Aug 25, 2013
DaveT (Note: I've edited this post to reflect qualified trading period for note conversion as Q3 and not Q4 like I originally thought.)
Recently I've seen people speculate that Goldman could be propping up TSLA to the $161.88 note conversion target price. I wanted to share my thoughts and try to clear up what I think is some unfounded speculation.
First, here's some docs to review:
- http://files.shareholder.com/downloads/ABEA-4CW8X0/2330621879x0x683938/21f1fee5-a449-4171-b459-24bee1e62c7e/Potential%20Dilutive%20Shares%20for%202013%20Convert%20and%20Warrants.pdf
- Tesla Motors - Prospectus Filed Pursuant to Rule 424
Alright, let's review the facts. Tesla issued $660m worth of convertible notes (in their May 17th secondary offering). This is separate from their common stock offering at this time (3.39 common shares) and their selling of warrants to generate cash to hedge dilution of the convertible notes (explained below). Tesla received $660m and the note buyers received a note to receive 1.5% annual interest as well as the ability to convert those notes to TSLA shares at a conversion price of $124.52 (ie., $1000 in principal amount of notes could be converted to 8 shares) anytime between March 1, 2018 to March 29, 2018 without restriction. Now, there's a special clause where the note holders can convert their notes early under a special condition:
- stock price is greater or equal to $161.88 for 20 days out of a period of 30 consecutive trading days starting from the 3rd quarter this year, then shares could be exercised the following quarter.
(I originally wrote that the trading period was after Sept 30, 2013 but I was incorrect. I've edited this post. See Curt's reply and below conversation.)
Second, I don't think there's even much motivation for Goldman to manipulate the stock in any significant way. Let me explain.
The total 660m note amount equals about 5.3m shares eventually when converted. First, let's examine why a note holder might convert to stock early. If they don't convert to stock early, then they get to receive 1.5% annual interest payments from Tesla, and then they can convert to the same amount of shares later. So, if they're like to hold TSLA stock they might as well just keep the note and collect interest while getting the same number of shares in in March 2018 as they would right now. It would be like owning shares and collecting 1.5% interest.
Let's examine why a note holder would want to convert early. Most likely, they'd like to convert early in because they want to take some profit and/or feel unsettled about the high TSLA stock price. So, they might convert to shares and then sell those shares on the open market (there doesn't appear to be any restriction on selling those shares after conversion).
So, the danger is that weak long note holders convert their notes early. That could put downward pressure on the stock price since we would have additional shares on the market. The total potential amount of these shares would be 5.3m shares, which is a sizable amount.
How would this affect the stock price? Well, people would anticipate this in some ways so the stock would likely be slightly depressed in anticipation of people converting their notes to stock and selling them on the open market. So, if TSLA is above $161.88 for 20 trading days out of 30 in a quarter starting this quarter (3rd quarter) then approaching the next quarter we could see downward price pressure on the stock as people anticipate a conversion sell-off (since conversion can take place anytime in the following quarter). However, if the stock goes down in anticipation, it could lessen the % of people who do convert as they might just wait for a better time. Or they might convert and just hold the stock to sell later. Or they could freak out and just sell to take their profits. It could present a buying opportunity IMO depending on the actual scenario that takes place.
Now, let's move on to the issue of Goldman manipulating the stock. The main motivation in doing so would be to prop up the stock price so that it holds above $161.88 so that their clients would be able to convert the notes, sell them on the market and book profits. However, this doesn't seem to be very convincing to me. First, these convertible notes are likely in the hands of hundreds and thousands of customers from various institutions. Goldman brokered the deal, but it doesn't mean that they hold these notes themselves or that their own clients hold a majority of them either. It's likely their clients hold 10-20% of them (this is a guess). In that case we're talking about the possibility of converting 1-2 million shares. That's about $162-324m worth or shares.
But what's the profit potential of trying to manipulate the stock to hold the $161.88 earlier than it might do so on its own? I think it's very minimal. Look at TSLA's chart. It's very likely sooner or later TSLA holds for $161.88 for 20 out of 30 consecutive trading days. There's really no need for Goldman to try to manipulate it to get there. Further, it's very costly to manipulate the stock. They would need to do some massive buying and then hold it (or else it would sink again). I can see them trying to lift the stock of one or two of the days it's $0.50 under the $161.88 level, then they could buy up a few hundred thousand shares and try to lift the stock price. That might be worth it to them. But even 200k shares would cost $32.4 million to lift the stock temporarily $0.50. Now, for Goldman to lift the stock $5, that would take probably hundreds of millions of dollars and that would be just for a temporary lift of $5 (ie., 1 day lift but would go back down the next day or so). For them to artificially lift the stock $5 for a month, that would take probably over a billion dollars IMO (but probably much more). TSLA has just too much liquidity and shares traded for someone to easily manipulate the stock via buying and/or selling.
Further, what would Goldman or Goldman's clients really gain for the chance to convert their notes a few months earlier than what they would naturally be able to do so? Well, they could liquidate about 162-320m in assets (converting 1-2mm shares worth $162 for example). But how much would that really save them? Well, if TSLA drops $15 after that, then they save $15-30m. $15-30m is chump change to these big banks. Why would they go through billions of dollars and try to prop up TSLA stock price by $5-10 dollars to get above the $161.88 price point for 20 out of 30 consecutive trading days, only to gain $15-30m for their clients? Doesn't seem very likely.
I just don't see a lot of motivation for Goldman or for any bank to engage in serious price manipulation via buying to prop up TSLA's share price for the purpose of note conversion. It doesn't make any financial sense. It also doesn't make any sense since they have a very bearish price target set by their lead auto analyst Patrick Archambault.
However, like I mentioned earlier I do see them motivated to prop up the stock by $0.50 if on one or two of the 20 trading days the stock is trading under $161.88 by a bit and they want to see it a bit above that for note conversion. That could make sense. But otherwise, I think it's an error to think Goldman will have a significant role in buying up TSLA's price in the coming months for the sake of note conversion.
Now, there's another misunderstanding some people have and that is with warrants. Tesla issued warrants for 2018 where warrant purchasers could exercise their warrants for TSLA stock at a strike price of $184.48. The warrants are completely different than the convertible notes. The warrants act like an option call for the purchaser. So, think of it like Tesla sold option calls to generate cash. They then used the cash generated from those option calls to buy hedges to offset dilution caused by the note conversion (thus the note conversion doesn't dilute total effective shares). So, in the end it's only the option calls (warrants) that Tesla sold that will dilute shares.
The warrants (ie., acting like option calls) have an expiry date of March 2018. Think of them as March 2018 LEAPs at a strike of $184.48. Tesla sold $50.9 million worth of these warrants (think of each warrant as costing about $25 each for the purchaser, so it would be like giving Tesla $25 for a Mar18 184.48 strike option call). When exercised this will dilute TSLA's shares by 2 million shares.
For the warrants, I don't view early exercise as a big concern or risk. Think of it as if you're in the purchaser's shoes. You bought a Mar18 184.48 option call for $25, and now it's worth a lot more. Why would you want to exercise it early? That would be like exercising a LEAP option call early. Rather than exercising it early, you'd rather just sell it. Thus, I don't foresee many of these warrants to be exercised early and view it as a non-issue for TSLA price action. Further, even to exercise it early TSLA stock price would need to be at least $184.48 + $25 (purchase price) in order just to break even. But at that point, the warrant (ie., option call) is worth way more just to sell it because of the time value and the leverage the warrant brings. My conclusion, the warrants are inconsequential to TSLA's stock price action until maybe after their exercised in March 2018.
So, in conclusion. I think it's highly unlikely that Goldman is doing any significant price manipulation to get the stock over $161.88. If they really wanted to prop the stock, they ought to just raise their price target with an updated analyst report. That would be much easier and a whole lot cheaper. It doesn't make any sense why they would keep their price target so low (ie., under $100) if they really wanted to prop the stock above $161.88.�
Aug 25, 2013
sleepyhead Great post as usual and I agree with everything that you are saying. But...
I find it hard to believe that the stock traded and closed at $161.87 by coincidence; especially after Curt Renz posted that the 30 day period started a few days back. Have you considered that maybe traders/day traders simply trade on rumor and they don't care if it is true or not, just as long as everybody has the same rumor? I am just speculating and have no clue if this is actually happening, just wondering what your thoughts would be on this?�
Aug 25, 2013
Curt Renz That's not the way I read it. Below is the relevant passage regarding the note conversion. The notes can be converted during the fourth quarter this year or a later quarter. The criterion is the price during the the final thirty trading days of the quarter preceding the conversion quarter. For conversion in the fourth quarter, it appears that the trading period to be considered began on August 19 and will end on September 30.
