One of the interesting and high-profile developments in corporate debt lately has been the rising cost of debt for Tesla (TSLA).
This is an important story not only for Tesla shareholders, as the company’s cost of operations is rising, but also an important story for all investors, particularly those who get enamored with a growth story driven by a powerful personality despite alarming fundamental financials.
Tesla’s cost of borrowing has always been high relative to other mid-cap firms, in no small part because it operates at a negative margin. Last quarter, its EPS of -$3.04 was 4.4x as big of a loss as the prior year, and worse than the prior quarter’s -$2.92.
The firm’s $3.52 billion cash on hand is extremely worrisome considering its liabilities are $23 billion, and that cash comes primarily from financing and not from sales, since Tesla loses cash for every car it sells.
This is why, in mid-2017, Tesla had to pay around a 5.4% interest rate on its debt, and it’s also why that has increased to 6.6%.
Part of the higher debt costs is a result of the prolonged cash bleed that Tesla has endured, but there is another part of the story: rising interest rates.
Interest rates across the board are up, and the Libor in particular has been spiking over the last few months for one simple reason: the Fed is expecting to increase interest rates, which is going to make corporate debts harder to service in the future.
One of the silent victims of rising interest rates are capital-losing high-growth and high-hyped companies. Musk’s ventures are high profile because of his personality, their extreme ambition, and how he has invigorated an interest in science with business. But the reality is that these ventures do not make money, and for anyone invested in Tesla at any level of the capital structure, this needs to be factored into their investment decisions.
One of the ways Tesla was able to operate through such a high debt load was the extremely low interest rate environment of the 2010s. With low interest rates, Tesla could borrow cheaply and refinance cheaply to pay previous debts. Higher interest rates makes the math work against Tesla, and may cause it to become insolvent very quickly.
Elon Musk is acutely aware of this, and for April Fools posted joke tweets making fun of the insolvency of his company. Sat next to one of his vehicles with a cardboard sign reading “bankwupt,” the tweet was an unsurprising success. But for TSLA shareholders facing increasingly hostile math, the joke may soon not be so funny.