Can Going Private Turn Tesla Around?

Mack Institute executive director Saikat Chaudhuri recently appeared on Wharton Business Radio on Sirius XM 132 to discuss whether going private will solve Tesla’s many problems. Listen to the interview or read a summary below.

This article originally appeared on the Knowledge@Wharton website.

The tweet heard ‘round the world on Aug. 7 came from Tesla CEO Elon Musk: He said he was considering taking the company private with a buyout price of $420 a share — a 23% premium over the prior day’s closing price — and that funding had been secured. Shares soared by 11% following the tweet. On the same day, the Financial Times broke the news that Saudi Arabia’s sovereign wealth fund had quietly accumulated a stake of about 5% in Tesla for between $2 billion and $3 billion.

Tesla, considered one of the most innovative automakers to come along in years, has only been a public company for eight years. Like Michael Dell, Musk wants to go private so he would not be distracted by Wall Street’s scrutiny as he goes about building the company. In a letter to Tesla’s employees, he said that as a public company, Tesla is “subject to wild swings in our stock price that can be a major distraction.” Moreover, the pressure of the quarterly earnings cycle leads Tesla “to make decisions that may be right for a given quarter, but not necessarily right for the long-term.” Musk noted that SpaceX, a private space transportation company that he founded, and Tesla, where all employees are shareholders, will continue to operate separately. His stake will remain at 20%.

Musk took aim at speculators who short the Tesla stock, or bet that its price would fall. “As the most shorted stock in the history of the stock market, being public means that there are large numbers of people who have the incentive to attack the company,” he wrote. But Musk also did not close the door to returning to the public markets.

A firestorm of speculation has followed about how Musk could pull off the plan. There are also plenty of questions about whether it’s the right way forward for the electric vehicle company that has also come under fire over its ability to take innovations to the mass market – and for some of Musk’s recent behavior, including heckling analysts on a May earnings call.

The most serious fallout may come from the U.S. Securities and Exchange Commission (SEC). According to a Wall Street Journal report, the SEC is investigating whether Musk was truthful in his claim that he had secured the funding to go private. At the price he announced of $420 a share, that figure would work out to $70 billion.

“When you’re private, nobody bothers you … except those who are in the inner circle.” – Saikat Chaudhuri

In an Aug. 13 blog, Musk explained that he had been in talks off and on with the Saudi fund about going private while the board was notified of his desire on Aug. 2. He also said that he plans to fund the going-private transaction with equity, not debt, to avoid becoming another Wall Street leveraged buyout. Musk said he believes two-thirds of his investors will stay with him and that the $420 a share buyout price is for those who want to leave — so published reports of the $70 billion price tag are overblown.

The Curious Choice of a Tweet

Saikat Chaudhuri

But Musk has been criticized for his choice of issuing a tweet to announce a major corporate decision. “It would be easy to interpret this as one of these usual, crazy remarks by a founder who’s successful but also erratic in many ways,” said Saikat Chaudhuri, Wharton adjunct management professor and executive director of the Mack Institute for Innovation Management. Musk is “probably a bit frustrated” with multiple issues, he noted, including investor pressure to replace three board members, production problems, and alleged sabotage by an employee in a factory fire in June.

The announcement on going private “may be a way to try to get at the people who sold the [Tesla] stock short,” said Peter Henning, professor at the Wayne State University School of Law, who was formerly senior attorney in the division of enforcement at the SEC. “He has shown that he’s very much troubled by the people who have shorted Tesla and who have been critical of the company.”

Henning described the tweet as “a very strange way to go about announcing a going-private transaction.” While the SEC does allow companies to communicate with investors on social media, he said, “the key is you have to communicate full and complete information, and a nine- or 10-word tweet is hardly communicating full information.”

“[Musk’s tweet] just strikes me as more glitter in the face of investors,” added David Kirsch, professor of management and entrepreneurship at the University of Maryland’s Robert H. Smith School of Business. “The idea that the public markets have been in any way unfair or mistreated Tesla and Elon Musk is preposterous. They’ve given him enormous latitude to pursue the story that he has told. So I can’t imagine how taking the company private would A, be feasible, and B, work.”

