A private Tesla allows Musk to think big but is fraught with risk

There was a recent tweet by Elon Musk of Tesla indicating that the firm was considering going private. Although this a surprise to the markets in general, he did not specify the form or the investors that may be interested in such an offer.

Typically, with these types of announcements, details on deal structure are included. Without the detail, there could be concern from regulators related to stock manipulation. The message indicated the offer would be for $420 per share, which at the time, was about a 20 percent premium over the current price. The question is why would Tesla want to go private and what are the ramifications for the firm?

{mosads}For investors that currently own the stock, it will be a large premium to their shares and could lead to a large payoff. At $420 per share, the market value for the firm would be around $70 billion, which would make it the largest private transaction to date.

Elon musk owns approximately 20 percent of the firm, so he will benefit financially. The overall benefit for the firm itself would be three-fold.

First, as a public corporation, Tesla has to report quarterly earnings, which forces the firm to show the financial status of the firm on a regular basis. This is a concern to Musk since the firm has missed forecasts over the past few years, and going private would remove the regular scrutiny from markets and analysts.

Musk argues that financial reporting is a distraction from focusing on running the firm and driving its success. A private firm is responsible to much fewer shareholders, and there is no requirement for quarterly reporting and dealing with analysts’ scrutiny.

However, these fewer shareholders will have a controlling interest in the firm and could still make demands on operations.

Second, Tesla is one of most shorted stocks in the market, which is an indication that many investors believe it is overvalued and that the short positions will profit from a drop in the stock price.

With an immediate increase in the stock price, driven by investor belief that the firm may go private and stockholders will receive a 20-percent premium on their shares, those shorting the stock will suffer an immediate loss to the value of their positions.

There is no possibility of shorting a private firm, and market volatility is not a concern. Also, Musk takes the shorting of his firm personally and has often commented about it. Going private would be a way to rid himself of this irritation.

Third, and most important in Tesla’s case, is that management of private firms can take a longer-term view. Short-term under performance will not be penalized since the investors do not expect to get a return for years.

With the market scrutiny, the firm has to show profitability and is spending all of its energy to increase production and likely focus more on vehicles with a higher profit margin, which is far above the $35,000 price it promised.

Without the immediacy of profits, it could sell the lower-priced cars and perhaps build more market share, which could be more valuable in the long run.

With the coming pressure from more established firms in the luxury segment that are aggressively moving into the electric-vehicle market, Tesla must be prepared and either needs to focus on the next vehicle in its lineup or perfect the current line of offerings.

This is very costly for firms and particularly one that has to use all of its current cash to facilitate production and spend below what it may need on research and development. A private Tesla will have the patience of long-term investors to deal with these issues. If new capital is raised in the process, then it could help support this effort.

There are challenges to Tesla going private given the current state of the firm. Typically, a firm goes private using debt or equity to purchase the existing shares.

To use equity, it would require the firm to raise billions of dollars to buy the current public shares. This would be very difficult since it does not seem that there are enough wealthy investors who would be interested in the deal, but this could change.

The debt alternative is more difficult since Tesla has a lot of debt and does not have the cash flows to service any new debt either now or in the near future. That would put pressure on the firm to produce even more vehicles very quickly.  

Once the firm is private, the ability to raise new capital will be more difficult since it will not have the public equity markets available to raise the new capital. As a public firm, Tesla could always issue more shares to raise equity capital even though it would be more expensive.

The financing issue is very large, and it is unclear how to overcome it in the near future. In general, the ramifications of the decision boil down to operating flexibility versus financial flexibility. 

Rohan G. Williamson is a professor of finance and Bolton Sullivan/Thomas A. Dean chair in International Business Studies at Georgetown University’s McDonough School of Business.