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What Wall Street Is Saying About Musk Taking Tesla Private

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What Wall Street Is Saying About Musk Taking Tesla Private
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Tuesday afternoon, Tesla Inc (NASDAQ: TSLA) CEO Elon Musk casually tweeted his intent to explore a go-private path for the controversial automaker. After a mid-session halt, Tesla’s stock closed up 10.3 percent.

Here’s what analysts had to say about the startling, unclear message.

It Makes Sense

Musk said in his email to employees that going private eliminates pressures driving myopic decisions, the distraction of stock volatility and short-sale incentives for “attackers.” Canaccord Genuity called the strategy “brilliant.” Evercore ISI said it makes sense.

“Traditionally, public markets have been there to provide a source of funding (note, we also believe they bring scrutiny and accountability which in many cases does lead to better practice),” Evercore wrote. “However, if a company does not need that funding or is able to source future funding privately, then there is no obvious reason for it to remain public.”

Evercore added that private funding might deepen Tesla’s pockets for faster international growth and buffer the firm against the next U.S. or capital markets recession. Morgan Stanley confessed similar positives.

“The scale and scope of launching an auto company while providing a focused internal narrative to employees and stakeholders on the goals of the enterprise may be better aligned outside of the eye of the public market with a longer-term horizon,” Morgan Stanley wrote.

And, the analysts said, an exit is better done now than later. Tesla isn’t expected to suffer significant challenges in electric vehicles for at least a few years, which means it’s currently at peak position to attract capital or pursue strategic alternatives.

But The Public Markets Were Working

While conceding the move “feels right,” Jefferies said Musk is underplaying the public markets’ support for Tesla. Other experts agreed.

“Tesla has benefited hugely from public markets, which have given it a huge valuation that allowed it to raise significant amounts of capital,” according to The Wall Street Journal's Charley Grant. “Those public investors have also been willing to look past years of operating losses.”

Going Private Is Risky

Although acknowledging incentives, Morgan Stanley considers the shift from public markets not entirely safe, particularly given near-term execution risk around the Model 3 ramp and sustainable cash flow generation.

“We see the benefits of potentially being private outweighed by risks of added financial leverage which can be even more strategically limiting,” the analysts wrote.

‘Funding Secured’ Is Vague

In the initial announcement proclaiming the $420-per-share take-private price, Musk assured funding is “secured.” But analysts are cautious about lacking details around the funders and funding structure, particularly given Tesla’s inability to take on more debt.

“Our view is that ‘Funding secured’ should be interpreted as a strong verbal commitment, with funds available and parties willing to execute quickly,” Evercore wrote. “However, it could be less than this. It may also be that initial legal documents, term sheets, letters of intent have been signed.”

An LBO Is Possible...

Some anticipate a leveraged buyout considering Tesla’s cash generation and earnings before interest, tax, depreciation and amortization. The Street's Brian Sozzi suggested Warren Buffett could approach with a bid given his regret not to have bet on Amazon.com, Inc. (NASDAQ: AMZN) and his concession that Tesla semis could kill his rail business.

However, Morgan Stanley sees no natural strategic buyer, and what’s more, it considers the requirements for a $420 LBO “extremely aggressive.” (Notably, Baird Equity expects shareholders to demand a steeper premium than what $420 provides.)

The analysts also posited, though, that Musk’s stated interest in providing exiting shareholders a “nice premium” may mean a transaction could be executed at far less leverage than a conventional LBO.

“While increasing the size of the equity check to 50 percent or even 70 percent would erode returns, the benefits of lower financial leverage could help mitigate economic and execution risks,” Morgan Stanley wrote.

...But There Are Other Options

Cowen asserted an LBO wouldn't work if existing shareholders remain. The WSJ anticipates no eager buyers for such a renowned cash burner. Evercore considers an LBO unlikely and instead expects current shareholders representing 50 to 60 percent of shares, including Musk’s 20 percent, to transfer their holdings to the new private structure.

“This would leave Tesla needing to raise equity capital of $31 to $39 billion to buy out those existing public shareholders who tender,” Evercore wrote, assuming debt rolled in.

He expects the remaining 40 to 50 percent of the $78 million market cap, calculated using the $420 buyout price, to be funded by a combination of a strategic investor’s 15- to 20-percent stake, two or three private investment firms seizing up to 10-percent stakes, and contributions by larger existing shareholders or a fund of smaller investors.

Bank of America also identified the Saudi Sovereign Wealth Fund and Chinese government as potential capital sources.

The resulting composition is critical to certain Street theses.

