The New Tesla Stock Sale: Either Good For Company OR Investors

The New Tesla Stock Sale: Either Good For Company OR Investors
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Tesla Inc (NASDAQ:TSLA) has decided to sell more stock. The company announced that it will sell shares directly into the market to raise approximately $5 billion. The announcement brings to mind two articles I wrote for Valuewalk in the recent past. The first was entitled, The Feedback Effect That is Helping Drive Tesla.

The point of that article was to note that an artificially high stock price can become, to a degree, a self-fulling prophecy because it allows a company to raise equity financing at a low cost of capital. In effect, the company receives a subsidy from investors who are willing to accept a lower return than the “true” cost capital. Given its sky-high stock price, Tesla can raise the $5 billion with only about a 1% dilution in the shares outstanding. If General Motors were to raise $5 billion in equity, it would have to dilute its shares by almost 12%. This amounts to quite a competitive advantage for Tesla.

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Tesla's Stock Price Should Drop When The Stock Occurs

The second article titled, The Tesla Stock Split Experiment, took a careful look at the recent Tesla stock split. In the article, I noted that splitting a stock is like stating the price of a good in dollars instead of Japanese yen. The number of shares increases by a factor of five (in the case of Tesla’s split), but the underlying company does not change a lick. From the point of view of fundamentals, the stock price should drop by a factor of five when the actual split occurs exactly offsetting the increase in the number of shares. This means that if the market is responding to fundamentals, an announcement of a split should have no effect on the stock price.

Of course, in the case of Tesla that is not what happened.  The last trade prior to the announcement of the split was at a price of $1,374.39 in the after-market on August 11. Within two minutes following the announcement, the price had jumped more than $100 in the after-market to 1,476.04 an increase of 7.40%. Over the next four days, there was no fundamental news about Tesla but a great deal of talk about the split and price kept rising.

Over the full four days, Tesla rose $ 460.61 (in terms of pre-split prices) or 33.15%. In total the stock price of Tesla rose $460.61 adding $85.8 billion to Tesla market capitalization. But the run-up was not over. When the split shares began trading on August 31, the stock rocketed up another $287.65 to an effective pre-split price of $2,511 adding another $53.6 billion in market capitalization. And throughout all this there was virtually no fundamental news about Tesla. The entire episode suggests that the run-up was greatly influenced by investor psychology.

Apparently, considering the run-up to sky-high levels and the likelihood that it was related to investor psychology, Mr. Musk and his advisors decided the time was right for the company to sell more shares. Who can blame them? That money could be used to shore up Tesla’s cash reserves or to help build new factories in Texas and Europe. It is interesting that Tesla is doing an at the money stock offering by selling shares into the market as opposed to a standard secondary fixed price offering. That approach is rare for a company the size of Tesla.

In closing it should be recognized that there are two sides to every transaction. If the deal is a great one for Tesla, then one would fear that it is not so good for the company’s shareholders. It is not surprising, therefore, that on the day following announcement, Tesla’s stock price dropped 4.67% and as I write this the stock is down another 5% on September 2.

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Bradford Cornell is an emeritus Professor of Financial Economics at the Anderson School of Management at UCLA. Prof. Cornell has taught courses on Applied Corporate Finance, Investment Banking, and Corporate Valuation. He is currently developing a new course on Climate Change, Energy and Finance. Professor Cornell has published more than 125 articles and four books on a wide variety of topics in applied finance. Professor Cornell is also a managing director at BRG where he heads the practice on Climate Change, Energy and Finance. In addition, he is a senior advisor to the Cornell Capital Group and to Rayliant Global Advisors. In both capacities, he provides advice on fundamental investment valuation.
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