From the 8-K filing mailed to shareholders on May 22:
Prior to the close of business on the business day immediately preceding March 1, 2018, the Notes will be convertible only under the following circumstances: (1) during any calendar quarter commencing after September 30, 2013 (and only during such calendar quarter), if the last reported sale price of the Common Stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the conversion price on each applicable trading day;�
Aug 25, 2013
aznt1217 DaveT great post and analysis of the literature of the convertible note offering. I think the conspiracy theorists may need to take a chill pill. I don't think Goldman was "manipulating" the stock in the way they are saying it.
The way the market is right now is it's extremely volatile and Tesla just magnifies that. I think much of the ebbs and flows of Tesla have been based on algorithmic and technical trading and not so much fundamentals. So to Sleepy's point-- yes Day traders with significant influence can be influencing this and triggering various stops to set off computers in trading which can have a significant effect on the swings. Nobody can really tell you exactly what is happening... it's the market. It used to be more simple...
The only way I can see something like this having an effect is if some fool posts a article about something and then the herd catches on. We all know press outlets are not accurate, but they still hold a significant amount of power over investors who will act on it quickly without full due diligence because time is money. We saw what happened with Goldman. It was a price upgrade, but yet the press called it a downgrade and then it caught fire to other people advising clients and money managers reading it. Algorithmic trading did the rest.�
Aug 25, 2013
ongba DaveT,
A very informative post as always. Are these warrants expiring in 2018 available to individual retail investors? Thanks.�
Aug 25, 2013
StapleGun Great write up DaveT. I've been wondering about the reasoning behind the supposed GS manipulation and couldn't quite figure out what they would have to gain from it.�
Aug 25, 2013
AlMc Ok Dave T and Curt have two different opinions on the start date to allow conversions....I am not skilled in reading these types of financial docs...anyone else got opinion on the exact kick off date for the 20 day price point beginning? Thanks Curt and DaveT.�
Aug 25, 2013
DaveT Hi Curt, it appears you're correct about the start of the trading period for conversion. I read it over more carefully and it does seem that the 20 of 30 consecutive trading days can occur in the quarter preceding the 4th quarter 2013, so that means in Q3 which we're currently in.
But it also appears that all 20 trading days at $161.88 or higher need to happen in the same quarter ("period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter").
So, for 3rd quarter we now have 26 trading days left until end of Sep 30th. So, that means TSLA would need to close at $161.88 for 20 of those remaining 26 trading days in order for people who hold the convertible notes to be able to convert them to shares in the 4th quarter.
I'd love to hear your opinion on what might motivate Goldman to prop up the stock when 1-2mm shares (ie., if Goldman clients held 1-2mm shares out of 5.3m possible) converted early might save maybe $15/share if TSLA dropped by that much later (ie., after conversion) and that's only $15-30 million. I'm not seeing a clear motivation to do a massively costly price prop up on a very liquid and high volume stock like TSLA.
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I'm thinking traders don't really care about a $161.88 price support rumor... unless we see it over the next several days be at around that level and "magically" lifted up to $161.88 or a bit higher. It's kind of like pinning on options expiration date, and that's usually done by the call writers to minimize loss/exposure. But what I'm questioning is Goldman's motivation on following through with a massive $161.88 pinning operation for every day that it's under that amount. It would appear to be very costly, and I'm not seeing the profit gain to justify it. Unless, of course, I'm missing something... which I definitely could be.
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Not sure. Would love for someone to find out though. I did call a couple banks (ie., Morgan Stanley, etc) the day after the secondary closed to inquire about the 2018 warrants but they didn't have info on them at that time.�
Aug 25, 2013
Curt Renz I'm pleased that you concur, Dave. Since there will be no trading on Labor Day, there are actually 25 remaining trading days this quarter. To be precise the criterion is for the price to close at or above $161.880806.
I never said that Goldman Sachs would prop up the price - only that it might be advantageous to convert if the conditions of the contract were met. I stated the facts and left it to others to draw their conclusions.
Let's not forget that Goldman Sachs sold some or perhaps all of the notes to its clients that may have largely been institutional.
If you would like my conjecture as to why Goldman Sachs and/or its clients would convert, it would be to quickly make a better than 30% profit by converting the notes to shares and perhaps selling the shares as soon that can reasonably be accomplished. If they sold the shares quickly, that would be out of concern of a coming drop in price. If they were confident of a further price rise, they may not be so quick to sell the shares.
If you would like my conjecture as to why they might want to prop up the price now, it would be because of the time value of taking a set profit (which may never be realized) sooner rather than later.
Will they actually do this? I don't know. But it will be interesting to try to read the tea leaves during the next few weeks.�
Aug 26, 2013
Lessmog Hi guys, thank you all (and I mean all) for sharing your views! I could never hope to find this much information on my own.
As to who is buying or selling, we just don't know. The same is true of their motives and motivation. So we can only guess, trying to interpret what we do know to fit some model or theory and always being prepared to adjust to new facts (or ideas).
Looking at the TSLA chart for Friday, it seems for much of the day it was no more than 50 cents away from the magic number, so if a resourceful trader really wanted to they could ease the price towards that level without spending very much, and trusting volatility they could be confident to sell back the next day with little or no loss.
As Curt points out, it might be a strategic move to grab an opportunity to keep a door open by not letting the number of remaining days of Q3 run out below those 20 over magic number and keep their options alive to execute early rather than having to wait much longer. I can understand that.
What I don't understand is why anyone would spend money to lock the closing price exactly 1 cent below (or, considering the rounding error Curt confirmed, more like 1.1 cents) when it had been below already. Because it certainly appears to me that a lot of trading went on to try and nail the closing at 161.87 -- only it occurred two seconds late! At 16.00.00 the volume was only 704 shares but at 16.00.02 it was in the hundred thousands; I saw one trade of over 129k among numerous smaller ones.
And that is the other anomaly I see. I wonder if the system clock was running fast after Nasdaq's great glitch Thursday?
I think what happened at closing Friday was very strange. (I commented before, in my first post here: Short-Term TSLA Price Movements - Page 701 and I did file a complaint with SEC.)�
Aug 26, 2013
Lessmog Sorry, I tried to link to my own post in another thread not noticing I don't have html priviledges. So I will be quiet now.�
Aug 26, 2013
uselesslogin Thank you so much for the writeup DaveT. It isn't until you explained it that I actually understood the full plan.�
Aug 26, 2013
gregincal Even if somebody wanted to cash in, couldn't they just sell the notes? Since the notes are worth stock + dividend payment, you should be able to get more for them than the basic stock. However, I could see if the notes were convertible in a quarter and at the end of the quarter the stock price had dropped and they wouldn't be convertible in the following quarter there could be an reason to convert and sell.
That's assuming I'm understanding things correctly.�
Aug 26, 2013
DaveT That's a good point. The convertible notes aren't expiring worthless at any time, and they can be sold to others (to my understanding). So, if people wanted to exit TSLA out of fear of a looming stock price drop, it's likely they could just sell the convertible notes to another party arranged through their brokerage.�
Aug 27, 2013
vgrinshpun Another possible reason to convert notes to shares is that a shareholder can hold shares long term, while engaging in leveraging the newly obtained TSLA position in order to accumulate more shares trading within the support-resistance lines. I would welcome any comments, but it seems that employing this strategy is impossible while holding the notes.
The above strategy would not result in selling off shares soon after the conversion.�
Aug 27, 2013
sub
Curt, can you explain to me the part I've highlighted? It seems we are not in that period since this quarter did not commence after Sept 30th?�
Aug 27, 2013
Zaxxon sub, I believe that is saying that the quarter of conversion must commence after 9/30/2013, but the quarter where the sale price criterion are measured begins in the quarter prior to conversion.
In other words, the notes can't be converted until next quarter, but eligibility next quarter is determined by performance this quarter.�
Aug 27, 2013
Curt Renz Zaxxon explained it very well. The trick was to read the rest of the sentence beyond your red highlighting.�
Aug 27, 2013
sub Ok got it now, sorry. I read it a few times and it wasn't computing. Carry on.�
Aug 27, 2013
gregincal I found this snippet on the web:
"Never convert a convertible� (convertible bond or convertible preferred stock) is a Wall Street adage that is usually attirbuted to Benjamin Graham (1894-1976), author of Security Analysis (1934) and The Intelligent Investor (1950). It�s not clear that the exact wording can be found in either book, although both books explain convertibles�an investment vehicle that Graham did not particularly like.
