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Hidden by Model 3 mess, Tesla's debt problem is about to emerge

Hidden by Model 3 mess, Tesla's debt problem is about to emerge
SolarCity installers put solar panels on the roof of a home in 2011. (Tony Avelar / Christian Science Monitor / Getty Images)

With all the car-making troubles hounding Tesla Inc. these days — the Model 3 bottlenecks, the furious cash burn — it's easy to overlook the company's SolarCity headache.

But 16 months after Chief Executive Elon Musk kicked up controversy by acquiring the solar-panel installer founded by two of his cousins, SolarCity's obligations are a strain on Tesla's finances. The $2-billion purchase came with a $2.9-billion debt load, and a chunk of that is soon coming due. That's bad timing for a company churning through about $6,500 a minute and trying to stave off the need for another capital raise.

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"SolarCity debt may not be the immediate cause of Tesla's problems, but it certainly isn't helping right now," said Alexander Diaz-Matos, an analyst at credit research firm Covenant Review LLC.

Tesla representatives declined to comment for this story. The solar business generated positive cash flow last year, according to the company.

Debt coming due

Tesla's debt runs the gamut — convertible bonds, promissory notes, term loans, cash-equity debt, asset-backed securities. Most of the total is tied to Tesla the automaker.

For investors, the focus has largely been on the cash burn linked to struggles speeding up production of the Model 3, the sedan Musk is betting will be the first to bring electric cars to the masses. There's also fresh concern over Tesla's Autopilot after the fatal crash of a Model X last month that occurred while the driver-assistance system was engaged.

Tesla shares plunged 22% in March and closed at $252.48 on April 2, the lowest in more than a year. The stock climbed 21% through Thursday, after the company stood by its next Model 3 production target and said an equity or debt raise won't be required this year. On Friday, the shares slid 2.1% to $299.30.

Higher leverage

The SolarCity debt is mostly non-recourse, meaning Tesla doesn't guarantee repayment; SolarCity does. That's backed by cash flow and assets. It's still included in Tesla's overall debt, though, which is used to determine credit ratings and affects borrowing costs. Of Tesla's $10 billion of total debt outstanding, about $3 billion is non-recourse, most of which comes from SolarCity.

Without that, Tesla's leverage probably would be more in line with that of single B rating, according to Bloomberg Intelligence analyst Joel Levington.

Single B issuers typically borrow at a rate of 5.9%, according to data compiled by Bloomberg. Tesla's bonds due in 2025, which are rated Caa1 by Moody's Investors Service and B- by S&P Global Ratings, yield about 7.2%, according to Trace bond price data. Tesla's issuer rating by Moody's is equivalent to S&P's B- rating.

Ratings downgrade

Mounting financial pressures, in addition to the Model 3 shortfalls, spurred Moody's Investors Service's downgrade of Tesla's credit rating last week to B3, six levels below investment grade.

In recent months, Tesla's solar business lost the residential-solar throne to rival Sunrun Inc., a San Francisco-based installer with a market capitalization about half the SolarCity purchase price. Tesla ceded market share as it attempted to boost energy-unit profitability and scrapped SolarCity's costly door-to-door retail sales strategy.

That was a smart move, according to Ross Gerber, co-founder of Gerber Kawasaki Wealth & Investment Management, which oversees more than $10 million in Tesla shares and options. He criticized the SolarCity deal but is still bullish on the company and Musk. "SolarCity was probably going to go bankrupt," Gerber said.

Although more than 85% of Tesla shareholders supported the 2016 acquisition, a loud minority contended Musk engineered it to rescue SolarCity from swelling debt. He was SolarCity's chairman and largest financier.

Before the deal was completed, Musk tweeted that although Tesla would absorb SolarCity's debt, he would "pay it personally if need be."

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Last week, a judge in Delaware ruled that shareholders who allege Musk duped them into backing the purchase could proceed with a lawsuit, saying they had produced enough evidence showing the deal may have been flawed by conflicts of interest. Tesla said in a statement that the allegations are false and that it would take appropriate next steps in the case.

One-stop shop

For his part, Musk hasn't wavered from his commitment to turn Tesla into a one-stop shop selling solar panels to capture power, devices to store the energy and cars that can be charged in the garage. The company started producing photovoltaic glass tiles in December at a factory in Buffalo, N.Y., and has begun selling solar at some of its own stores and through retailer Home Depot Inc.

In the meantime, the bills have to be paid.

"SolarCity debt, in and of itself, is a burden," said Hitin Anand, an analyst at CreditSights Inc. "It is incremental debt for a part of the franchise that isn't core but that they want to grow."

UPDATES:

1:20 p.m.: This article was updated with Tesla shares' closing price on Friday.

This article was originally published at 9:15 a.m.

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