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Private Tesla, Public Elon

By Imperial College Investment Society

Public figure Elon Musk and his attempt to privatise Tesla.

An article by Xerxes Chong Xian, member of the society. Please note that the below article was not written by a committee member of Imperial College Investment Society, and hence does not necessarily reflect its views.

On August 7, 2018, Chief Executive Officer Elon Musk announced via Twitter his intentions to privatise Tesla, stating that funding had been “secured”. Existing shareholders could accept the buy-out at $420 per share or "hold shares and go private”. Frenzied investors attempted to grasp the situation as Tesla’s share price spiked 11%, reaching $389.46 before being halted by the Nasdaq stock exchange. This incident sparked inquiries into the legality and motives of his tweet. Speculations ran wild that Elon had violated regulations under the United States Securities and Exchange Commission (SEC).

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CEO of Tesla Inc, Elon Musk’s incriminating tweet. Source: Twitter

Public vs Private

Publicly-traded companies are traded on a stock exchange whilst private companies are not. Also known as having access to the capital markets, it connects companies to investors, allowing companies to raise capital to fund growth by selling shares and debt. Shares, also known as equity, represent a piece of ownership of the company. This allow investors to share in a company’s prosperity through the increase in value of its shares and a cut of the profits via dividend pay-outs. Debt, sold through bonds, are essentially a loan given to the company, with varying terms of interest payments and the eventual return of the principal sum borrowed. Public companies are subject to greater scrutiny, having to report quarterly and annual earnings in addition to announcements and other filings to the SEC and the local bourse. Private companies are not subject to this.

The case against Elon

Under Rule 14e-8, Section 240 of the SEC’s Securities and Exchange Act of 1934, it is prohibited for publicly-traded company officials to announce plans to buy and sell securities (shares) if there is no intention or there is present, reasonable doubt that said action will not be followed through. This prevents any manipulation of the company’s stock price. With Elon’s intention of brevity, the 9 words offered little factual evidence of such a deal occurring. Having tweeted whilst driving to the airport on August 7, a routine update-tweet would soon be a thorn in Tesla’s side.

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Rule 14e-8. Source: U.S Securities and Exchange Commission

Despite the stellar performance of Tesla’s stock price, having risen almost 1800% since it went public, Tesla had only 2 profitable quarters to speak off, making it a target for short sellers. Short sellers, unlike regular investors, profit from a decrease in share price and incur losses on an increase. Elon’s animosity for them is widely known, having publicly denounced those who would bet against the future of his companies. With an almost Trump-like Twitter etiquette, he often lashes out at any negative publicity received. At a conference call in May 2018, Elon referred to an analyst’s query about funding as “boring”, “bonehead” and “dry”. According to an analysis by IHS Markit, Tesla had a peak short balance of $13bn on August 7, making it the most shorted U.S equity in dollar terms at time of tweet. A misleading tweet to surge his share price may had been Elon’s perfect revenge plan.
For the quarter ended June 30, Tesla had $2.2bn in cash and $9.1bn in total current liabilities on top another $9.5bn in long term debt. Current liabilities refer to debt repayable to a company’s creditors within a year. Tesla’s propensity to burn through cash is an open secret, exacerbating the state of Tesla’s finances. Its biggest concern would be the repayment of $920 million in convertible bonds maturing in March 2019. Convertible bonds contain special clauses which permit holders to exchange the principal owed to them for a predetermined number of shares of the company prior to maturity, thus converting debt into equity. This is exercisable at a specific range of share prices and date.
A conversion price of $359.87 is set for the $920 million convertible bonds, lower than the $389.46 attained after the surge post-tweet. Should the share price remain above its conversion price on December 1, 2018 and all bond holders decide to exercise conversion rights, Tesla would pay out in equity instead of drawing down on its dwindling cash reserves.

Elon’s explanation

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Crown Prince Moha Crown Prince Mohammed bin Salman is Chairman of the Saudi Arabia Public Investment Fund. Source: Reuters

In 2 letters sent to the employees of Tesla in the days following his tweet, Elon outlined his rationale for taking Tesla private. He revealed that interest for privatisation had existed since early 2017, when he was first approached by the Saudi Arabia Public Investment Fund (PIF). The kingdom’s sovereign wealth fund was seeking a suitable investment to diversify returns away from oil and was keen on a deal to take Tesla private, approaching Elon “multiple times” over the course of 2 years. During a meeting on July 31, 2018, prior to which PIF had bought a 3% to 5% stake in Tesla, the fund’s managing director “expressed regret” that a going-private transaction had not yet occurred and reiterated “his support for funding a going-private transaction”. This reassured Elon that a deal was highly probable, prompting the mention of “funding secured” in his tweet.
Elon aimed to create the optimal environment for Tesla to achieve its goals, “free from as much distraction and short-term thinking as possible”. As a relatively young company in the early stages of its business cycle, it burns cash to fund growth whilst revenues and profit lag. Being public puts Tesla’s finances into the cross-hairs of analysts and investors, to whom Elon needs to account quarterly and annual performance. The need to appease shareholders and analysts, on top of stomaching fluctuations in share price and attacks by short-sellers served as a “major distraction to everyone working at Tesla”, all of whom are shareholders due to its stock-based compensation policies. Elon intended to keep Tesla’s long-term mission in check. Going private would shift the company’s focus from accounting and worrying to executing and achieving.