The theory behind �never convert a convertible� is that the option to convert to common stock shares is usually worth more than actually doing so.�
Aug 27, 2013
Curt Renz In the case at hand the right to convert is not perpetual. It is only during quarters in which the conversion criteria were met toward the end of the previous quarter. It's possible that conversion will be permissible during the fourth quarter this year but not during the first quarter next year.�
Aug 27, 2013
Bgarret If the criteria for conversion is met in this period, and the note holders convert their notes to stock - didn't TESLA essentially remove $600 million + debt from their balance sheet, or, in other words complete a non-dilutive secondary offering at an effective $124/share cost, but potentially offset any potential dilution by warrants and options to protect shareholder value? Would that be equivalent to about $5/share in shareholder value ($600 million/118 million shares) or the equivalent of 2-3 years of expected earnings?
Tesla could potentially enter 2012 with approx. $500 million in debt, $225 million in cash and a negative EPS of more than -$2.00/ share and exit the year with no debt, $750 million in cash, $1.00+/share EPS. I could refer to the balance sheets for more accurate numbers, but isn't that about a $1.0 billion increase in shareholder value for essentially a roughly 3.0 million share dilution/secondary offering?
Am I missing something?�
Aug 28, 2013
gregincal That's sort of the point of this discussion. The key point is whether the note holders convert. I don't see why they should let Tesla off the hook for paying them.
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I did note that in my previous post. People will know for sure whether they will be convertible the following quarter right at the end of the quarter, so I assume that will be the point when they would be converted, if at all.�
Aug 28, 2013
sleepyhead I haven't really done that much research on this topic, because it is immaterial in my opinion, so could you please answer this:
Even if your scenario comes to fruition that they are able to convert in Q4, but not Q1, they will still be able to convert for a full year beginning in Q2 of next year no matter what, right?
The second reason I don't see anyone in a hurry to convert these shares is because the people/funds who bought these shares most likely already hold TSLA, so they can sell of those shares instead of converting to sell.
And third as somebody already mentioned you will get more money on the market by selling your convertible bond than converting it and selling the shares.
This issue is somewhat irrelevant in my opinion, and you shouldn't base your trading off this. The only way it becomes relevant imo is if everything starts believing that it is relevant, which would be illogical but not unlikely.�
Aug 28, 2013
Bgarret I've seen Sleepyhead, Greg and Kevin discuss holding the notes as being more financially advantageous than converting. How? The notes are for 1.5% interest until 2018, or 7.5% total interest (whether simple or compounded) over 5 years. The shares are convertible at 124 theoretically in September and immediately saleable for a profit of over 30% a 4 month holding period. I would guess most of the notes are held by large investors/institutions & hedge funds who are more interested in realizing a 30% return over 4 months or an annualized return of 120% than holding notes at 1.5% (or below nominal inflation) for 5 years - the definition of dead money. They may be able to convert later...but why wait - to collect interest? 1.5% is now a full percent lower than you can get for a 10yr Treasury note. A 120% annualized return on $100 million invested will get you a bonus, a 1.5% return every year for 5 years will get you fired.
I believe they will convert if they are able - I'm not convinced they will sell all the shares on conversion.�
Aug 28, 2013
gregincal Converting and not selling the shares would be really silly. You are still sitting on the money, and now the money is earning zero interest. And instead of converting and selling, you can make more money just selling the notes. Converting always ends up getting you less money, so why convert? Once they are convertible, the value of the notes should track the stock except be worth a little more, so I can't see why anybody would want to destroy the extra value by actually converting them. If they are in danger of reverting to non-convertible I'm not so sure what happens.�
Aug 28, 2013
sleepyhead If you could convert the note today and sell the stock, lets say that you will get $1400 for the stock. But if you sold the note, you would get $1420 instead. So why would you convert and sell when you can simply sell the note for more (numbers are made up by me). The note is worth more than the stock itself, because the note has that same stock but also allows you collect interest at 1.5%.�
Aug 28, 2013
Bgarret Greg, thanks for the clarification, but from my reading of Curt's posting of the 8k, the notes are only convertible IF the criteria of 20 out of 30 days is met AND (only during such calendar quarter).
If 161.88 for 20 of 30 is met, I don't think the notes are convertible in perpetuity until March 1, 2018, but only during the calendar quarter...so I'm back to 30+% in 4 months or the potential for 7.5% in 5 years or hopin for another quarter that meets the criteria from the 8k.
If I am reading this right there are reasons to convert because of interest rates, the time value of money, risk of being unable to convert until March of 2018....or ever.
I would appreciate your feedback.�
Aug 28, 2013
sleepyhead Edit: I guess it is March 2018 and not 2014, so the notes will not be convertible automatically beginning in Q2 to answer my own question.
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I still think that the notes are worth more than converting them, because you will always find someone willing to buy TSLA with a plan to hold for a minimum of 5 years. Such an investor will gladly take the notes off your hands to collect interest knowing that he doesn't plan on selling the stock until 2018 at the earliest. That is why they will always have a premium to them.
Heck, I will gladly buy the notes myself and I will pay a 1% premium to the intrinsic value of the underlying shares associated with the note.�
Aug 28, 2013
gregincal Also note there is never an uncertain risk of the shares becoming non convertible. In any quarter where you can convert, you can convert until the last day of the quarter. At that stage you will know absolutely whether the shares will be convertible in the following quarter or not. I do think as sleepyhead says that there is a chance the notes will still be worth more than converting, but I'm less certain in that case. However, that case would only be if the shares became convertible and the next quarter they would not be (and the stock was still over the conversion price).�
Aug 28, 2013
Bgarret Thanks for the input, and I would agree with those of us on this board being willing to take a portion of the convertible notes and holding them for 5 years at a conversion price of $124 and getting a little interest along the way...but how much? It is an illiquid market as these are not in $10,000 and $20,000 tranches. This is a game for institutions, and I'm not convinced that institutions are as sanguine about the 5yr probability of success for a startup, EV technology, auto manufacturer as we are. I'd like to lay out some scenarios/ideas for a hypothetical $6.6 million investment and see what you think:
1. The conversion criteria (20/30 at 161.88+) is not met in Aug/Sept of 2013....moot point, bonds stay in place and holders collect 1.5% interest. If TESLA never meets the conversion criteria the $6.6 million bondholder makes $495,000.00 on their $6.6 million over 5 years.
2. The conversion criteria is met and bond holders keep the bonds and collect the interest until March of 2018, then convert at the stock price in March 2018. Tesla keeps the liability on their books until 2018 and:
a) The stock price is 167 - same as today. The bondholders get $495,000 in interest over 5 years and their shares are worth $8,851,590 for a total gain of about $2,750,000...or 41% over 5 years or just over 8%/yr. (8% not being too sexy for a 5yr ROR)
b) The stock price is less than 167 - The bondholders get $495,000 interest over 5 years and their shares are worth less than they were 4.5 years ago. If they want to sell their bonds at any time, they need to find another institution/individual to purchase their investment.
c). The stock price is greater than 167 - the bondholder get $495,000 interest over 5 years and 53,000 (# of shares) x difference in stock price.
3. The bondholders exercise the conversion option and get 8.0306 shares at $124.52 strike price, and TESLA removes $600 million+ from its balance sheet and:
a.) They sell the shares immediately and realize about $2,750,000 in gain for a 5 month investment for an annualized ROR of about 100% (pretty sexy).
b.) They hold their shares for 5 years and sell them at whatever the price is in March 2018 and receive $495,000 less than if they had exercised their conversion option in September of 2013....but they also could sell them anytime into an extremely (11 million shares/day) market, based on when they thought was the best timing.
While this is hyperbole, I believe many of the hedge fund guys would sell their own sisters into bondage to make 1.5% on a deal....but not 1.5%/year, with restricted liquidity. Bond interest of $495,000 is their bar bill at the club - and they would prefer to go in and out, hedge, etc. with their money rather than have it tied up for 5 years in a startup, EV, auto company's bonds. I think it is more likely that they are hoping for a 100% or greater short-term return to help their (really poor ytd) stats to keep attracting new money, but also on the chance that removing $600 million from TESLA's balance sheet might spur the stock to even higher levels, further amplifying their short-term return (either through short-squeeze, people/institutions wanting a company with rapidly increasing earnings, no debt and ample cash and a history of a 1 year 1000% increase in shareholder equity). In comparison, Netflix at $283 looks sad with $3.3 billion in debt, (-$576 million) in tangible assets and similar forward P.E. at $1.49 for this year and $3.30 for next year.
