TSLA convertible notes and warrants

[DaveT]

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.

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.

 

[hershey101]

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.

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.

 

[Bgarret]

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.

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.

 

[DaveT]

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.

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.

 

[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...)

 

[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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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.

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.

 

[serkol]

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.

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.

 

[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.

 

[DaveT]

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.

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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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.

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.

 

[serkol]

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.

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.

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?

 

[Norbert]

There's no reason to convert sooner than later (at least that I can think of).

Like a so-called european-style option.

 

[DaveT]

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?

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.

 

[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.

 

[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/stockstowa...-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!

 

[Convert2013]

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/stockstowa...-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!

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..

 

[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.

 

[DaveT]

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.

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).

 

[Jonathan Hewitt]

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!

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

 

[westhouse]

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).

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.

 

[SuryaDham]

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.

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.