“He has shown that he’s very much troubled by the people who have shorted Tesla and who have been critical of the company.” – Peter Henning

With Tesla still in the red, Moody’s Investors Service said Tesla would need to access the capital markets to keep the company going. Musk has said that Tesla can start generating cash in the second half of this year so it doesn’t need to raise more capital, according to the The Wall Street Journal. But analysts think that Tesla needs to raise billions over the next few quarters to fund ongoing operations and pay down debt obligations worth $1.15 billion.

Chaudhuri, Kirsch and Henning discussed the challenges Tesla could face in the wake of Musk’s tweet on the Knowledge@Wharton show on Wharton Business Radio on SiriusXM. (Listen to the podcast at the top of this page.)

Trouble Ahead?

Henning said proposals to take a company private are typically negotiated with the board before an announcement is made. As it happens, Musk had discussed with Tesla’s board his wish to take the company private, as six of its nine directors said in a statement, Bloombergreported. He also expected other legal troubles to be headed Tesla’s way. “I suspect there were some corporate lawyers who viewed this as a very cringe-worthy moment,” he said. “There is a plaintiff’s attorney out there who is salivating at the possibility.”

Shareholders would make up the first wave of the legal troubles Tesla and Musk might face, Henning said. “Plaintiffs’ attorneys will bring shareholder derivative suits, and if the company starts to spiral downward, that is a classic basis on which you try to hold current directors in management responsible,” he said. “So there’s a real risk here over the next six to 12 months if Tesla doesn’t actually start delivering and generating some kind of profit. I’ve got to believe their stock price is astronomical just based on hope. At some point that’s going to end.”

Tesla’s Shifting Narrative

According to Kirsch, Musk is “just trying to distract people from the underlying problem, which is [that] the company is not making money.” Over the last few years, he said, Tesla’s game plan seemed to be changing to “a series of new stories … a new narrative” that introduced new uncertainties for shareholders. “It’s had the effect of prolonging, extending that time horizon, and postponing the day of reckoning when investors can look at the company and say: Is this a profit-making concern that is doing what they’ve said they’re capable of doing and making money doing it?” He pointed to several such announcements, such as its Gigafactory plans, a new Roadster edition, and its autonomous truck plan. “Every few months when it looks like the uncertainties are about to be resolved, and that we’re about to actually have a true read on whether the firm is capable of doing what it says it can do and make money, there is a change of story,” he said.

In its 2018 second-quarter results announced on Aug. 1, Tesla earned $4 billion in revenue and incurred a loss of $520 million. Tesla in its earnings update also raised hopes that it was close to becoming consistently profitable. It closed June with a weekly production of 7,000 cars, or 350,000 vehicles annually, which the company said “should enable Tesla to become sustainably profitable for the first time in our history.”

All the same, Tesla’s promise has been “the mass-produced affordable electric vehicle that competes with the comparable internal combustion vehicle … and it has not been realized,” said Kirsch. “And if Musk cannot deliver on that promise, everything else is immaterial.” He rejected “the idea that it would be somehow easier for him dealing with an empowered board” if the company were to be taken private.

“Every few months when it looks like the uncertainties are about to be resolved … there is a change of story.” – David Kirsch

Musk has to decide whether he can deal with the pressures of a publicly held company in an open forum with shareholders, or “go private and do things on [his] own and not worry about it,” said Chaudhuri. “When you’re private, nobody bothers you … except those who are in the inner circle.”

A Question of Leadership

Chaudhuri noted that while the process Musk followed to make his announcement was “rather unusual, unconventional and problematic,” it is important to also consider “the merit of the content.” In his letter to employees, Musk noted that his firm SpaceX is “far more operationally efficient, and that is largely due to the fact that it is privately held.” The question that arises is whether going private will solve Tesla’s problems, he added.

