Shares in Tesla (TSLA) slumped on news that US regulator SEC filed a civil complaint against Tesla CEO Elon Musk alleging securities fraud related to his 7 August "funding secured" tweet about taking Tesla private. The Justice Department is also investigating this tweet as a criminal matter but has not filed charges. The SEC is seeking civil penalties, disgorgement of any ill-gotten gains, and wants to bar Musk from serving as a director or officer of any US public company.
The latter item is most significant for investors in our opinion because as we said in our 26 August note: "We think for now Musk is effectively Tesla and without him Tesla is just a capital-intensive automaker burning cash with too much debt due soon." If Musk were not allowed to be a key decision-maker at Tesla, or if we grow more uncomfortable with the legal risk surrounding Tesla in the future, then we would likely raise our weighted average cost of capital to nearly 12% from about 10%. This change, holding all else equal in our model, would lower our fair value estimate to about $126 from $179, but for now we are maintaining our fair value estimate while we see how this complaint plays out over time in the courts or via litigation.
The SEC held a short press conference and we also read its complaint. The agency believes that at the time of the 7 August tweet, Musk knew he had never discussed going private at $420 per share with any potential funding source and had done nothing to research if all current shareholders could remain owners if Tesla went private. This issue was a key reason Musk eventually abandoned his plan to go private as announced via a late night 24 August blog. The complaint does say Musk met on 31 Julywith a sovereign investment fund, which Musk said in a 13 August blog post was from Saudi Arabia.
"Nothing in Writing"
At the 31 July meeting, the fund said it had taken a 5% stake in Tesla and wanted to take Tesla private. The complaint also says Musk assumed Tesla would have to open a plant in the Middle East for the deal to happen but the complaint also says that meeting, "lacked discussion of even the most fundamental terms of a proposed going private transaction" and there was "nothing exchanged in writing."
We took Elon's 7 August "funding secured" tweet and a later tweet that day by him saying the only contingency to a deal was a shareholder vote to mean he had at least a verbal, if not written, commitment of funding. If the SEC can prove this was not true, then Tesla may have to bargain with the SEC to keep Musk in an executive role at the company.
Section 30 of the complaint alleges that between 31 July and the 7 August "funding secured" tweet, Musk did not talk to the fund again, did not discuss a $420 going private deal with any potential funding source, did speak with an unnamed private equity contact about the process to go private but did not talk to any other potential investors about their interest, did not provide a specific proposal to Tesla's board to go private, did not contact current shareholders with a specific proposal to go private, did not formally retain advisors for a transaction, did not determine if retail investors could remain invested in a private Tesla, and did not investigate regulatory issues around going private.
According to the complaint, Musk did email the board on 2 August with the subject, "Offer to Take Tesla Private at $420" and had a conference call with the board on 3 August. During the call, Musk told the board the sovereign fund was interested in taking Tesla private. The board authorised Musk to contact certain investors to discuss the matter but there is no mention of an actual deal in place at that time.
