TMC is an independent, primarily volunteer organization that relies on ad revenue to cover its operating costs. Please consider whitelisting TMC on your ad blocker or making a Paypal contribution here: paypal.me/SupportTMC

TSLA convertible notes and warrants

Discussion in 'TSLA Investor Discussions' started by DaveT, Aug 25, 2013.

  1. DaveT

    DaveT Searcher of green pastures

    Joined:
    Nov 15, 2012
    Messages:
    2,564
    Location:
    San Diego
    #1 DaveT, Aug 25, 2013
    Last edited: Aug 25, 2013
    (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.
     
  2. sleepyhead

    sleepyhead Active Member

    Joined:
    May 31, 2013
    Messages:
    1,915
    Location:
    Texas
    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?
     
  3. Curt Renz

    Curt Renz Active Member

    Joined:
    Mar 5, 2013
    Messages:
    1,859
    Location:
    Chicagoland
    #3 Curt Renz, Aug 25, 2013
    Last edited: Aug 25, 2013
    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;
     
  4. aznt1217

    aznt1217 Active Member

    Joined:
    Aug 27, 2012
    Messages:
    2,238
    Location:
    New York, NY
    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.
     
  5. ongba

    ongba Member

    Joined:
    Apr 27, 2013
    Messages:
    228
    Location:
    North America
    DaveT,

    A very informative post as always. Are these warrants expiring in 2018 available to individual retail investors? Thanks.
     
  6. StapleGun

    StapleGun Member

    Joined:
    May 9, 2013
    Messages:
    270
    Location:
    Detroit, MI
    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.
     
  7. AlMc

    AlMc 'Senior Moments' member

    Joined:
    Apr 23, 2013
    Messages:
    5,378
    Location:
    Delaware
    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.
     
  8. DaveT

    DaveT Searcher of green pastures

    Joined:
    Nov 15, 2012
    Messages:
    2,564
    Location:
    San Diego
    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.

    - - - Updated - - -

    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.

    - - - Updated - - -

    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.
     
  9. Curt Renz

    Curt Renz Active Member

    Joined:
    Mar 5, 2013
    Messages:
    1,859
    Location:
    Chicagoland
    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.
     
  10. Lessmog

    Lessmog Member

    Joined:
    Aug 24, 2013
    Messages:
    809
    Location:
    Smögen
    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.)
     
  11. Lessmog

    Lessmog Member

    Joined:
    Aug 24, 2013
    Messages:
    809
    Location:
    Smögen
    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.
     
  12. uselesslogin

    uselesslogin Enthusiast

    Joined:
    Jun 13, 2013
    Messages:
    1,299
    Location:
    Omaha, NE
    Thank you so much for the writeup DaveT. It isn't until you explained it that I actually understood the full plan.
     
  13. gregincal

    gregincal Active Member

    Joined:
    Oct 26, 2012
    Messages:
    2,136
    Location:
    Santa Cruz, CA
    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.
     
  14. DaveT

    DaveT Searcher of green pastures

    Joined:
    Nov 15, 2012
    Messages:
    2,564
    Location:
    San Diego
    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.
     
  15. vgrinshpun

    vgrinshpun Active Member

    Joined:
    Apr 5, 2013
    Messages:
    3,835
    Location:
    PA
    #15 vgrinshpun, Aug 27, 2013
    Last edited: Aug 27, 2013
    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.
     
  16. sub

    sub Member

    Joined:
    May 24, 2013
    Messages:
    925
    Location:
    California

    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?
     
  17. Zaxxon

    Zaxxon Member

    Joined:
    Dec 11, 2012
    Messages:
    896
    Location:
    USA
    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.
     
  18. Curt Renz

    Curt Renz Active Member

    Joined:
    Mar 5, 2013
    Messages:
    1,859
    Location:
    Chicagoland
    Zaxxon explained it very well. The trick was to read the rest of the sentence beyond your red highlighting.
     
  19. sub

    sub Member

    Joined:
    May 24, 2013
    Messages:
    925
    Location:
    California
    Ok got it now, sorry. I read it a few times and it wasn't computing. Carry on.
     
  20. gregincal

    gregincal Active Member

    Joined:
    Oct 26, 2012
    Messages:
    2,136
    Location:
    Santa Cruz, CA
    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.
     

Share This Page