TESLA:ATALEOFDISRUPTION,WITHADEBTTWIST!

Interestpaymentswithhopeandpotential?

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TheStoryStock

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FromStorytoValue!

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FromHeighttoHeight:ThemarketlovesTesla

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Leapingovertheestablishment…

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Whiledeliveringgrowth(thoughnotprofits)

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AndChangingtheAutoBusiness

¨ TheEarlyResponse:Whileitwasdismissedbytheotherautomobilecompaniesasanewcomerthatwouldlearnthefactsoflifeinthesector,asitaged,thereversehasoccurred.

¨ TheStatusQuoshifts:Itistheconventionalautomobilecompaniesthatare,slowlybutsurely,comingtotherecognitionthatTeslahaschangedtheirlong-standingbusinesswithitsinnovations.Volvo,aSwedishautomakernotknownforitsflair, announcedrecentlythatallofitscarswouldbeeitherelectricorhybridby2019,and Ford'sCEOwasdisplacedfornotbeingmorefutureoriented.

¨ Inahide-boundsector:Alittlemorethanadecadeafteritburstontothescene,itisatestimonialtoElonMuskthathehasstartedthedisruptionofoneofthemosttradition-boundsectorsinbusiness.

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ValuationUpdate

¨ StoryUpdate: MystoryforTesla,fromJuly2016,ofacompanythatwillbeabletomeldthemarginsandreinvestmentneedsofatechcompanywiththerevenuesofanautomobilecompanyremainsintact.

¨ NumbersUpdate: Thereweretwotweakstothenumbers:¤ Higherend-yearrevenues:Therevenuesinyear10willbecloseto$93

billion,upfrom$82billioninmyJuly2016valuation.¤ Lowerreinvestment:Theimprovedoperatingmarginsreduce

reinvestmentneedstofundgrowth.Youstillhavesevenyearsofnegativefreecashflowstotaling$15.5billion,requiringcapitalinfusions.

¨ ValueUpdate: Updatedvaluepershareof$192.34,upfrom$151.85fromJuly2016.

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Tesla’sChallenges

¨ CanTeslasellmillionsofcars? TherevenuesthatIprojectin2010willrequireTeslatosellcloseto2millioncars,inthefaceofincreasedcompetition.

¨ Canitmakemillionsofcars? TherearetwoproductionteststhatTeslahastomeet. Thefirstistiming,sincethedeliverieshavebeenpromisedforthemiddleof2018andtheassemblylineshavetobehummingbythen.Thesecondiscost,sinceasubtextoftheTeslastory,reinforcedbyElonMusk,isthatthecompanyhasfoundnewandinnovativewaysofscalingupproductionatmuchlowercoststhanconventionalautomobilecompanies.

¨ Canitgeneratedoubledigitmargins? Inmyvaluation,Iassumeanoperatingmarginof12%forTesla, almostdoubletheaverageof6.33%forglobalautocompanies.

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Tesla’sOddFinancingChoices

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Withanewdebtissuecomingup..

¨ Thatdebtload,alreadyhigh,givenTesla’soperatingcashflowsislikelytogetevenbiggerifTeslasucceedsinits newestdebtissueof$1.5billion,whichitishopingtoplacewithaninterestrateof5.25%,tryingtowoobondbuyerswiththesamepitchofgrowthandhopethathasbeensoattractivetoequitymarkets.

¨ Thatsuggeststhatthosemakingthepitcheitherdonotunderstandhowbondswork(thatbondholdersdon'tgettosharemuchinupsidebutsharefullyinthedownside)orareconvincedthatthereareenoughnaivebondbuyersoutthere,whothinkthatinterestpaymentscanbemadewithpotentialandpromise.

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TheDebtEquityTradeoff

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AndwhydebtdoesnotmakesenseforTesla¨ Notaxbenefits:Itisacompanythatis notonlystilllosingmoneybuthas

carriedforwardlossesofcloseto$4.3billion,effectivelynullifyinganytaxbenefitsfromdebtforthenearfuture.

¨ Nodisciplinaryfunction:WithElonMusk,thelargeststockholderatthecompany,atthehelm,thereis nobasisfortheargumentthatdebtwillmakemanagersmoredisciplinedintheirinvestmentdecisions.

¨ Largebankruptcyrisk:Thecompanyisstillyoungandlosingmoney,and addingacontractualcommitmenttomakeinterestpaymentsontopofalloftheothercapitalneedsthatthecompanyhas,strikesmeasimprudent,withthepossibilitythatonebadyearcoulditspromiseatrisk.

¨ Agencyproblems:InacompanylikeTesla,makinglargeandriskybetsinnewbusinesses, thechasmbetweenlendersandequityinvestorsiswide,andlenderswilleitherimposerestrictionsonthecompanyorpriceintheirfears(ashigherinterestrates).

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SowhyisTeslaborrowing?

¨ TheDilutionBogeyman:Thefirstisthatthecompanyoritsinvestmentbankersaresoterrifiedofdilution,thatastockissueisnotevenonthetable.Oncethedilutionbogeymanentersthedecisionprocess,anyincreaseinsharecountforacompanyisviewedasbad,andyouwilldoeverythinginyourpowertopreventthatfromhappening,evenifitmeansdrivingthecompanyintobankruptcy.

¨ Inertia:AutocompanieshavegenerallyborrowedmoneytofundassemblyplantsandthebankersmaybereadingthecapitalraisingrecipefromthatsamecookbookforTesla.ThatisincongruentwithElonMusk’sownstoryofTeslaasacompanythatismoretechnologythanautomobileandonethatplanstochangethewaytheautobusinessisrun.

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WhatTeslashoulddo..

¨ IssuingsharestofundinvestmentneedswillincreasethesharecountatTeslabyabout3-4%(whichiswhatyouwouldexpecttoseewitha$1.5billionequityissue)butthatisafarbetterchoicethanborrowingthemoneyandbindingyourselftomakeinterestpayments.

¨ IfTeslaisdeadsetonnotraisingitssharecount,whynotissuelongterm,reallylowcouponconvertiblebonds, verysimilartothisonefrom2014,abondonlyinnamesincealmostallofitsvaluecamefromtheconversionoption(whichisequitywithdelayeddilution)?

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TheConclusion

¨ TheTeslastorycontinuestoevolve,andthereismuchinthestorythatIlike.Itischangingtheautomobilebusiness,afeatinitself,anditisstartingtodeliveronitsproductionpromises.

¨ Thenextyearmaybemanufacturinghell,butifthecompanycanmakeitsthroughthathellandfindwaystodeliverthetensofthousandsofTesla3sthatpeoplehaveputdowndepositsfor,itwillbewellonitsway.

¨ Istillfindthestocktobetoorichlypriced,evengivenitspromiseandpotential,formyliking,butthismuchIknow.Iwouldratherownequityinthiscompanythanthebondsthatitisplanningtoissue.