Sorry about the length, but I would value your opinions. I don't think this is a conspiracy, but I think this particular convertible offering, with its warrants and non-dilutive nature and low bond interest rates is designed as a elegant secondary offering and, if completed, could cause another run...but at the cost of stock/options, I am less interested in being on the wrong side of the trade.
I've enjoyed the back and forth, and would appreciate your opinions.�
Aug 28, 2013
gregincal The ability of note holders to easily trade them is definitely something I don't have any insight into. If these were freely traded TSLA-B shares or something, I think it would be clearer. Here's what the prospectus has to say:
The notes are new securities and there is currently no established market for the notes. Accordingly, we cannot assure you as to the development or liquidity of any market for the notes. The underwriters have advised us that they currently intend to make a market in the notes. However, they are not obligated to do so, and they may discontinue any market making with respect to the notes without notice. We do not intend to apply for a listing of the notes on any securities exchange or any automated dealer quotation system.�
Aug 29, 2013
DonPedro I admit I didn't read every single word in this conversation, but i believe converting early would be a bad decision. The convertible should be more valuable than the stock, because it has downside protection.
If you convert, then you get today's share price for every $124.52 of principal. You could do better by writing a $124.52 call expiring in March 2018. You would then get the value of that call today + the principal of the loan + 1,5% interest (the two latter cash flows discounted).
I am aware that there are no standardized contracts such as this, but an institutional could synthesize them or write a custom contract.
UPDATE:
I did some math. A $100,000 principal, if converted at $166, pays $133,320.
Alternatively, the holder writes 803 $124.51, March 2018 calls. Each call yields $105.47 (assuming 4.5 years to maturity, 3% risk free rate and 70% annualized volatility). His cash flow is then:
Today: $84,708
Each year to maturity: $1,500
At maturity: $100,000*
Discounting by 3% gives a net present value of $180,887.
You would be quite foolish to exercise.
This calculation disregards credit risk, but buyers of the convertible were clearly not worried about that in May, so why would they be worried now. Besides, the yield of not converting is far beyond what you could get on the worst junk bond.
* You either get $100,000 from Tesla returning the principal (if the share price in March 2018 is below $124.51). Alternatively you convert, and then hand all the shares off to they guy exercising the calls you sold. You then get paid $100,000 for the shares.
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Oh, and by the way, if someone exercises now, then Tesla can exercise their options with Goldman. Effectively, they would be issuing stock at $161.88 and not at $124.51. That is not a dilution I would feel bad about at the moment - if they can raise cash at that valuation I am quite happy as a shareholder.�
Sep 2, 2013
HongKongFan
The bond is freely traded. Please check the following link for the TESLA corporate bond details: Bonds Detail
and the following link for the historical trade activity: Bond Trade Activity Search Results�
Sep 3, 2013
gregincal Ok, there you go. Currently trading at 155 and you would get .8 of a regular share per share, which would be worth 138.�
Sep 3, 2013
DaveT That's cool to see the bonds being freely traded. This means there's even less motivation to manipulate the stock price to try to convert the bonds to stock.
I wish I could find the 2018 warrants as freely traded. Anyone have any info on this?�
Sep 9, 2013
Curt Renz It's the warrants that are best not exercised until 2018. It is desirable for the note holders that they meet the conversion criteria ASAP.�
Sep 9, 2013
Bgarret And that the stock trade not only at 161.88....but the higher the better...�
Sep 9, 2013
sleepyhead I don't see why, could you please elaborate?
The bonds are currently trading at a 10%? premium to the stock price (based on 0.8 shares per bond), so it makes no sense to convert.
Since there is a 10% premium, the price of the bond will not go up by a material amount if you meet the conversion criteria; because it doesn't make sense to convert anyway when you can sell it for more.�
Sep 9, 2013
Mario Kadastik Maybe it's trading at 10% premium because it's anticipating the movement up to continue and well basically acts like a call
Then again, if there is liquidity I'd just sell with 10% premium and buy 10% more common stock on open market, so indeed...�
Sep 9, 2013
Curt Renz The conversion rate is 8.0306 common shares per $1000 note. The notes were sold at a price equivalent to common shares at $124.52. They were selling at a premium based on the share price having risen nicely above the conversion criterion of $161.88. If the share price falls, or even worse if it appears that conversion will be unlikely, look for the note price to fall. If the conversion criteria are met this month, note holders will have the next three months to decide if conversion is beneficial. There is value in being able to make that decision at any time during the coming quarter while the share price is continuously being monitored. Hence note holders would deem it desirable to see the conversion criteria met this month.�
Sep 9, 2013
sleepyhead I still don't think that it is beneficial unless there is no liquidity in the bonds (and I think the DaveT agrees with me?).
The bonds last traded at $146.88:
http://finra-markets.morningstar.com/BondCenter/BondDetail.jsp?ticker=C593595&symbol=TSLA4007901
Each bond converts into 0.80306 common shares and TSLA was at $162. Therefore:
$162 * 0.80306 = $130.10, which leaves a premium of $16.78 for the bond (more than 10%).
So if you convert your bond it is worth $130.10, but if you sell it on the bond market you will get $146.88.
I still stand by what I said that the ability to convert this bond ASAP is irrelevant to the bondholders (unless there is a serious lack of liquidity in the bond), making the $161.88 price irrelevant.
Note: I used $100 denominated bond from the FINRA website instead of the normal $1,000.�
Sep 9, 2013
Curt Renz A large part of the note value is the "right, but not requirement" to convert at any time of the note holder's choosing during the coming quarter, if the conversion criteria are met this month. If the criteria are met and yet the notes are not immediately converted, those notes will likely become worth more than they are today. If the conversion criteria are not met this month, look for the premium to decline.�
Sep 9, 2013
Toolie What's gong to happen if it closes below 161.88? Does this reset the 20/30?�
Sep 9, 2013
Curt Renz No, the 30 days must be consecutive but the 20 days need not be. The 30 days are the trading days from August 19 through September 30. For the conversion criterion to be met, the share price must close above $161.88 for any 20 of those 30 days. Prior to today that has happened 9 times.�
Sep 9, 2013
DaveT
The note is already liquid and openly traded, so thus this reduces any significant value achieved in early conversion.
The value of converting the notes in the coming quarter is liquidity, and that would be a significant value if these notes weren't liquid. But since they're openly traded, this achieves liquidity already and there's no need or real value to have the right to convert these notes early.
The value in the notes is threefold IMO:
1. Note holders get 1.5% interest for the next 5 years.
2. Note holders are guaranteed as long as Tesla is still around to get their original investment amount (ie., $1000/note) at the end of the note holding period. This offers downside protection that regular shareholders don't have (ie., if stock is $30 in 2018, note holders will still get their full $1000/note back).
3. Note holders have access to the full upside potential of the stock rising as they are able to convert the notes into stock (8 shares for every $1000 bond/note) at the end of the note holding period, in 2018 (or earlier if they choose to and the stock meets the early conversion criteria).
However, exercising the notes early the note holder would lose out on the benefits of #1 and #2. And those are significant benefits. Add to this the liquidity already achieved because these notes are openly traded, and you really have no reason to convert early.
It's like controlling shares with added yearly interest income and built-in downside protection. In other words, these notes likely aren't going to be converted until 2018 and being able to convert early (ie., next quarter) doesn't add value to these notes because an early conversion actually reduces the value of the notes (removes the 1.5% yearly interest income and downside protection benefits).
As to possible stock price manipulation above $161.88 that some people are talking about. Again, this makes no sense at all.
First, these notes are openly traded and are likely in the hands of thousands of people and institutions. A coordinated stock price manipulation effort would be just too difficult to pull off.
Second, significant stock price manipulation would be just too costly. It would likely run in the several hundreds of millions of dollars to manipulate a stock like TSLA (that has high volume) for a significant period.
Third, as I explained earlier there really is no motivation for note holders to have the right to exercise early. The benefit of the notes don't lie in early conversion but rather in the threefold value shared above (1.5% yearly interest, downside protection, right to full upside potential). If the notes weren't openly traded, there might be some value in liquidity achieved via early conversion, but since the notes are openly traded even that benefit in nullified.
Put yourself in the shoes of a note holder. You spent $1000 for a note that gives you 1) 1.5% yearly interest until 2018, 2) downside protection to get your full $1000 back in 2018 as long as Tesla is still around, and 3) right to convert to 8 shares in 2018 if you want thus exposing you to full upside potential over the next 5 years. And add on top of this, you can sell your note at any time because it's openly traded. So, if you're a note holder why would you want the right to convert the notes as early as next quarter? Or how much would you pay to have that right to convert the notes as early as next quarter? IMO the note holder has no interest in converting early (thus removing interest income and downside protection benefits), and wouldn't pay anything for the right to convert early. They already can sell the note in the open market, so there's really no added benefit gained for early conversion.
