That calculus worked in the past. If it doesn’t work next time, it’s over for Tesla.

This is a cleaned-up transcript of my podcast on Sunday. You can listen to the podcast on YouTube.

The senior unsecured bonds that Tesla issued in August 2017 closed on Friday at a record low of 81.6 cents on the dollar. That’s a decline of over 18% from the price at which they were issued 21 months ago. Bond prices reflect what the market thinks the probability is that Tesla will default on those bonds, and what bondholders will get if it defaults.

When the price of a bond falls, the yield rises. On Friday, the yield hit 9.3%. In other words, investors demanded to be paid 9.3% in interest to compensate them for taking the risk of owning this bond.

That yield of 9.3% compares to the risk-free 10-year Treasury yield of about 2.3%. The difference between them is 7 percentage points. That spread is a sign that the bond market is getting nervous about Tesla going bankrupt.

Tesla shares closed on Friday at $190.63, down 50% from their 52-week high last December. Shares first hit $190 on the way up in September 2013. That was five-and-a-half years ago.

When Tesla raised $2.4 billion in cash from investors in early May via a convertible-bond offering and a stock offering, those hapless investors have lost 12% on the bonds already, and they have lost 25% on the shares, all in about three weeks.

So what does this mean for Tesla, the automaker?

Before we go on this journey, let me just say what I have said many times. I give Tesla’s CEO Elon Musk a huge amount of credit for having made electric cars something that people want to own. No one in the world has ever been able to do this before him.

Usable electric vehicles have been around since the 1880s, competing with steam cars and horse-drawn carriages. The technology of the electric motor has always been superior to anything else because of the flat torque curve that is ideal for transportation uses, and because electric motors are small and light-weight and simple. And they’re cheap to make, compared to an internal combustion engine. And they can run for many years without much maintenance.

The battery has always been the problem. They’re too heavy for the amount of charge they hold, they take too long to charge up, and they’re too expensive. But battery technology has advanced in leaps and bounds, and continues to do so, and it’s much less of a problem today than it was even a few years ago.

So Musk came along, supported by government subsidies for EVs. He bedazzled investors and raised many billions of dollars from them — $2.4 billion most recently in early May – and he has gotten these cars on the front page of every mainstream website, newspaper, and magazine. And the internet has become a cauldron of Tesla hype.

This investor support has made a lot of things possible. Teslas are now taking market share from BMW and Mercedes. And seeing this, all automakers have jumped into the fray. They’re now all selling EVs or will come out with EVs soon, from GM to Porsche.

This was Musk’s genius. He created an entire industry. That’s an awesome accomplishment.

His genius was having a vision and, by hook or crook, creating hype in the market and bedazzle investors – particularly big institutional investors that can invest billions of dollars and would likely remain loyal investors for years. This genius caused investors to pour many billions into Tesla, that Tesla then burned in its operations.

But Tesla still doesn’t know how to manufacture cars in a profitable self-sustaining manner. The company is a chaotic cash-burn machine, and that $2.4 billion in cash it extracted from investors in early May will only fuel this cash-burn machine for another 10 months, according to Musk himself.

Ten months from now, the company will face another liquidity crunch, and it will have to return to the market to extract a couple more billions of dollars, by issuing bonds or shares or both in order to fuel its cash-burn machine. And that fuel might not last long either.

The bond market is already nervous about the chance of Tesla defaulting and filing for bankruptcy, and 10 months from now, it might be even more nervous about it. If Tesla had to sell similar senior unsecured bonds today, it would have to pay over 9% in interest, instead of 5.3% three weeks ago; 9.3% is a huge amount of interest to pay for a company that is already burning cash hand-over-fist.

But if the bond market gets even more nervous about a default, Tesla might have to pay 11% or 15% or more in interest 10 months from now, to find investors willing to take the risk.

It would be ruinous for a cash-burn machine. And everyone would know it. And that knowledge would preempt any chance of pulling off that kind of bond offering.

Tesla’s situation gets even more complicated. The only reason why investors still handed Tesla $2.4 billion in early May – despite all the facts known about its cash-burn mechanics – is its stock price.

It was around $250 a share at the time of the offering in early May. While that was down 35% from the 52-week high, it was still a huge share price that induced investors to think that Tesla could sell more shares anytime to raise more money if it runs out of money. This was seen as a guarantee, of sorts.

Bondholders have counted on that guarantee. It was the most important consideration in the past: Their calculus was that as long as the share price is high, Tesla could avoid a default because it could sell more shares to get more cash to service its debts. But this sort of guarantee is contingent on a high share price.

Musk knows, come hell or high water , he has to inflate the share price so that Tesla can sell more shares and raise cash, and that bondholders see this, and are willing to lend Tesla more while counting on the guarantee provided by the high share price.

That calculus worked in the past. But if it doesn’t work next time, it’s over for Tesla.

In other words, if Musk’s hell-or-high-water strategy of inflating the stock price fails, and shares continue to fall, Tesla would be cut off from the bond market 10 months from now.

It might still be able to sell shares, but if the cash-crunch is obvious, and the cash-burn machine runs red hot, the stock market might not be excited about Tesla’s shares, and the price might fall further, and raising more cash by selling shares becomes more dilutive and punitive to existing shareholders.

Now, getting diluted is better than getting wiped out, or getting mostly wiped out, as would be the fate for Tesla’s shareholders if Tesla were to default on its bonds and file for bankruptcy. So if the price drops far enough, there might be enough buyers out there willing to hand Tesla another $2 billion, while praying for a miracle.

Assume Musk can raise another $2 billion in cash 10 months from now at a much lower share price and keep Tesla afloat for another 10 months. And then what?

Since mid-December, Tesla’s shares have plunged 50%. And Tesla still has a market cap of $34 billion. That’s still a gigantically inflated value, for a tiny automaker like Tesla, with a market share of less than 1% in the US, and near-zero market share in the largest market in the world, in China. The only thing big about Tesla are its losses and its cash burn.

So if investors are starting to look at Tesla’s reality, and are less bedazzled by Musk and Wall Street hype organs, then they will demand larger and larger price cuts to the shares before they’re willing to buy and take those risks.

And this could be fatal for Tesla. As long as it remains a cash-burn machine, Tesla’s survival is uniquely dependent on its high share price. When the share price drops below a certain level, Tesla will be cut off from the bond market; and if it drops further it will be cut off from raising more cash in the stock market. And it will run out of cash.

Other companies can brush off a low stock price. But a low stock price can push Tesla into default and bankruptcy.

So, come hell or high water, Tesla must do what is anathema to Musk: Figure out how to come up with a self-sustaining business model, make consistent profits, and be cash-flow positive. That would allow it to survive.

But wait… Once Tesla makes a profit, investors will look at the PE ratio of a tiny auto maker with a market share of less than 1%, in an industry that is terribly mature, and is now declining, and where all automakers make EVs.

Once this reality sets in, Tesla’s share price – with the halo worn off – will shrink until its PE ratio is similar to the PE ratio of other automakers. And that’s the optimistic scenario.

The realistic scenario is that Tesla will never get to the point where it is a consistently cash-flow positive self-sustaining company. And instead, the scenario kicks in where Tesla just runs out of money, like so many automakers before it.

You can listen to my podcast on YouTube.

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