TSLA convertible notes and warrants

[sleepyhead]

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.

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).

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.

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.

Just let us know when you load up so we can, too I'm almost only in LEAPS and stock right now.

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.

 

[AlMc]

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.

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?

 

[sleepyhead]

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?

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.

 

[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?

 

[Chickenlittle]

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 ?

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?

 

[DonPedro]

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?

Godman sold Tesla a bull call spread (Google it)

 

[Bgarret]

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

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

 

[Bgarret]

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.

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:

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

Average 643 transactions each 2 month period since the bonds were issued.

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.

 

[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.

 

[uselesslogin]

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.

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.

 

[bhzmark]

Hoping folks that may be following this old thread can discuss the upcoming MArch 2019 notes.

If I read this 424B5
correctly, the share price needs to be above $359 on December 1, 2018 and then note holders will be better off converting to shares. Or perhaps a little higher to account for the accrued interest? And technically the note holder has to think that it will be above that at the time that they can convert and sell.

There is also an interesting discussion of a note hedge transaction to prevent dilution -- does anyone have any insight into that part? It appears that Tesla spent $186 million to hedge against the dilution that would otherwise be caused by the conversion of the notes. If I understand that, Telsa will settle the notes, not by issuing new shares, which would be dilutive, but by using shares acquired through this hedge transaction. One way to do that would be to have bought calls that settle at the time of note conversion. There are likely more complicated ways to get that same exposure.

Is Tesla itself on the other side of a lot of shorts? Are shorts selling naked calls? Is the tsunami going to come via the hedge transaction settling along with the notes?

In looking into this further, it seems that the fact of the convertible note issuance itself will generate short interest by bond investors who lower their cost of investing in the bonds by also selling short the equivalent number of shares, thus giving up the equity upside, but capturing more net yield because of the lower cost of the net investment. That is, they might have bought $1000 of bonds and only gotten a pathetic $2.50 or 0.25% annual yield, but if they also sold short the equivalent 2.7788 shares at $350 each and received $972 (ignoring borrowing and other transaction costs), then their cost was only $27.42 and their $2.50 in interest is now a more respectable 9.1% yield.

I’m not sure what all this means except that a good portion of the short interest is simply an artifact of the convertible notes allowing Tesla to get very low interest debt at a price of hedge costs so as to be nondilutive.

 

[neroden]

bhzmark, your analysis seems correct.

I personally expect the March 2019 notes to mostly or entirely convert; I think the stock price will be high enough. Institutional holders do generally short the stock against the notes, so we'll see a drop in short interest when the notes are converted to newly issued shares and the stock is delivered to cover. This will relieve the pressure on short sellers, making a squeeze less likely.

The hedges are custom-written by some investment bank, and were never described very clearly. I should really ask exactly what they are some time. My current guess is that they are contracts for difference; if this is the case, then for every dollar by which the stock price is above the conversion price, the hedges will pay Tesla that amount of cash, or (perhaps more likely, since the hedges are described as antidilutive) TSLA shares worth that amount of cash. It's not clear.

Assuming the notes convert, the hedges may be a source of cash funding, or if they pay off in stock they may have an antidilutive effect (which would bring us right back to the same amount of pressure on short sellers as before).

Finally, at a much higher price, $512.66, Tesla has sold warrants. So if the stock is at $600, then the noteholders will convert, Tesla will exercise the hedges to recover the same amount of stock given to the noteholders, but then the warrantholders will execute the warrants and end up diluting the stock.

 

[generalenthu]

Tesla has sold convertible notes, mostly to hedge funds who would sell short the stock as a hedge. Tesla also entered into hedge transactions, which are managed by investment banks like Morgan Stanley or Goldman,who would be long stock against these.

So as TSLA goes up, the hedge funds sell more stock against their notes and investment banks buy more against the hedges they sold Tesla. This ends up basically a wash. When the price approaches the options sold by tesla (at $560?), the math changes, but thats for later.