What is wrong with a tweet?

Harvey Pitt, a former SEC commissioner stated that the circumstances in which the tweet was published; whether funding was secured with a deal as compared to an understanding between the 2 entities involved, can be viewed as “misleading” and “fraudulent” by regulators. As of August 15, 2018, the SEC had issued subpoenas to Tesla regarding Elon’s plan to privatise, according to a Fox News business report. A subpoena will indicate the opening of a formal inquiry into Tesla by the SEC, although both Tesla and the SEC have declined to comment on the investigation.
Fair Disclosure Regulations aim to prohibit the selective disclosure of information by public companies to prevent unfair advantages. Although the use of Twitter possibly violates the Fair Disclosure Regulations, an SEC announcement in early 2013 cleared social media platforms such as Facebook and Twitter as acceptable platforms to disseminate information so long as investors have been informed about them. Tesla submitted a filing in late 2013 which listed Elon’s Twitter feed as a disclosure channel. Elon would have to thank Netflix’s CEO Reed Hastings for this rule, when Hastings’s Facebook post in 2013, detailed key subscriber data and prompted an investigation by the SEC. Hastings pointed out his then 200,000 following as being “very public”, leading to an update in regulations. As a reference, Elon has a 22.4 million following on Twitter.

The road to privatisation

While Elon’s legal tussle about his tweet was on-going, there were more hurdles ahead. Elon worked closely with; the board of directors, private equity firm Silver Lake, Goldman Sachs and Morgan Stanley on structuring the deal. He continued to engage with other potential investors with the intention of creating a broad investor base. The Vision Fund, managed by CEO of SoftBank Masayoshi Son, a big proponent of innovative technologies, with whom Elon had met in 2017 was a popular candidate to buy out Tesla. Talks fell through reportedly due to SoftBank’s vested interest in General Motors, several ride-hailing companies, increased competition in the electric vehicle market and Tesla’s failure to deliver on its mass market ambitions.
Perhaps the biggest hurdle lied in the economic and strategic value of the cutting-edge technology developed at Tesla to the United States government, making any investment from overseas investors subject to the approval of the Committee on Foreign Investment in the United States (CFIUS). The committee reviews the national security implications of foreign investments in U.S businesses. Even investments by U.S allies are subject to scrutiny depending on the assets involved. Acquisitions of assets such as nuclear power plants and defence contractors are a vulnerability regardless of the state of diplomatic ties.

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President Donald Trump signing the John S. McCain National Defence Authorization Act. Source: Dailymail.co.uk

In March 2018, President Donald Trump blocked a buyout of the U.S-based wireless telecommunications company, Qualcomm, by the Singapore-based Broadcom, stating that “[t]here is credible evidence…that Broadcom…might take action that threatens to impair the national security of the United States”. The signing of the John S. McCain National Defence Authorization Act in August 2018, broadened the jurisdiction of the CFIUS, making any overseas-funded deal even more unlikely. With several potential investors based overseas, the CFIUS would have been the nail in the coffin on the road to a private Tesla.

End of the road

On August 24, 2018, Elon published a blog post on Tesla’s website announcing the scraping of plans to privatise Tesla. Having spoken to multiple shareholders, common consensus was that Tesla would be better off as a public company. The proposed plan to allow retail shareholders to continue owning shares of a private company was not a proven path. Also, some institutional investors faced internal compliance issues when investing in a private company. Whilst most shareholders declared their continued support for Tesla had it been privatised, the sentiment was summed up as “please don’t do this”, wrote Elon. Again, he reaffirmed the commitment to deliver on Tesla’s promise for the Model 3 and to achieve profitability, issuing a rallying call for stakeholders to “continue to focus on what matters most: building products that people love and that make a difference to the shared future of life on Earth”.

After 18 uncertainty-filled days, this chapter of Tesla’s story has turned abruptly. Tesla’s stock price has dropped 10% from its pre-tweet price of $342 to its current price of $305 (at time of writing), far from the conversion price for its debt. The decision to stay public further compromises Elon’s declaration of having “[f]unding secured”, fanning the flames of class action lawsuits against Elon and Tesla Inc by short sellers. Being mired in lawsuits will punish Tesla’s bottom line, pushing the cash-strapped company’s finances further into the spotlight. Throw in the SEC’s investigation, of which neither party has commented on, dark clouds are gathering on the horizon. But if there is one story everyone loves hearing, is that of a good comeback. Elon Musk, whose scale of successes and failures has awed the world, whose innovation and grit has disproved and inspired, may just give us the best one yet.

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Tesla has been making promises to ramp up the production numbers for the Model 3. Source: Getty Images

Author: Xerxes Chong Xian
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Please note that this article was not written by a committee member of Imperial College Investment Society, and hence does not reflect its views.