Why the Tesla Model 3 Megahype Is Turning the Stock Into a Binary Play

Another day, another equity offering from Tesla Motors Inc. (NASDAQ: TSLA). Announced May 18, this time it’s a $2 billion float, $1.4 billion of which will be used to fund the roll-out of the ever-anticipated Model 3, purported to be the Holy Grail of the electric vehicle (EV) industry as the world’s first mass-market fully electric car. The other $600 million will be sold by CEO Elon Musk himself through the exercise of stock options.

On the one hand it’s exciting for the company and its shareholders because Tesla claims to have 400,000 preorders for the Model 3, which, at $35,000 a car, translates to a top line of $14 billion. After incentives, discounts and cancellations though that number will probably end up being much smaller. As for the offering, $2 billion is quite a high number, especially considering that the total amount of cash burned by the company since inception is $2.6 billion. This equity offering will nearly double that overnight.

Given the sheer amount of capital that Tesla has consumed already, the only thing keeping the company from seriously testing market patience and having the bottom drop out of its stock is the very hype and hope for the Model 3 itself. If investors did not believe there is a reasonable chance that Tesla will finally bring EV to the mass market, Tesla’s stock would be considerably cheaper, perhaps even by an order of magnitude. Those 400,000 preorders better materialize and be fulfilled or the dream could start to fade fast. Musk must know this, which is why he’s making sure the funds are there to meet fulfillment ahead of time.

There look to be four ways this could play out come the time when those Model’s have to be delivered. First, Tesla could come short on fulfillment, which has happened before. Back in April, the company fell short of its delivery guidance for its Models X and S, actually citing its own hubris. Second, it could end up reporting high losses on Model 3 sales, even if delivery and sales targets are met. It doesn’t matter if everyone in the world owns a Model 3 if the company loses money on every sale.

Third, a project this size and this revolutionary can easily lead to unexpected quality assurance issues and the car could disappoint performance-wise, even if sales targets are met and losses are narrow. Finally, if everything works out and losses are less than expected, investors will continue giving Tesla some breathing room, despite it burning through close to $5 billion in capital by the end of the initial launch.

As it stands now, Tesla desperately needs the Model 3 to live up to the hype, and it needs to show that at least it isn’t losing too much money on every sale. Considering the high expectations and the amount of capital involved, Tesla no longer has much room for any error. If the launch succeeds, then Goldman Sachs’ estimation of a 22% upside could come to fruition. But if anything goes wrong on the scripted dream of mass market EV, investors may finally call in the favor for loaning Musk $4.6 billion in equity, meaning Tesla shares would fall hard and fast.

Here’s to hoping.

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