TSLA - NIO: Dilution Fears And Rumors

2023-09-27 07:00:00 ET

Summary

• NIO's stock slumped after news of a convertible bond offering, but the company's underlying business growth has picked up.
• NIO issued $1 billion worth of convertible bonds to fund manufacturing capacity and retail expansion.
• Market worries about an additional capital raise should ease as NIO denied planning one in the near future.

Article Thesis

NIO Inc. (NIO) is a company with a very volatile share price. Recently, news about an equity offering caused market worries that made NIO's stock slump closer to the 52-week low -- in the meantime, underlying business growth has finally picked up again. While there are question marks when it comes to NIO's future, the valuation isn't high for an electric vehicle stock.

What Happened?

NIO, one of the larger Chinese electric vehicle pure-play companies, has been in the news lately due to a capital raise and speculation that additional equity issuance might happen.

NIO's Convertible Bond Offering

The first news item is a convertible bond offering that did happen. NIO issued $1 billion worth of convertible bonds, split evenly between bonds maturing in 2029 and bonds maturing in 2030 -- $500 million each. NIO is a fast-growing EV player that needs to invest heavily in order to build out manufacturing capacity, its retail footprint, and so on. At the same time, NIO is, like many other EV pure-plays, not profitable yet, which means that these investments are not financed via operating cash flows, but, instead, via cash on the balance sheet. When that starts to run lower, adding new capital via a bond offering, equity offering, or a "mix" between the two -- a convertible bond offering -- makes sense. Other growth companies, including current EV king Tesla ( TSLA ), have operated in a similar way, as we can clearly see when we take a look at Tesla's share count over the years:

Since Tesla went public, its share count has easily more than doubled. This was partially due to shares and options being issued to Elon Musk and Tesla's employees, but secondary offerings also played a major role. It has not hurt Tesla's share price, as underlying business growth was fast enough to more than offset the headwinds of a rising share count.

Ideally, the same will happen at NIO, too: If the share count climbs at a certain growth rate every year, but the revenue growth rate is substantially higher than the share count growth rate, then revenue per share will rise, no matter what. Of course, there is no guarantee that NIO's underlying business growth will be appealing, but in recent months, growth has accelerated -- more on that later.

While capital raises are more or less normal for fast-growing, not-yet-profitable companies such as NIO, the market still didn't like the convertible note offering. Shares continued to decline in a trend that began in early August when shares peaked around $15 -- they are now trading at just above $8.

NIO used some of the proceeds to buy back convertible bonds it had issued earlier, ones with maturity dates in 2026 and 2027. The bonds that NIO bought back had a face value of $500 million, meaning NIO still had substantial leftover cash to add to its balance sheet to fund future growth.

Worries About Additional Capital Raise

While the market didn't like the fact that the convertible bond offering did happen, the market also worried about an additional capital raise that has, at least so far, not happened.

There were some reports and rumors about NIO potentially seeking to raise another $3 billion worth of capital from investors. For a company that is valued at around $15 billion right now, that would make for a pretty substantial share count increase (assuming that NIO would issue equity, not debt). It would not be surprising to see shares experience selling pressure if NIO actually issued this much equity, but the company didn't do that. In fact, the company denied even planning an additional capital raise right now. This is the company's statement on the subject (see link above; highlights by author):

The Company has been made aware of certain media speculations claiming that the Company is considering raising certain capital from investors, which have been widely circulated today. In light of the unusual market activity in the Company's American depositary shares today, the Company would like to clarify that the Company currently has no reportable capital raising activity, other than the recent convertible notes offering that was completed on September 25, 2023.

While the company does not deny that it will raise capital in the future -- denying that would make no sense, as the company doesn't know about its long-term cash needs yet -- it seems pretty clear that there will not be a capital raise anytime soon.

This should ease investors' concerns, due to two reasons:

• First, with no additional capital raise planned right now, shareholders don't need to worry about dilution too much.
• Second, NIO seemingly is happy with its cash balance now, which indicates that planned capital spending is aligned with the resources the company has access to right now. If no capital raise is planned in the foreseeable future, then one could argue that overspending isn't a major concern at NIO.

Operational Progress And Valuation

The electric vehicle market continues to grow across different geographic markets, including in the US and China. As a Chinese EV player, NIO naturally is most exposed to Chinese EV demand.

While NIO's growth rate was pretty appealing over the last couple of years, growth declined during the first half of the current year -- even though others, such as BYD (BYDDY)(BYDDF) continued to deliver outstanding volume growth.

That was disappointing, as EV investors naturally want to see the companies they invest in generating strong business growth. However, NIO seems to have overcome headwinds such as supply chain issues now, as growth has improved markedly in recent months. New product introductions that fit well with what consumers in China are looking for also helped in improving NIO's business growth rate.

In August, NIO delivered more than 19,000 vehicles, which made for a growth rate of 81% compared to the same month one year earlier. That growth rate is very compelling, both in absolute terms and also compared to the much more meager growth NIO has been achieving during the first half of the current year.

This growth was partially driven by NIO's recent new model introductions, such as the ES6 smart SUV which has been well-received by consumers in its home market. While not as much of a volume model, the new ET7 sedan also has played a role in improving business growth at NIO, and due to its above-average sales price it should have a positive impact on revenues and margins going forward, all else equal.

NIO isn't profitable yet, thus we can't value the company based on the profits it generates, which would be one of the most common approaches to valuing a company's shares. We can, however, look at the revenues that NIO generates:

Today, NIO trades at 1.7x forward (this year's) sales, based on current analyst estimates. That's a higher valuation compared to most legacy automobile companies, but far from expensive compared to other EV pure-plays. Tesla is valued at a 4.5x higher sales multiple, while Rivian Automotive (RIVN) and Lucid Group (LCID) are trading at big premiums compared to NIO as well. Tesla is profitable, unlike the other three, thus one can argue that a premium valuation is justified. But LCID and RIVN are pretty far from being profitable, they sell way fewer vehicles compared to NIO, and yet, they trade at high valuation premiums. While NIO being a Chinese company can be seen as a macro risk factor, one can also argue that this is an advantage for NIO, as China's EV market is the most important one in the world, and NIO is advantaged there, compared to American competitors.

Takeaway

While an investment in an unprofitable growth company undoubtedly comes with major uncertainties and risks, the violent selloff NIO has experienced over the last couple of weeks seems somewhat overdone.

NIO's growth has improved, and the valuation isn't high -- at least compared to other EV pure-play stocks. If NIO can keep up its volume growth rate, sales and margins should improve considerably going forward. Following the recent capital raise, the company also should have ample liquidity for a while, thus balance sheet worries have eased. With the valuation having come down a lot over the last couple of weeks, NIO is now a much better deal again than it was with shares trading in the mid-teens.

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