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.
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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.
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.
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.
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.
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.
InTheShadows
Active Member
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.
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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.
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.
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:
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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.
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.
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.
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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.
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.
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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.
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.
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