So if the note holders receive no tangible benefit for the right to convert the notes as early as next quarter, I see no basis for the $161.88 stock manipulation conspiracy.
I actually have a lot more thoughts on this, but I'll stop here for now. I'd love to hear your feedback if I'm missing something.�
Sep 9, 2013
Theshadows I have a question Dave, how can I buy one (or more) of these notes?�
Sep 9, 2013
DaveT You can call and ask your broker. Just give them the info from here: Bonds Detail .�
Sep 9, 2013
Lessmog DaveT, I think maybe I understand what you are saying, and I think maybe I agree with you. But I still do find very strange the heavy trading last-second-plus-two the other Friday at $161.87, exactly one penny below that magic $161.88 mark.
I guess what is wrong with this picture could be simply - that some entity's trading strategy makes no sense at all. Just as you said.
After all, why would it make any financial sense for Market Matadors to donate billion upon billion to the company and stock holders by shorting TSLA? Yet this behavior persists, or so it appears. So let's grab a spoon and munch the manna while it rains from the sky.�
Sep 9, 2013
sleepyhead Thanks Dave for this write-up; I am glad someone agrees with me that the ability to convert these notes early is virtually worthless.
As far as TSLA closing at $161.87 a couple of weeks ago: This was a new all time high and there was (obviously) no resistance left for the shorts to hold the stock from going up a lot higher. Therefore, they used the $161.88 as a new resistance level. The reason why they might have thought it was a significant number is that two weeks ago there was a lot of misinformation (especially on TMC) about the significance of this $161.88 conversion price.
And even though there is no significance to this $161.88 conversion price according to DaveT and myself, there are still many intelligent people such as Curt Renz that believe it is significant.�
Sep 9, 2013
Lessmog Ahh. Thanks, Sleepy, now I can finally rest my weary head and go to bed: Clarity grows.
(Late night here.)�
Sep 9, 2013
Curt Renz Apparently my point has been missed. The criteria that would allow a note holder to decide to convert earlier rather than later has value. They were among the conditions that made the notes attractive to the original investors. Otherwise, why include them? Meanwhile, 1.5% annual interest is inconsequential relative to a stock that vacillates that much almost hourly, while superior fixed income investments exist with less risk. In the case of Tesla Motors, there are many people who doubt its survival to 2018. We may not be among them, but they exist. The ability to convert the notes to shares at what might be a high point next quarter rather than at a later quarter increases the value of the notes. As I've said before, I'm not arguing that anyone is manipulating the stock to meet the conversion criteria, but rather stating the facts and leaving it to others to judge their ramifications. The mere perception that manipulation is possible could affect the decisions of some players in the market.�
Sep 9, 2013
hershey101 Hey DaveT,
I understand what you are saying, but I asked the same question back in August (Post #5017, Wow that's many pages ago on this thread!) and this is what deonb had to say:
"Takes the risk out of it and frees the money back up for other investments. Converting at $168 in September gives them a much better ROI than converting at $200 in 2017"?
That to me makes perfect sense. While I think that the risk of default is very close to 0% at this point, he does have a good point. Converting right now to shares, and then selling those shares frees up hundreds of millions of dollars that can be invested elsewhere. A yearly ROI of 1.5% isn't very appealing to anyone.�
Sep 9, 2013
sleepyhead I think that you completely missed Dave's point, which is that you will get a lot more money if you sold them instead of converting them. If you converted them today you would have gotten $130, while you could have sold them for $146.
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There was some strong support today at $158.50. It hit that level twice (or three times, depending on how you look at it) during regular trading hours, and then one more time in AH trading.
Each time the stock rebounded from that level.�
Sep 9, 2013
Curt Renz They can't be converted today. However, next quarter the unconverted notes would likely be more valuable, if the conversion criteria are met this month rather than if they are not.�
Sep 9, 2013
DaveT I disagree. I think the early conversion criteria was included in the note offering to add liquidity to the convertible notes. The early conversion criteria and liquidity provided with it has real value only in the case where the notes are not liquid (ie., they're not openly traded). However, if the notes become openly traded then the value of early conversion becomes trivial, if any. This is because the notes are already liquid (and at a premium), and it no longer makes sense to early convert the notes for liquidity because by doing so the note holder would actually lose value of the note (the inherent value provided by the combination of the income interest, downside protection, and full upside potential). Converting a note early would be similar in some ways to exercising an 2018 option 5 years early (ie., by exercising the option 5 years early, the person would lose the huge option time premium inherent in the option). In a similar way, converting the note early would not financial sense because upon conversion the note gets converted to shares ($1000 note converts to 8 shares) but that value is less than the value that they could receive on the open market for the convertible notes. Because on the open market, there is a premium attached to the convertible notes because of it's added value (interest income, downside protection, full upside potential).
I would say 1.5% is actually significant because it's added onto the note's other benefits of downside protection and full upside potential. Put all this together and the notes are very attractive. This is why the notes carry a premium when bought/sold (over just their conversion value).
This is an issue of liquidity. If the notes weren't openly traded and thus illiquid, then yes, having the ability to convert the notes next quarter would increase the value of the notes. But as it stands, the notes are liquid assets openly traded and that carry a premium over just their conversion value. Thus, it's a much better deal for the note holder to sell their note (they'll get conversion value plus premium for interest, downside protection) rather than convert the note early. This is why early conversion doesn't add any real value to the note. Because liquidity is already achieved in the open market, and the liquidity in the open market is much more lucrative for the notes because it allows for the inherent value of the notes outside of just their conversion value to fetch monetary value.
Thus, if a note holder is doubtful of Tesla's future (ie., thinks it's overvalued), then it's much better to sell the note in the open market and receive the notes conversion value plus premium attached (for its added benefits).
Exactly. And this will apply even after the early conversion criteria is met.
Even if the conversion criteria is met and note holders are able to convert, the value they receive via early conversion is significantly lower than just selling the note in the open market.
You're assuming that meeting conversion criteria will increase the value of the notes. And I'm saying that there's no reason why it would since the notes are already liquid and liquid in a much more valuable way than conversion. There might be a bit of added value for the extra liquidity achieved for early conversion but I would imagine this to be trivial, if any. This depends on how liquid the notes are already in the open market. If the notes are very liquid already, then the extra value of early conversion liquidity will be next to nothing. But if the notes are not very liquid in the open market, then having added liquidity from an early conversion option could add some trivial value to the note. But again, I don't think it would be significant since the open market value would be much greater. Thus whatever extra liquidity the early conversion option would provide would be negated by the extreme discount the note holder would take when converting early vs selling the note in the open market (even if the open market was sparsely traded).
Early conversion will net significantly lower amount than just selling on the open market. Deonb's point was the early conversion could offer liquidity. But since we found out the notes are openly traded, liquidity is already achieved, and this liquidity is much better than conversion liquidity which only nets your conversion value and you lose all the other value of the notes. Selling the notes in the open market gets you the true value of the notes which will be the highest price possible.�
Sep 9, 2013
sleepyhead Curt, I will concede that there is some extremely minimal value to being able to convert these bonds next quarter if the criteria are met, but I would say that it is immaterial.
What I was saying is that the bond traded today at $146, which allowed you the potential to convert to common shares worth $130.
What you are saying is that if the criteria are met then next quarter then using my example:
The bond will trade at something more than $146, while still allowing you to only convert to $130 worth of shares (assuming TSLA stock stays exactly the same). Now if you want to tell me that the bond will now be worth $146.06, then I might agree with you (i.e. immaterial amount). But there is no reason why this bond will be worth a lot more, such as $150 since the underlying shares are still only worth $130.
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The reason that there was an early conversion clause in the contract, was because there was a real risk that these bonds would not be liquid and/or easily traded (as stated in prospectus) and therefore the clause was added.
Now that these bonds are easily traded this clause virtually becomes worthless.�
Sep 9, 2013
Curt Renz The 1.5% feature of the notes declines significantly in value in a rising interest rate environment. If the conversion criteria are met this month, then next quarter a note holder will find more receptive potential buyers if they have the option to convert at anytime during the quarter. That increases the price they might be willing to pay. If the share price were to eventually enter a prolonged decline, it's conceivable that next quarter would be the only quarter in which the conversion option is available until 2018. For all anyone knows, in 2018 the shares could be worth $38, which is more than I paid seven months ago. In the meantime the liquidity for the notes could dry up. Premiums could evaporate. It's quite possible that the shares could peak next quarter and begin a decline that would motivate conversion and quick sale of the new shares, especially if the notes lose their added premium. The right to do that has value. Right now it is uncertain if note holders will have that right next quarter. If that right becomes guaranteed, then that should increase the value of the notes, at least during that quarter.�
Sep 9, 2013
DaveT Actually most of the note premium is made up of the downside protection along with full upside potential. This is why the note carries a nice premium over plain conversion and over non-convertible issues.
