650 billion market cap — revenue of $175 billion and Ebitda of $6 billion, a margin of just 3.4 percent.

Of course, you wouldn’t care about the latter if the company’s valued at $650 billion. However, expecting Tesla to be 11 times bigger than it is now and sporting multiples of anywhere from 50 to 100 times Ebitda would put even today’s bullishness to shame.

Getting anywhere near revenue north of $100 billion would require quantum leaps in Tesla’s vehicle sales and, in all likelihood, expansion in renewable energy and new ventures. All of this will take a lot of spending and, in all likelihood, coming to the market for more capital. And the compensation scheme tilts so heavily toward higher market cap and top-line, or upper-line, growth that, by extension, it encourages Tesla to do something for which it has hardly needed encouragement in the past: sell more shares.

In theory, issuing more equity is dilutive and stock prices should adjust accordingly. To date, though, that hasn’t really been the case with Tesla, even when it springs a stock sale on the market just months after saying it didn’t need one. And since a market cap is just price multiplied by number of shares, Tesla is in the enviable position of being able to push its market cap toward Musk’s milestones not merely by talking up growth expectations, but selling more shares in pursuit of them.

This is why, while the dazzling targets obscure a risk for Tesla’s shareholders, they offer a curious comfort to those invested in its bonds.

As I wrote here, anyone buying Tesla’s aggressively priced bonds in August was implicitly buying into the same long-term vision thing motivating the company’s equity investors. The risk for bondholders was that Tesla’s high spending might either encourage it to issue further tranches of debt subordinating them or run the risk of an outright cash crunch.

The safety cushion for the bonds has always been the company’s rarefied stock, providing an obvious source of equity funding if things really got tight. The new compensation scheme aligns closely with this, encouraging Tesla to sell more paper further down the capital structure and persuading investors to buy it. As Hitin Anand, an analyst at CreditSights, put it to me:

You want to see growth so that you can at least see refinancing opportunities down the line.

For bondholders, Musk’s exact milestones are less important than the warm glow they will give Tesla’s shareholders.

 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal’s “Heard on the Street” column. Before that, he wrote for the Financial Times’ Lex column. He has also worked as an investment banker and consultant.



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