Reason for AH TSLA price drop after SCTY offer

[MikeC]

A lot of people attribute the drop in share price to the acquisition being a bad deal for TSLA. Here is my alternate theory:

By offering .122-131 share ratio, TSLA enabled an arbitrage opportunity. The closing prices today for TSLA and SCTY were 219.61 and 21.19, respectivly. This is a ratio of 0.096, which means you would sell TSLA and buy SCTY at that ratio, and have your TSLA returned back to you at .122-.131. You will notice the ratio of the AH closing prices is 0.126, right in the middle of the offer's range.

So TSLA had to go down when SCTY went up.

 

[dakh]

I don't understand the math but more importantly that would also mean that traders see this as a done deal, correct?

Why didn't SCTY go up more and TSLA move less to even out the ratios?

 

[MikeC]

I don't understand the math but more importantly that would also mean that traders see this as a done deal, correct?

Why didn't SCTY go up more and TSLA move less to even out the ratios?

Because the ratio is roughly 1:8 TSLA to SCTY. TSLA dropped about 8x what SCTY gained. I wouldn't say that this would mean that traders see it as a done deal, it's just that since it's the current offer on the table, it's the apparent fair market price.

I'm thinking of it from the standpoint of "Should I sell my SCTY to buy more TSLA"? Since ~.125 share of TSLA will be worth one SCTY share, it will make sense to sell SCTY to buy TSLA whenever the ratio gets higher than that. But I think that the two will stay at the fixed ratio of the terms of the offer.

 

[Waiting4M3]

Because the ratio is roughly 1:8 TSLA to SCTY. TSLA dropped about 8x what SCTY gained.......

If it's 1:8 for TSLA:SCTY, TSLA should move 1/8 of what SCTY is moving, not 8x, right?

 

[ggies07]

But why did you create ANOTHER thread on this topic when there are over 10 pages in the Short-term thread talking about this?.....

 

[MikeC]

If it's 1:8 for TSLA:SCTY, TSLA should move 1/8 of what SCTY is moving, not 8x, right?

I think I made a mistake there. I was thinking that since one share of TSLA is 8x greater, the magnitude of the TSLA price changes will need to be 8x more than SCTY's price changes, in order to keep them at a fixed ratio. I still think that's true, but that doesn't account for TSLA happening to drop about 8x what SCTY gained in AH.

My main point is simply that the offer has established that a share of TSLA is worth 8x what a share of SCTY is worth. I expect that this ratio will persist until the deal is completed.

 

[MikeC]

But why did you create ANOTHER thread on this topic when there are over 10 pages in the Short-term thread talking about this?.....

Because I was interested in feedback on this specific point and didn't want it to get buried in the over 10 pages in the short-term thread about the general issue. This way, only people who are interested in the topic (or looking to complain, I guess) can choose to click on the thread to read it.

 

[SteveG3]

A lot of people attribute the drop in share price to the acquisition being a bad deal for TSLA. Here is my alternate theory:

By offering .122-131 share ratio, TSLA enabled an arbitrage opportunity. The closing prices today for TSLA and SCTY were 219.61 and 21.19, respectivly. This is a ratio of 0.096, which means you would sell TSLA and buy SCTY at that ratio, and have your TSLA returned back to you at .122-.131. You will notice the ratio of the AH closing prices is 0.126, right in the middle of the offer's range.

So TSLA had to go down when SCTY went up.

while there is something interesting in how you are looking at this,

Tesla set the price it will pay for Solar City. as with any acquisition with a premium, SCTY moved closer to but not up to the offer price. once the market had the news of the offer, fair value for SCTY became Tesla's offering price less whatever discount the market attributes to the deal falling through. that is, when the news became known, one could not sell TSLA and buy SCTY at a 0.096 ratio to get your Tesla returned at .122-.131

the fact that the currency of this deal is Tesla shares does not change this.

 

[MikeC]

while there is something interesting in how you are looking at this,

Tesla set the price it will pay for Solar City. as with any acquisition with a premium, SCTY moved closer to but not up to the offer price. once the market had the news of the offer, fair value for SCTY became Tesla's offering price less whatever discount the market attributes to the deal falling through. that is, when the news became known, one could not sell TSLA and buy SCTY at a 0.096 ratio to get your Tesla returned at .122-.131

the fact that the currency of this deal is Tesla shares does not change this.

But I don't think they actually "set the price" at 26.50-28.50 - that's just what the price would have come out to at TSLA's share price averaged over the last 5 days. It looks like what they actually did was "set a ratio" of shares. The fact that any arbitrage opportunity disappeared immediately supports the theory. We will see if the share price of each stays at a fixed ratio going forward.