According to Chaudhuri, the controversy also raises questions about the quality of leadership Musk brings. “Is this the way to lead a company, especially when it faces [severe] challenges?” he asked. He noted that Tesla has set for itself a difficult task — to disrupt the existing automotive industry. But is Musk the right person to carry out that plan? “Maybe this is a moment that will allow other management to perhaps come in and think about the future of Tesla,” Chaudhuri said. “I don’t think that Mr. Musk would be too happy about that. I think there is a little bit of a period for him to retract or at least back up what he [said] or make some amends and give some explanation, which is very important.”

The true test is how Tesla under Musk overcomes its problems, Chaudhuri noted. “Substance matters a lot in terms of what he will do to tackle some of [these issues] … and move the company forward,” he added. “We often romanticize the disruption story — somebody comes in and just displaces the incumbent. Clearly, production is not that easy for a very technologically advanced modern car. There are established players who do it better, even on the automobile front-end design. … The mass car is very different from a niche product. So there are a lot of questions — strategic and innovation-wise, but also leadership-wise.”

Chaudhuri said the critical issue is Musk’s credibility with investors. “If investors still believe in Mr. Musk or sufficient investors do, we’ll see this story continue,” he said. “If some investors start having doubts about his credibility, authenticity, genuineness and ability to realize these things, you’ll begin to see things crumble. We all want to see a good impact on the industry and positive change taking place, but in a manner that is sustainable.”

“We often romanticize the disruption story — somebody comes in and just displaces the incumbent.” – Saikat Chaudhuri

Even in the face of its controversies, “[Tesla’s] investors seem to be the true believers,” said Henning. “There’s almost a religious aspect to being a Tesla shareholder.”

Time of reckoning

Kirsch pointed to Tesla’s debt obligations as a worrisome factor that could lower its credit quality and impact its stock price. The market’s belief in Musk’s ability to raise money has kept its “implied risk of default lower than similarly rated junk bonds,” a Reuters report said.

Kirsch noted that Musk has “so far lost money hand over fist.” He acknowledged that Tesla is perceived as a success story, and credited that to Musk’s accomplishments thus far. At the same time, he noted, “the actual transformation of the industry through the mass production of an affordable electric vehicle for everyone — he has not succeeded at that [yet].” Added Henning, who is from Detroit: “Henry Ford is a model of the person who actually made money hand over fist by changing the industry. Is Elon Musk the next Henry Ford? We’ll see.”

The debate must move beyond tweets and stock prices to “the real, the detailed challenges of bringing this product to market,” said Kirsch. “Is there demand? This, to me, is the underlying question. Will people pay a price that will sustain the company and lead to the transformation of the industry, when even a $35,000 electric vehicle is still much more expensive than a Toyota Camry I can get for [between] $22,000 and $27,000 that I know will run a quarter of a million miles?”

Kaleidoscope Time for Tesla

Chaudhuri noted that Tesla faces production challenges on several fronts, such as establishing its supply chains end-to-end, and that it extends beyond product development or conception to implementation. “These are capital-intensive businesses where a lot of expertise is required,” he said, suggesting that they call for more resources than Tesla has displayed thus far.

Maybe Tesla will succeed in becoming a full-fledged car company, but if for some reason that vision doesn’t pan out as planned, “maybe Tesla at some point will end up more as a battery company,” Chaudhuri said. “That’s one vision that’s been put out there.” Tesla’s energy storage and generation business generated revenue of $374 million in the last quarter.

According to Kirsch, “If the company really does implode,” Tesla could change hands. He recalled having predicted earlier that Tesla will be acquired in 2018. “Tesla could be acquired at a fire-sale price by a Daimler or one of the big European car companies, because someone will buy it,” he said. “There’s value there.”

“If the company cannot start delivering consistent results, that could explain why Musk wants to take it private,” said Henning. “At the moment, Musk and Tesla have been able to raise money almost by snapping their fingers. Will that end? That’s really going to be the interesting part of the story. They’re burning through cash. Are they going to be able to keep raising money? Are they going to be able to meet their debt covenants? That’s where a death spiral can start.”

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