Professor Elam

Monday July  10 2017

When the story of Tesla TSLA 1.42% is finally written, this week will be seen as a crucial juncture. On Friday, the electric car company started production on its highly anticipated Model 3, one day after its stock briefly fell into a bear market.

The week’s 13% share-price decline as of Friday morning brings the company’s financial position into fresh focus given its historic reliance on the equity market. At first glance, the company has plenty of cash on hand—more than $4 billion as of March 31. But that is likely to go quickly.

Tesla’s free cash outflow was $622 million in the first quarter. Since Tesla delivered fewer cars in the second quarter than in the first, there is a decent chance that number will worsen. Tesla said Friday that about 3,500 cars were in transit to customers at the end of June, the lowest tally in five quarters.

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Accounts payable have risen to nearly $1.5 billion. Meanwhile, Tesla has $7 billion in long-term debt outstanding.

The Model 3 isn’t likely to improve matters, at least in the short term. Tesla said in the first quarter that it expected an additional $1.5 billion on capital spending before the Model 3 began production.

Analysts at Guggenheim Securities, which have a $430 price target on the stock, about 37% above its current level, predict that gross margins on the Model 3 will be negative 15% at the start of the launch. Gross margin won’t turn positive until the middle of next year, according to their estimates. Tesla reported an automotive gross margin of 27.4% in the first quarter.

Tesla could forgo some of its planned capital spending if it chose to do so. But that would slow the Model 3 rollout amid increasing competition, which could hammer the stock.

The good news is that Chief executive Elon Musk should have other options.

Tesla historically has had no difficulty accessing the capital markets. The company has issued equity or convertible debt in every year since its 2010 initial public offering, most recently in March. And despite a bad week, the shares are up more than 40% so far this year.

Yet Tesla needs to raise several billion dollars to meet its goals. Assuming a $1 billion cash balance and four quarters of similarly negative cash flow, Tesla would need to raise nearly $3 billion over the next year. At current prices, that amounts to roughly 6% of the total equity value. The more the shares slip, the greater the potential dilution of existing owners.

Chinese technology company Tencent ’s recent investment in Tesla stock is an encouraging sign that there is appetite for large chunks of equity. While that deal didn’t involve fresh cash, it suggests other potential options besides a traditional secondary market issuance.

So the past would suggest that the recent selloff won’t be much of a long-term problem for Tesla shareholders. Yet Tesla’s balance sheet and the increasingly crowded electric-car field suggest this is a moment the company can’t risk squandering.

Write to Charley Grant at charles.grant@wsj.com