The notes are senior debt, so they are paid off first before anything else. Common shareholders can be wiped out but the convertible note holders are holders of senior debt, and are obligated to receive their $1000 per note in 2018 unless Tesla has gone bankrupt (and even in that case the note holders are first in line to receive payment for liquidation of factory, etc).
When the stock was $92 (at the secondary offering) the note holders could have just bought common stock instead of the notes. But they paid an equivalent of $125/share ($1000 for a convertible note that could convert to 8 shares). This is a $33 (36%) premium they paid over just buying common stock.
The reason they were willing to pay the 36% premium over just buying common stock was largely because of the downside protection the convertible notes offered. Whether the stock was at $1 or $50 in 2018, they would still get their $1000 per note back from Tesla (or an equivalent of $125/share). So any downside under $125 is protected. They have zero loss if the stock is under $125 in 2018. This is of course Tesla remains solvent (but even if Tesla is insolvent note holders would be first in line still). So, it's more like if the stock is $1 or $124 in 2018, it doesn't matter the note holders will still get $125/share (or $1000 back).
This is great downside protection and something common stock can't provide.
It's kind of like buying a built-in put of sorts. This is the main reason the note holders paid a 36% premium over just buying common stock.
The other reason for the premium is that while the notes provide great downside protection under $125/share, the notes expose the note holder to the full upside potential of the stock above $125/share. In this manner, the note (purchased for $1000) acts like 8 common shares. If the common stock is $1000/share in 2018, the note holders realize the full gain from the stock rise (from $125 to $1000) when they convert their note to common shares. They'll have 8 common shares per $1000 note, so if each common stock share is worth $1000 in 2018 then their 8 commons shares will be worth $8000.
So, it's like buying stock at $125/share (when the common share price is $92/share) because your stock has full upside potential of stock but comes with almost full downside protection under $125/share. This is worth a lot to some people, thus the 36% premium paid.
The other benefit is that the note holder gets 1.5% annual interest. This is in addition to the full upside potential and almost full downside protection under $125/share.
Combine these three factors, and the notes are very attractive and it's no wonder that Tesla was oversubscribed in the secondary offering, and it's no wonder why people paid an equivalent of $125/share for these benefits while the common stock was trading at $92.
Now, fast forward to today, and the stock is around $160 or so.
The note still has the three main benefits: almost full downside protection under $125/share, full upside potential over $125/share, and 1.5% annual interest.
This is the reason why the notes fetch a premium in the open market.
If the note holder chooses to convert these notes early (ie., if conversion criteria is met) then the note holder is only realizing the conversion value (ie., value of 8 common shares for each $1000 note) and immediately loses the other inherent value factors of the note (especially downside protection).
Sleepy noted an example if you converted the note to stock (if it was possible today) you would get $130/share. This is the conversion value. However, on the open market the note is trading for $146/share. This is because the note has the added value I mentioned above.
Now, what happens when the early conversion criteria is met and the note holders can convert the notes early. Does this add any value to the note itself? I would say no.
The reason being is because by converting early you lose all the inherent downside risk protection that the convertible note provides. This downside risk protection is the main reason why the note is bought/sold with a premium in the open market. According to the example Sleepy brought up people are paying a 12% premium for note over common stock. The reason for this 12% premium is because the note holder is protected from almost all downside risk under $125/share. It's like having a built in put of sorts. This is worth a lot. By converting early, you're throwing away this value. It would be foolish to convert early. If you no longer want to be invested in Tesla as a note holder, it's much better to sell the note in the open market and get the fair market value for the note (which is conversion value plus note premium which includes downside protection under $125/share, along with some interest). In other words, you'll get 12% more for selling your note in the open market vs early conversion.
Curt, you mentioned how note premiums could evaporate and liquidity dry up if the stock price declines. Actually, threat of stock price decline only makes these notes more attractive because of the stellar downside protection they offer (ie., anything under $125/share is protected). These notes are very attractive and will always carry a premium over common stock because of the extra benefits they offer.
Again, if note holders want to cash out now they can do so by selling the stock in the open market and receive a 12% premium over conversion value.
Lastly, you mention that note premiums could increase if early conversion becomes an option but this is assuming that early conversion is desirable and has value. When early conversion fetches the note holder 12% less than the open market, early conversion has no real value. Thus, having an early conversion option effectively adds no real value to the note premium.�
Sep 9, 2013
Bgarret Sleepyhead and Dave..while I am with Curt and others on this question, the real answer is...it depends - each investor is making different assumptions on different criteria not all purely based on math. Some will hold the bonds, some will sell the bonds...some will convert - based on the nearly infinite variables at work in their lives and investments. There is no right answer, it's what gives us shorts at over $Billlions of losses convinced of the truth of their valuation argument and NYU professors with a sliderule and a valuation, and those of us (much richer now) who believe in Tesla today and likely tomorrow.
I don't think there is a conspiracy, but I think a lot of bondholders will convert to stock and hope the stock appreciates significantly if Tesla is not operating with any debt for very little share dilution. I easily could be way off, but my investments reflect my research and my biases.
Let the market decide.�
Sep 9, 2013
DaveT I think I understand what you're saying, but in this case I think math wins. If you've got an asset that can be sold in two different ways, both in the open market right now. The first way fetches you $8.50. The second way fetches you $10. And they're both identical in terms of when and how you receive the money. You go with the $10 way. Maybe a 1% might choose the $8.50 way but that will because they didn't know about the $10 way.
What sleepy and I are saying is not complicated. It's like owning a 2018 option call and exercising it 5 years early. By doing so you lose the option premium you could have realized if you sold it in the open market. Now if that option premium is significant (ie., more than 10% of the asset), then it makes no sense to exercise a 2018 call five years early. If you wanted to get rid of it, you'd just sell the option call and get a lot more money for it than exercising and selling the shares.�
Sep 9, 2013
hershey101 What happens to the value of the notes if TSLA announces a dividend? Do note holders also get a dividend as if they were normal stock holders? If not, then wouldn't they want to convert so they can get the dividend? Or is it actually like a stock option, whose premiums are adjusted to factor the dividends into the pricing.�
Sep 9, 2013
Bgarret That may be, but you are talking about the "option premium" on September 9th...not what it will be and what will impact it if the conversion criteria is met. I personally have called away stock instead of selling the underlying, more valuable option because of the tax consequences of exercising vs calling away. A fund manager, who is behind for the year and needs short term performance to attract and retain investors may want a short-term paper profit of 30+ percent 70+ percent annualized rather than holding the bond for the duration or trading it if there is a premium on Oct. 1. I don't disagree with your well reasoned and well presented arguments, I am not convinced the numbers you are using are as static as you believe.�
Sep 9, 2013
DaveT If Tesla offers a dividend before 2018, note holders don't get a dividend because they don't officially own common shares. However, their notes convert to shares (1 note to 8 commons shares) in 2018, so then their common shares will be like every other common share with rights to dividends.
However, Elon Musk said in a tweet a few months ago that Tesla won't be offering a dividend for a very long time. My guess is we'll be waiting at least 10-15 years before Tesla offers a dividend.�
Sep 9, 2013
Norbert Here is what I understand from the posts above:
The notes derive their value from 3 components:
1. interest (regardless of stock price)
2. downside protection (regardless of stock price)
3. upside potential due to ability to convert into 8 shares.
1 and 2 are not worth much on their own, as the interest rate of 1.5% isn't exceptional. So the value depends on the convertibility. And the potential gain from convertibility increases if it is possible to take advantage of peaks in the share price that are not preceded by 20 days of > $161.88. When you want to sell the note because you need or want the cash, before the stock price reaches a high value, you can sell the note to someone else who anticipates being able to keep the note until it reaches a very high value. But even that other person will not be able to take advantage of a sudden peak unless it is preceded by 20 days above $161.88. The question is whether that additional ability is worth very much. Is that it?
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Another question I have: Is affecting the stock price by buying or selling shares also potentially a "manipulation", or is that an accepted means of changing the price?