 

[neroden]

I have no idea how to accurately predict the layers of hedging which the investment banks and hedge funds would do in response to the convertibles, "hedges", and warrants. It probably involves stock long and short, and calls at many strikes, and puts at many strikes.

However: I would actually expect most of the original convertible buyers did the following. Purchased the convertible bond, and then sold calls for the conversion strike price or near it. Why? Implied volatility has been sky-high in options, and not so high in the convertibles, so there was an arbitrage trade available. The pure trade was only available once 2019 LEAPS became available, but something similar was probably done.

I suspect the hedges are similar to a call option but paid for like a contract-for-difference. The warrants provide a ceiling price, and were originally held by the same banks which wrote the hedges. I would expect the banks to have bought actual call options to reduce their remaining exposure from the hedges. (They might even have bought them from the convertible buyers.)

In short I think at some point the convertible buyers wrote calls around $360 and the banks bought calls around $360; I am not sure what their *subsequent* re-hedging or trading activities have been.

 

[bhzmark]

here is some more relevant background on what appear to be a "call spread" convertible note deal:

• A “call spread” transaction refers to the issuance of convertible debt, hedged by the purchase of a call option with terms similar to the option embedded in the bond, and the sale of a call option or warrant that economically converts the entire transaction to a convertible bond with a higher conversion premium. For tax purposes, U.S. issuers often “integrate” the bond and the purchased bond hedge into a synthetic nonconvertible discount bond.

• Issuers for whom the interest expense deduction is a gating item may be less interested in call spread transactions, or may price them with less costly bond hedges if additional discount attributable to a higher premium for the bond hedge would not be deductible.

• Issuers [like Tesla] that don’t expect to be able to deduct the tax discount may choose to enter into call spreads without integration in order to avoid the additional complexities that an integrated transaction requires, for example more complicated documentation for the bond hedge.

https://media2.mofo.com/documents/couplingcallspreads.pdf

https://spectrum.library.concordia.ca/980477/1/Final submission.pdf

Twitter to offer $1 billion convertible note as shares rally

 

[schonelucht]

Hoping folks that may be following this old thread can discuss the upcoming MArch 2019 notes.

If I read this 424B5
correctly, the share price needs to be above $359 on December 1, 2018 and then note holders will be better off converting to shares. Or perhaps a little higher to account for the accrued interest? And technically the note holder has to think that it will be above that at the time that they can convert and sell.

It needs to be above that price on maturity date. For early conversion from December it needs to be at 130% of that price for a number of days.

That is, they might have bought $1000 of bonds and only gotten a pathetic $2.50 or 0.25% annual yield, but if they also sold short the equivalent 2.7788 shares at $350 each and received $972 (ignoring borrowing and other transaction costs), then their cost was only $27.42 and their $2.50 in interest is now a more respectable 9.1% yield.

Most likely they'd have sold short the moment they went into the transaction to buy the bonds. At that point, they would not have gotten $350 per share. But the point stands. The hedging structure allows bond holders to not be exposed as much to the stock price will still capturing some of its potential gains. In return they offer Tesla a super low interest.

I’m not sure what all this means except that a good portion of the short interest is simply an artifact of the convertible notes allowing Tesla to get very low interest debt at a price of hedge costs so as to be nondilutive.

That's correct and also why the stock short number seems to have a hard floor. That's all the convertible related positions (there are more convertibles outstanding)

 

[bhzmark]

"Elon Says" on Twitter

This actually seems mostly right -- suggesting that the price needs to be (and stay) above $253 rather than $359 in order to settle in stock rather than cash. Reason being that Tesla has the option to lower the conversion price down to as low as $253 to avoid settling in cash.

But it also suggests that the lowering the conversion price down to $253 has to be all or nothing -- that they can't lower it below $360 but still above $253 -- say at $320 . . . I think it is incorrect on that point. any other thoughts?

If anything I think this is good news for cash flow as it means that the debt need not be settled in cash at a stock price as low as ~$253.

 

[neroden]

It definitely doesn't have to be "all or nothing"; it can be any price Tesla chooses in between ~$253 and ~$360.