Tesla boss, Elon Musk has grabbed the headlines in recent months with construction of a solar powered battery plant in South Australia, and now a big, oversubscribed, sub investment grade bond issue
At what yield would you be prepared to invest in a Tesla bond?
Would the environment, governance and social impact (EGS) of the company make a difference to how you viewed the investment? That is, would you be prepared to earn less if you thought Tesla was helping the planet?
The new Tesla bond, rated B- by S&P and B3 by Moody’s, upsized from its initial USD1.5bn to USD1.8bn was priced at a paltry 5.30% per annum.
Putting the perceived credit risk into perspective, S&P consider the eight year bond has a probability of default of circa 23% in its lifetime.
The funds will assist the rollout of Tesla’s newest car, the Model 3 sedan, and is expected to help push broader sales after it received thousands of advanced reservations per day since the car’s launch. With Tesla dependent on long term cashflow models that assume rising fleet penetration of electric vehicles, the debt offering will help transform it from niche luxury carmaker to mass market rival of Ford and Chevrolet.
Tesla has raised billions of dollars in equity by selling stock investors a story of unlimited growth - it seems bondholders are also jumping on board for the ride.
Sub investment grade bonds typically have bondholder protections, or covenants, but those available on Tesla’s bonds provide few limitations. According to Moody’s, covenants in the US High Yield market, are currently as weak as they have ever been on new issues. Fixed income security analysis is as much about the investor protections available as it is about company quality and debt serviceability.
A poor covenant package, a low yield and the likely need for growing funding should have investors shying away from the bonds. Instead, its success reflects an appetite for risk and willingness to accept a comparably low yield and perhaps a desire to be part of a growing EGS movement.
Other B- rated bonds – on a relative basis
To put the Tesla issue into perspective, Table 1 shows three other USD fixed rate ‘B-’ rated bonds and the corresponding yields to maturity. All three offer above 8% pa and all have maturity dates of less than eight years.
Tesla has certainly taken advantage of its position and raised some very cheap funds in a market that many consider is at its most expensive for years.
Note: Bonds available to wholesale investors only. Minimum of $10,000 parcels and minimum upfront spend of $250,000.
Prices accurate as at 15 August 2017 but subject to change.
A little bit about Environmental, Social and Governance
In 2006, the United Nations introduced a mandate called the Principles for Responsible Investing (PRI), which has since gained nearly 1800 signatories representing over USD6 trillion in assets under management. A cornerstone of this mandate is the incorporation of Environmental, Social and Governance (ESG) factors into the investment decision making process.
Although ESG is comparably new, there is mounting evidence that long term returns may best be calculated using a company’s ESG metrics. For example, the S&P 500 ESG Index saw 14.52% total returns in the 2016 calendar year, 2.56% higher than the S&P 500 as a whole.
In particular, the asset management industry is experiencing a dramatic change that is seeing millennial investors demanding more transparency in company activities. The importance of ESG goals in the investment process continues to evolve as more investors seek to do good, not just generate Alpha.