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("Sudden peak" such as a short squeeze...)�
Sep 9, 2013
DaveT There still seems to be confusion around the convertible notes, so I'll try another analogy. I'll leave out details and the analogy won't be perfect but it's to get the idea across.
Buying a convertible note is like buying Super Shares with special powers. So, when the market price for common shares was $92/share, you decided to buy Super Shares for $125/share. The reason you paid the extra money was because of the special powers of Super Shares.
The main power of Super Shares is that it comes with a built-in put (hedge) of sorts. Meaning, if the stock price goes under $125, then you'll still get your full $125 you paid for it. So, if the stock goes to $50 (or even $1) you can still get $125 for each share. That's the main Super Share power. Conversely, if the stock price for shares goes above $125, for example to $500, then your Super Shares can get the full market price of $500. The downside is limited but the upside is not.
The reason you bought Super Shares (and not regular shares) was because you wanted to invest in the company but also didn't want to lose money if things didn't work out. So the Super Shares were perfect because you're guaranteed not to lose the $125/share you put in, and yet you can still realize all the gains above $125/share.
Now Super Shares have their special powers for 5 years, and then they lose their super powers and become regular shares (ie., full exposure to downside).
You can sell your Super Shares at anytime to another person. You'll get what a regular share is worth plus extra for the special powers of a Super Share.
Now, there's another way you can get rid of your Super Shares. You can (if certain criteria is met) convert your Super Shares into regular shares and then sell your regular shares. But by doing this, you don't get any money for the special powers of the Super Shares. (It would be better to just sell your Super Shares to another person and get more money for them.)
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I don't think early conversion ability will affect note premiums much, if at all. The reason being is that the note premium is based on the value of the convertible note which is mainly it's downside risk protection (vs common share).
Liquidity is already achieved through the notes being openly traded, thus added an undesirable liquidity option like early conversion provides no benefit to the note holders.
Now, I'll admit that there might be some added perception benefit that the notes are more liquid and that might increase the note premium, but if so it will likely do so only in a trivial manner (ie., less than 1% of note value) since liquidity is already present and the bulk of the note premium is it's built-in hedge.
I thought about possible tax benefits to early conversion but couldn't think of any, especially because the notes are 5 years in length.
Lastly, for the fund manager wanting to increase his short-term performance, his best bet is to sell the convertible notes (if he wants to) when the stock price is the highest to gain maximum profit, whether it's before or after Oct 1 it doesn't really matter.�
Sep 9, 2013
serkol If conversion criteria is met, nobody takes the downside protection off the notes, unless the notes holder converts the notes and keeps the stock.
I think that the only reason to convert the notes early would be to sell the stock immediately. In this case the note holder gets the cash, and the downside protection does not apply anymore.
What if the note holder believes that TSLA is a bubble and is getting near the peak of its value, and is about to burst? What if he sees the liquidity of the notes drying up?
Having the freedom to convert the notes and immediately sell the stock may be a value for some note holders.�
Sep 9, 2013
Norbert DaveT: However you'll have to convert sooner or later, and it's better to have more options there, for all theoretical possibilities, such as the share price staying below $160 for a long time.�
Sep 9, 2013
DaveT If a note holder wants to exit his TSLA position (ie., thinks its a peak), then it will almost always be better to go to the open market to sell the notes than to convert early and sell regular shares. The reason being is in the open market, the notes will fetch the cost of regular shares plus the premium attached for the downside protection the notes offer. This downside protection is very significant. It's like having a $125 put until 2018. That's worth a lot, and even more in a jittery market. (Note: a Jan15 125 strike put is almost $27 right now. Imagine what a June2018 125 strike put would be worth right now...)
Having the freedom to convert early and immediately sell the stock is of trivial value. It sounds better than it really is. There's already an open market to buy/sell these notes, so liquidity already exists. When you convert and sell the stock immediately you lose all the downside risk protection value of the convertible note, which is a sizable % of the value of the note.
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Yes, you'll have to convert sooner or later, but later is better. It's because you get the under-$125/share downside protection until June 2018 (ie., stock can go to $5/share and you'll still get $125/share) and there are no restrictions on the upside potential. There's no reason to convert sooner than later (at least that I can think of).
If you wanted to sell the notes before 2018, you could do so at anytime on the open market.�
Sep 9, 2013
serkol So do you think that the liquidity of these note will always be very good, and the note holder will never have any problem selling them?
So when Curt writes "In the meantime the liquidity for the notes could dry up. " this is just a fictional assumption?
He also wrote "If the share price were to eventually enter a prolonged decline, it's conceivable that next quarter would be the only quarter in which the conversion option is available until 2018. ... In the meantime the liquidity for the notes could dry up."
I don't know a sh...t about this stuff, so I'm really curious. May there be circumstances, like a prolonged decline of TSLA or something else, that will make it difficult to sell these notes? But it would be easier to convert the notes and immediately sell the stock?�
Sep 9, 2013
Norbert Like a so-called european-style option.�
Sep 9, 2013
DaveT I think liquidity for these convertible notes will be good because of the huge value they have over regular shares. In some ways it's like having a regular share with an attached June2018 125 strike put. Your guaranteed from having any losses if the stock price falls under $125. This is of immense value.
Compare this to just regular common stock which has 100% downside risk potential (ie., you can lose 100% of your investment amount).
If the TSLA's stock price declines, these notes will likely appeal more to people (vs common shares) because of the protection from downside risk.
Now, these convertible notes will lose a lot premium value when the shares increase so high that it's super unlikely TSLA will ever go under $125/share and you don't need that downside risk protection. But up until then, these convertible notes will be a very attractive asset.�
Sep 11, 2013
DonPedro Guys,
This is a question that is thoroughly covered in financial theory. The conversion right is an option - the opportunity for early conversion makes it an American option (as opposed to European).
The two styles are discussed here:Option style - Wikipedia, the free encyclopedia
As you can see, the right to convert early is assumed to have some value, but if you review the criteria which make early conversion profitable you will see that they would apply to this security in only the most obscure circumstances. So for all practical purposes, DaveT and Sleepyhead are right.�
Sep 13, 2013
sleepyhead I hate to say this but these guys in the media are idiots. And I am talking about so called "experts" from Streetinsider and Barrons:
http://blogs.barrons.com/stockstowatchtoday/2013/09/13/tesla-convertible-note-conversion-may-affect-stock-streetinsider/?mod=yahoobarrons
Basically these guys are saying that the note holders are going to convert into common stock, because the stock has stopped moving and a 30% profit in a few months sounds great.
They are clueless, since these notes are publicly traded (and worth more as a whole than converted) and nobody is going to convert until 2018!
I am starting to get very excited about Q3 coming up. I am going to load up on options once again. I can't believe how easy it is to make money on TSLA. Here comes another "Unexpected" earnings beat from Tesla.
I am loving it!�
Sep 13, 2013
Convert2013 I was getting excited too until someone here said that earnings call is not till first week of November, which is almost 2 months from now.. yawwwn..�
Sep 15, 2013
westhouse I can guess a number of reasons why a financial institution would want to convert the notes they own as early as possible.
Suppose you have a large short position on TSLA. After Q1 ER you suddenly realized you made the wrong bet. You can purchase shares from the open market to close your short position, but that will squeeze you to death. Instead you can purchase convertible notes during the offering, then convert them to common stock. Done. Yeah you lose 1.5% per year, but to be able to close the short position? Priceless.
Even if you just want to hold the stock, you can sell covered call options to get yield. It's very likely to be much higher than the 1.5% paid by the note. I'm sure those wall street types can think of many more complex schemes to make money out of holding the stock.�
Sep 15, 2013
DaveT You miss the point that they can just sell the convertible notes in the open market and get the price of a common share + a 5 year put.
In other words, if they needed to close out their short position, they could just sell the notes in the open market and buy shares to cover their short with the money (and they'd end up with more cash than if they'd choose to early convert the notes).�
Sep 15, 2013
Jonathan Hewitt Just let us know when you load up so we can, too�
Sep 15, 2013
westhouse This only works if you have a small position. If someone attempts to buy a large amount of shares on the open market with money, the share price will increase, dramatically. The amount of floating shares of TSLA is very small, and the short ratio is very high.�
Sep 15, 2013
SuryaDham No.
If you hedged your short-position with these bonds you don't have to care if the share price increases dramatically, because you are delta-neutral. Even if you are short 5mm shares and buy them back on the open market and driving up the share price by 100 dollars your bonds will simultaneosly rise up almost the same amount (a little less because the time value decreases with rising market-price of the bond).
