Tesla is Raising Capital: What Does it Tell Us About the Stock Price?

By May 7, 2019 Blog

Tesla is raising capital and it tells us something about the way to the stock is priced.  To see how, we need to take a step back into the world of academic research on financial markets.  One of the most consistent results of that research is that when companies announce issues of new securities, the stock price falls.  Furthermore, the drop is related to the information sensitivity of the securities being issued.  The more information sensitive the issue, the larger the drop.  By information sensitivity, academics mean the extent to which a security will be affected by new information about the company.  For instance, debt is less information sensitive than stock because payments to debt are promised and because debt has superior rights in bankruptcy.  If bad information about the company is released the stock price will fall by a larger percentage than bond prices

What was unique about Tesla is that when the company announced that it was planning to issue more stock and sell new convertible bonds, the stock price rose.  And the stock price rose more than the price of outstanding bonds.  This implies that investors concluded that giving Mr. Musk $2.7 billion dollars was going to create value in excess of $2.7 billion dollars.  That suggests that there are enough investors who still believe in the genius of Mr. Musk that giving him money creates immediate value.  The question is, are those investors right?  Given the recent performance of the company with regard to profitably making cars, and given the rising competition, our answer at Cornell Capital is probably not.  For all the reasons we have reiterated in this blog, we continue to see holding Tesla stock as a high risk, low expected return venture.  Nothing in the planned capital raise changes that view.

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