Edit: Taking this further, my theory is that the market initially wanted to buy SCTY up to near the offer price at $26.50 but there was a counter force immediately bringing TSLA down due to the arbitrage opportunity. E.g., If SCTY goes to $25, it makes sense to sell TSLA at any price over $200 in order to buy more SCTY, so TSLA immediately goes to $200. SCTY goes to $24, TSLA is worth $192, etc.

 

[SteveG3]

But I don't think they actually "set the price" at 26.50-28.50 - that's just what the price would have come out to at TSLA's share price averaged over the last 5 days. It looks like what they actually did was "set a ratio" of shares. The fact that any arbitrage opportunity disappeared immediately supports the theory. We will see if the share price of each stays at a fixed ratio going forward.

from Tesla's blog on the deal:

"This proposal represents a value of $26.50 to $28.50 per share, or a premium of approximately 21% to 30% over the closing price of SolarCity’s shares, based on today’s closing price of SolarCity’s shares and the 5-day volume weighted average price of Tesla shares."

think about it, which scenario makes more sense,

1. a team inside Tesla determined what they SCTY was worth in dollars, and recommended to the board an offer price, X dollars, to buy SCTY. some basic arithmetic involving X dollars, SCTY's closing price today, and the 5-day volume weighted price of Tesla shares were used to determine the ratio of TSLA to SCTY shares before finalizing documents (in the time between the 4pm close and the release of news of the deal a little over an hour later).

2. Tesla set up a ratio of TSLA shares to SCTY shares to propose to SCTY, which meant a moving target valuation of SCTY based on the week's stock market moves of TSLA and SCTY.

or look at it from another point of view,

say tomorrow some theoretical event happens (say, Trump and Hillary agree that the U.S. will do x, y, and z to move to solar swiftly (I did say hypothetical!) that makes SCTY worth twice as much as it was today. it would make sense for Tesla to go up some with this news, but if the ratio is some sort of automatic driver of both companies stock prices, SCTY doubling would mean Tesla doubling. of course, that's not what would happen... Tesla's new potential asset being worth ~$6B rather than ~$3B doesn't make Tesla worth $60B rather than $30B just to keep a ratio happy.

 

[Waiting4M3]

I think I made a mistake there. I was thinking that since one share of TSLA is 8x greater, the magnitude of the TSLA price changes will need to be 8x more than SCTY's price changes, in order to keep them at a fixed ratio. I still think that's true, but that doesn't account for TSLA happening to drop about 8x what SCTY gained in AH.

My main point is simply that the offer has established that a share of TSLA is worth 8x what a share of SCTY is worth. I expect that this ratio will persist until the deal is completed.

The absolute PPS of TSLA vs SCTY is 8:1, you sell 1 share of TSLA and can buy 8 shares of SCTY. But there is no set rules that says selling 1 share of TSLA will drop TSLA's PPS by x%, and buying 8 shares of SCTY will raise SCTY's PPS by y%. Stock price is not a zero-summed game. So I don't see any reason why the price change should follow the 8:1 ratio.

The after market movement still doesn't quite make sense to me, TSLA has lost $4 billion in market cap while paying SCTY $2.6 billion in the acquisition. This only makes sense if the market thinks SCTY will fail in long term and it will be worth nothing, except TSLA will take on its debt. SCTY has $2.7 billion in long term debt and $890 million in equity as of March if I believe my quick Google search, so net $1.8 billion in debt. So the market is reacting as if TSLA just paid $2.6 billion now, and will throw away another $1.8 billion in the future to pay off SCTY's debt, totaling 4.4 billion.

 

[SteveG3]

The absolute PPS of TSLA vs SCTY is 8:1, you sell 1 share of TSLA and can buy 8 shares of SCTY. But there is no set rules that says selling 1 share of TSLA will drop TSLA's PPS by x%, and buying 8 shares of SCTY will raise SCTY's PPS by y%. Stock price is not a zero-summed game. So I don't see any reason why the price change should follow the 8:1 ratio.

The after market movement still doesn't quite make sense to me, TSLA has lost $4 billion in market cap while paying SCTY $2.6 billion in the acquisition. This only makes sense if the market thinks SCTY will fail in long term and it will be worth nothing, except TSLA will take on its debt. SCTY has $2.7 billion in long term debt and $890 million in equity as of March if I believe my quick Google search, so net $1.8 billion in debt. So the market is reacting as if TSLA just paid $2.6 billion now, and will throw away another $1.8 billion in the future to pay off SCTY's debt, totaling 4.4 billion.

indeed, it's just shorts trying to create perception. I don't know if the deal is good or bad, but, I'm also pretty confident that the shorts didn't in the span of a few minutes analyze the two businesses and the probable outcomes of an acquisition and determine that SCTY is completely worthless when owned by Tesla, despite the market valuing it at ~$2B as a stand alone business an hour earlier. again, I see this as the shorts having a go at trying to create perception...

the kind of games Cramer talked about as part of the hedge fund world in this video,

 

[renim]

sometimes a good company gets 'infected' when it buys a bad company.