“If funding is secured as part of the deal that includes [about] $10 billion of liquidity without diluting equity capital, we would revisit our investment thesis for the company's long term growth prospects,” Cowen wrote, noting that regardless of structure, Tesla needs additional funding.

The Announcement Medium Is Strange

Tesla closed a significant gap between its trading value and targeted $420 buyout price when Musk made his announcement. The likely intentional catalyst drew questions.

“If Tesla’s CEO really wanted to go private…why announce it to the world in this way…which could significantly contribute to the required premium and financial leverage?” Morgan Stanley wrote. “For much of the past few months, Tesla’s CEO has made statements directly engaging investors and at many times making supportive statements to the share price. Investors might reasonably ask why Tesla management would want the stock price to reflect all the premium of an LBO up-front. It is hard to understand the potential reason for such a negotiating strategy.”

Debt Is Up In The Air

Although Musk announced vague plans for Tesla’s equity, he made no mention of debt. Tesla has a $320 million tranche of debt due in November and $920 million due in March.

“It is also unclear if current publicly traded debt would remain public, which would in turn continue to require financial reporting in the public domain and make the company subject to the quarterly scrutiny it is trying to avoid,” Cowen wrote.

Keeping Shareholders Will Be Hard

Musk said he intends to pursue a structure where current shareholders can remain investors. Cowen doesn’t see the value of this strategy for buyers, though.

“It is obvious to see how such a transaction would benefit a CEO who has been very distracted by social media and is focused on ‘burning shorts,’ but we question how remaining investors would benefit from a less liquid structure in which management receives far less scrutiny despite its historically poor execution and track record,” analysts wrote. “[...] We would argue that the public scrutiny regarding the company's operations are a benefit in ensuring efficient allocation of capital and improved company transparency.”

Competitors Should Be Worried

Evercore suggested private funding could accelerate Tesla’s achievements in electrifying transportation, thus pressuring auto competitors to hasten powertrain transitions.

Tesla’s exit could inflict broader industry pain, though.

"For the traditional OEMs, a privately held Tesla exacerbates several problems,” Berenberg wrote. “Firstly, the company will be much better placed to execute its expansion plans, such as in China and Europe, with potentially accelerated time frames. That means Tesla competitors may have even less time to produce viable alternatives, or risk losing significant market share. Meanwhile, with likely less visibility on profitability or investment levels at Tesla, the OEMs will struggle to benchmark their own electric vehicle development plans and gauge the risk of becoming laggards. That means the OEMs may need to bolster their own investment plans, putting cash flow and return targets in danger."

Musk Better Execute

JPMorgan assigns a mere 50-percent probability of follow-through, particularly at the $420-per-share price point.

If Musk can't pull off the take-private strategy, some suspect he may be in trouble. Kelley Blue Book analyst Rebecca Lindland echoed early concerns that Musk may have violated disclosure policies in dropping the news in an informal tweet or could be accused of fraudulent manipulation if his plans don’t come to fruition.

“Is this an SEC issue?” Lindland said. “Has he manipulated the stock? Is this the proper way to go about making such an enormous announcement when so much money is on the line?”

As of Wednesday afternoon, the SEC had begun making inquiries into Musk's informal, market-moving statement and examining its veracity, according to the Wall Street Journal. The regulator allegedly inquired why the disclosure was made on Twitter Inc (NYSE: TWTR).

Notably, some of Tesla's board members validated Musk’s claims in a Wednesday statement affirming the prospect of a go-private path was previously and formally discussed.

Ratings Changes

Most analysts adjusted their price targets to reflect greater upside.

“We think some shareholders may demand a steeper premium than the $420 mark, and we think shares could move higher as shorts cover and investors demand a higher price to go private,” Baird Equity wrote in a note. “We view the risk/reward as extremely favorable at current levels.”

  • Bank of America Merrill Lynch maintained an Underperform rating and a $200 target;
  • Cowen maintained an Underperform rating and $200 price target;
  • Evercore maintained an In-Line rating with a $301 target;
  • Jefferies maintained a Hold but raised its target from $300 to $360;
  • JP Morgan maintained an Underweight rating but raised its target from $195 to $308; and
  • Morgan Stanley maintained an Equal-Weight rating and $291 target.

The stock traded around $372.40 at time of publcaition.

Related Links:

Elon Musk's Tesla Go-Private Tweets: Are They Legal And Is The Deal Even Plausible?

Morgan Stanley Raises Tesla Estimates After Earnings Analysis

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Oct 2018Canaccord GenuityMaintainsHoldHold
Oct 2018JMP SecuritiesInitiates Coverage OnMarket Outperform
Oct 2018MacquarieInitiates Coverage OnOutperform

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