S&P Assigns 'B-' Rating to Tesla (TSLA); Notes 'Vulnerable' Business Risk Profile

May 27, 2014 2:43 PM EDT

Standard & Poor's Ratings Services said today that it assigned its unsolicited 'B-' corporate credit rating to Tesla Motors Inc. (Nasdaq: TSLA). The outlook is stable.

We also assigned our unsolicited 'B-' issue-level and '4' unsolicited recovery ratings to the company's $920 million 0.25% unsecured convertible notes due 2019, $1.38 billion 1.25% unsecured convertible notes due 2021, and $660 million unsecured convertible due 2018. The '4' recovery rating indicates our expectation for average recovery (30%-50%) for the noteholders in the event of a payment default.

Our "vulnerable" business risk profile assessment incorporates Tesla's narrow product focus, concentrated production footprint, small scale relative to its larger automotive peers, limited visibility on the long-term demand for its products, and limited track record in handling execution risks that could arise in managing high volume parallel production.

The business risk profile is also constrained by Tesla's niche and independent market position, compared to its significantly larger and stronger peers, and its very limited product range and operating diversity. We expect global competition for alternative fuel vehicles to intensify over the next few years as competitors penetrate this market through improved products. We believe there is considerable uncertainty in Tesla's long-term prospects and believe that the company is less likely (compared to larger, more established automakers) to successfully adapt to competitive and technological displacement risks over the medium to long term.

Mitigating factors include improving brand recognition, ongoing cost structure improvements with higher unit sales leading to better absorption of fixed costs and lower logistics costs, as well as Tesla's ability to command a price premium through its Model S product, design, and technology.

"The stable outlook reflects our view that Tesla will continue its recent improvement in gross margins and generate positive cash flow from operations in 2014 while maintaining sufficient liquidity despite its large growth-related cash investments," said Standard & Poor's credit analyst Nishit Madlani.

We could lower the rating if it appears likely that the projected long-term demand for Tesla's vehicles will fall meaningfully below our estimates, leading to overcapacity, or if FOCF will likely remain significantly negative for the foreseeable future, causing liquidity to become insufficient. A downgrade may also occur if additional debt funding needs arise or significant execution risks and cost overruns materialize related to the company's expansion of Model S into Europe and Asia this year or the launch of its Model X in early 2015.

Though unlikely over the next 12 months, we could raise the rating if a combination of higher demand for Tesla's product and operational cost reductions leads to a credible pathway for positive free operating cash flow (FOCF to debt approaching 5%), with leverage falling well below 6.5x and liquidity remains "adequate." We would also need to believe that the company's improved market position is sustainable.

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