Even in your described "large amount"-scenario you are much better off selling the bonds in the open market and buying the stock - maybe in tranches, to be able to better handle the price-changes in both stock and bonds.�
Sep 15, 2013
sleepyhead Your scenario doesn't work for many reasons. One of them being is that if you bought convertibles during the offering, you might have to wait until 2018 to be able to convert them. Another reason is that this move doesn't make any financial sense (explained below).
The bonds are trading at something close to a 12% premium. You would probably have to put in a buy order of 2 to 5 million shares in order to move the stock 12%. To put this into perspective you would have to basically buy all of the convertible notes issued to get that many shares (post conversion).
This has been a heavily debated topic, but there is really no financial reason to convert early unless TSLA starts paying a dividend, which will not happen before 2018 - guaranteed.
The problem is that the market will figure out what is going on in Teslaville sooner or later. The run may start as soon as this week and the stock might reach $190 by the end of the month. Alternatively the stock might fall to the $150's and consolidate there until October (highly unlikely scenario). There could be a piece of bad news that comes out that pushes TSLA to $130. It is impossible to tell what happens short term. LEAPS are a good way to play TSLA, since you will win for sure. If you want to win more, you have to take on more risk (but then risk losing).
I have been buying some Dec TSLA options this past week. I hope that TSLA further consolidates int the $160's this week and I will buy more this week. If it starts going up this week, then I will wait till it hits $185 and construct a delayed bull call spread. Then wait for the next pullback and load up before earnings. If TSLA goes down this week, then it might be the last opportunity to load up before earnings.
Wall St. is always late to the game, but they will figure it out sooner or later. You just never know when it will happen. This happened to me with SPWR. I knew all along it would do very well. So I was buying on the way down from $7 to $5 to $4. My 401K had something like -18% return in 2012 while the S&P was up double digits I believe. I knew that I will be right eventually and every day that SPWR kept going down, I was actually happy and licking my chops to buy more at an even steeper discount. Finally SPWR went up 50% to $6 in a matter of days, so I sold half thinking that I will buy back next week for $4. Then the next day or so it went up to $8 and I sold the rest.
What I failed to realize is that Wall St. finally figured out what I knew all along (for about 6 months) that SPWR is worth a lot more than its valuation indicates. I watched SPWR go up to $13 in a few weeks after that. I could have doubled or tripled my SPWR investment, but instead settled for about a 50% return.
Fortunately I realized my mistake and bought back into SPWR at $12 with the vast majority of my capital and quickly doubled my money. I didn't play options back then.
All I know is that, unless there is a market correction or some bad news from Tesla, TSLA will go above $200 and probably a lot sooner than most people expect. I think it happens some time before the end of the year.
Buying LEAPS is still the best way to play TSLA as far as risk/reward goes. You might make twice as much with shorter term options, but your chance of getting wiped out is probably 5 times bigger. It all depends on your risk tolerance. LEAPS are already very, very risky to begin with.�
Sep 15, 2013
AlMc So Sleepy...Even though this is a short term thread....Your advice to play TSLA with the least amount of risk is buy and hold the actual stock?�
Sep 15, 2013
sleepyhead That is correct. If I had a couple million dollars, I would probably just buy 10,000 shares of TSLA and watch it grow to $10 million. Since I don't, I will try to play with stock options to take advantage of leverage and have the potential for a lot larger gain. This strategy is a lot riskier and you can get wiped out quickly. With LEAPS it is a little less risky, but horrendously bad timing can wipe you out as well. Stock will recover sooner or later as long as the company does well in the future.
Let's say that with stock I will get a 10 bagger. With options I might get a 100 bagger or I might get wiped out. I would say odds are 50/50 and I would gladly take that risk, but many people wouldn't. With Leaps you could probably get a 40 bagger in this situation with a 80/20 chance of succeeding/getting wiped out. These odds are made up by me, but you kind of get the point.
Everyone has to assess their own risk level, but even LEAPS are extremely risky investments because they have an expiration date. Stocks don't expire.�
Sep 22, 2013
hoang51 Just to get this thread some life, it appears that there are potentially six days left to stay above $161.88, for which TSLA needs to stay above for remaining 2 days to get to 20 days out of the 30 consecutive days requirement. TSLA also went past the $184.48 mark but has fallen a bit since then. So at this point, when comes this October (or even after the two remaining days), will GS be back at it with a "downgrade"? TSLA to do another offering since the notes and the warrants were hit real quick?�
Sep 23, 2013
Chickenlittle I am confused over the "hedges to prevent dilution". Anybody know what these are? If bonds not converted do they still operate and reduce number of shares? Are they a buy back?�
Sep 28, 2013
DonPedro Godman sold Tesla a bull call spread (Google it)�
Oct 8, 2013
Bgarret Just wanted to give everyone something to consider regarding the convertible bonds:
In looking back at Hong Kong Fan's link and reviewing the trading of the convertible securities during volatile (downward) movement of the stock a couple things stood out:
1. The Tesla convertible bonds are not trading today in a manner consistent with other drops:
May 28 - June 3 drop from $110 to $92 - there were over 110 trades of 1 million or greater
July 12 - July 16 drop from $129 to $109 - there were over 30 trades of 1 million or greater
August 9 - 14 - drop from $153 to 140 - there were over 79 trades of 1 million or greater
September 5-9 - drop from $169 - $160 - there were over 26 trades of 1 milliion or greater
October 2-3 - drop from $193 to $173 - there were over 47 trades of 1 million or greater
Today - from $185 to $173 - there have currently been 6 trades, 5 of 1 million or greater
There could be a bunch of explanations for this....but it could be a lack of supply because of a number of bond holders that have converted their bonds to common shares and sold them into the market for a rather large short-term profit, while also reducing the debt on Tesla's balance sheet and completing a "shadow" secondary offering. If a good percentage of bond holders convert, TSLA will have gone from:
Dec 2012: -(negative) EPS, $220 million cash, $466 million debt to
Oct 2013: Positive EPS, $746 million cash and ? debt
at a cost of 4.6 million shares of dilution for $1 billion of increase to their balance sheet. With that $746 million, they will announce ???
Thought both supporters and detractors for conversion would be interested.
Updated - theory is probably as bad as data from one day....traded about 20 trades over 1 million today - more like you would expect. C'est la vie - I may be working more on hopium than data.
RG�
Jan 13, 2014
Bgarret This thread languished since the October conversion - but there was some good back and forth between Curt, Sleepy and Dave T about the convertible notes. I wanted to add some additional information and see what people think (while we are waiting for the North American Auto show press conference). The data I am using for comparisons is located here:
The bond is freely traded. Please check the following link for the TESLA corporate bond details: Bonds Detail
and the following link for the historical trade activity: Bond Trade Activity Search Results
Some Data:
Number of transactions for the convertible notes in the 1st 13 days of the month and for a rolling 2 month period:
Average 643 transactions each 2 month period since the bonds were issued.
Convertible Notes Transactions -
Dates
# of Transactions
6/1-6/13
121
7/1-7/13
99
8/1-8/13
335
9/1-9/13
169
10/1-10/13
112
11/1 - 11/13
287
12/1/- 12/13
48
1/1 - 1/13
13
Average of 167 per 13 days
6/1 - 7/30
517
8/1 - 9/30
819
10/1 - 11/30
595
12-1 -1/13
116
As of January 1, 2014, the bonds are no longer convertible until TESLA reaches the stock price requirements again or 2018.
There has been about 10% of normal convertible bond activity since the first of the year and we are on track to have an average of 500 less transactions in December and January than any other 2 month period since the bonds were issued (about an 80% drop in transactions). There could be other explanations, but Occam's Razor tells me that a large number of the bonds converted to stock (most likely to facilitate shorting the stock down from 190) thereby reducing trading activity and that either tomorrow, in an earnings pre-announcement or at earnings, there will be a marked improvement in Tesla's balance sheet, positioning them for investments in Gen III and the battery giga-factory.
Be nice to know. If anyone knows how to confirm...I'm all ears.�
Jan 13, 2014
GenIIIBuyer Bgarret, very interesting dataset. I guess we'll know for sure when Tesla files its next quarterly report how many, if any were converted. Usually, it doesn't make any sense to convert the bond early, as the bond *should* trade at a premium to the convertible stock amount.
However, back when TSLA shares were harder to borrow I could see a convertible arb strategy buying puts, exercising the bond early, and lending out shares. If they could lend out shares for long-term contract and gain more in interest than the puts cost plus the loss from conversion.�
Jan 13, 2014
uselesslogin If that was actually a good strategy what amazing luck for Tesla. I doubt it but will also leave it to others to figure out if that is possible. I know the volume in TSLA equity has also been low in the new year.�
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