Tesla Investors Should Be Prepared for Dilution

Tesla (TSLA) has played the Model 3 hype card. As expected, the EV-maker unveiled the Model 3 last week and Elon Musk tweeted the following day that pre-orders for the vehicle hit 253,000. Musk also said that Tesla was expecting the pre-orders to be 25%-50% of what is actually coming in. The pre-orders are pouring in and according to the latest reports, the figure has now jumped to 276,000.

Supply problems

Demand for Tesla’s cars has always been strong, it’s the supply that has been the problem.
While the pre-orders look impressive, I don’t believe Tesla will be able to meet the demand. Musk already said that the pre-orders are 2-4 times higher than what the company was expecting and I’m sure it will be impossible for Tesla to convert all the bookings into sales.

Moreover, the large pre-orders also pose a threat to present Tesla investors as I think the company will need to dilute shares in order to fund the growth. No matter how you look at it, shares of Tesla are currently overvalued. Tesla commands a market cap of over $31 billion. The overvaluation is the primary reason why I believe the company will dilute equity to fund Model 3 sales.

Given the overvaluation, I can see Tesla diluting about 10% of its equity to raise over $3 billion to fund the production of the Model 3.

Losing money

Tesla was losing money at a rapid pace even when it was producing luxury vehicles. However, the arrival of the Model 3 will make Tesla’s profitability worse as it will have a negative impact on the company’s margins. If Tesla was losing money when it was selling $70,000 cars, it is obvious that the company will continue burning through cash if it sells cars for as less as $35,000.

So, while the Model 3 will boost Tesla’s sales, it will have a huge negative impact on the company’s profitability going forward.

Conclusion

The chances of Tesla diluting 10% of its equity to raise cash to fund the Model 3 are very high. The pre-orders may be pouring in, but Tesla will find it very difficult to convert them to sales. Due to the high probability of dilution and the overvaluation, I think investors should short Tesla at current levels.
Published on Apr 4, 2016
By Ayush Singh

Copyrighted 2016. Content published with author's permission.

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