Solarcity is a bad company, their bonds were trading at 60cents in the dollar. about a year before bankruptcy, Peabody Coal's bonds were doing the same thing.

That is infection, now Tesla has effectively burned the bridge for some forms of capital raising pre Tesla model 3 deliveries.

another examples were the markets response to Hyundai's hubris in buying an expensive property in Korea.

 

[MikeC]

from Tesla's blog on the deal:

"This proposal represents a value of $26.50 to $28.50 per share, or a premium of approximately 21% to 30% over the closing price of SolarCity’s shares, based on today’s closing price of SolarCity’s shares and the 5-day volume weighted average price of Tesla shares."

think about it, which scenario makes more sense,

1. a team inside Tesla determined what they SCTY was worth in dollars, and recommended to the board an offer price, X dollars, to buy SCTY. some basic arithmetic involving X dollars, SCTY's closing price today, and the 5-day volume weighted price of Tesla shares were used to determine the ratio of TSLA to SCTY shares before finalizing documents (in the time between the 4pm close and the release of news of the deal a little over an hour later).

2. Tesla set up a ratio of TSLA shares to SCTY shares to propose to SCTY, which meant a moving target valuation of SCTY based on the week's stock market moves of TSLA and SCTY.

or look at it from another point of view,

say tomorrow some theoretical event happens (say, Trump and Hillary agree that the U.S. will do x, y, and z to move to solar swiftly (I did say hypothetical!) that makes SCTY worth twice as much as it was today. it would make sense for Tesla to go up some with this news, but if the ratio is some sort of automatic driver of both companies stock prices, SCTY doubling would mean Tesla doubling. of course, that's not what would happen... Tesla's new potential asset being worth ~$6B rather than ~$3B doesn't make Tesla worth $60B rather than $30B just to keep a ratio happy.

I see what you're saying. Okay, so the price is already set. But the fact remains that at a certain point in the future, approximately 8 shares of SCTY will convert to 1 share of TSLA, right? Or is it something that would go retroactive somehow?

When the market opens tomorrow, if say, SCTY is at $25 and TSLA is at $190, why wouldn't I sell 400 shares of SCTY for $10,000 and buy 50 shares of TSLA for $9500.

Or conversely, if SCTY is at 20 and TSLA at 200, why not sell 500 shares of TSLA for $100,000 and buy 5,000 SCTY shares, which will then convert to 625 shares of TSLA?

Re: your hypothetical, SCTY doubling would equal just 1/8 of TSLA doubling, making TSLA now worth 9/8ths of what it was before.

 

[MikeC]

The absolute PPS of TSLA vs SCTY is 8:1, you sell 1 share of TSLA and can buy 8 shares of SCTY. But there is no set rules that says selling 1 share of TSLA will drop TSLA's PPS by x%, and buying 8 shares of SCTY will raise SCTY's PPS by y%. Stock price is not a zero-summed game. So I don't see any reason why the price change should follow the 8:1 ratio.

But arbitrage is a zero sum game. If it's correct that there is a point in the future at which 8 shares of SCTY become 1 share of TSLA, it will be profitable for the market to sell/buy SCTY and buy/sell TSLA if the share price diverges from that ratio.

 

[SteveG3]

I see what you're saying. Okay, so the price is already set. But the fact remains that at a certain point in the future, approximately 8 shares of SCTY will convert to 1 share of TSLA, right? Or is it something that would go retroactive somehow?

When the market opens tomorrow, if say, SCTY is at $25 and TSLA is at $190, why wouldn't I sell 400 shares of SCTY for $10,000 and buy 50 shares of TSLA for $9500.

Or conversely, if SCTY is at 20 and TSLA at 200, why not sell 500 shares of TSLA for $10,000 and buy 5,000 SCTY shares, which will then convert to 625 shares of TSLA?

Re: your hypothetical, SCTY doubling would equal just 1/8 of TSLA doubling, making TSLA now worth 9/8ths of what it was before.

you could make such trades. some people do. the risk involved is that the deal falls through (or is revised that takes your arbitrage from profit to loss), and this backfires.

as to hypothetical, agree with your description Mike.