When do shorts have to cover? (Neroden's megathread)

[neroden]

. Also (discussed with a hedge fund manager acquaintance ) it seems if you hold a short position, you can wait until you cover until after deal goes through

You really, really can't. You'd have to have a lender who was willing to accept not getting their shares back, which means the lender has to be someone who is planning to get cashed out at $420. That's the thing about a deal where a large number of the shareholders are holding onto their shares....

We're not going to find out how many shareholders will be able to hang on during the transition to a private company for a while. We won't find out how many will *choose* to hang on until after that. If it's too many (see the math below), the short-sellers are in awful trouble. It probably won't be that many.

However, think about this: most of the lenders of shares are large institutions which are quite capable of holding and carrying private equity. All the borrowing is going to have to come from institutions which are capable of holding private TSLA stock and choose not to. Where's the supply of shares to lend going to COME from?

I expect an orderly exit; it's possible that the short-sellers who hang out until the bitter end of the go-private deal will borrow from an institution which plans to cash out all its shares merger-arbitrage style. But that institution has a strong incentive to demand more than $420 from the short-seller.

, thereby him noting " he would never pay above 420". Why do I believe him...well simply, I do not have a three level hot tub, or even a hottub for that matter, he does, and its awesome.

Hilarious.

So essentially, I strongly feel. ..
1. deal gets approved, and stock goes to 420.
2. deal does not approved, and stock goes to 300.
3. No squeeze.

I think there's not going to be a squeeze. But it's math. If 75% of the stockholders who aren't Musk, Saudi, or Tencent decide to stay on in the private company, *and* are able to do so, then there will be a squeeze. I think that's a bit too high to be likely.

If the deal falls through for whatever reason -- and I think it's unlikely since Musk is hell-bent on going private and has a lot of potential sources of funding -- the clear profits will definitely have some positive impact on the stock price, though the *insane disinformation campaign* seems to be neverending.

It's looking to me like Bailie Gifford can stay in and like they want to stay in.

This makes the math:
170.59 million shares outstanding
33.74 million shares fabricated by short-sellers
97.81 million shares held by institutions
(including 13.17 million held by Bailie Gifford)
33.74 million shares held by Elon Musk
roughly 1.7 million shares held by other insiders
8.17 million shares held by Tencent
Between 5.11 and 8.52 million shares held by Saudis, but call it 5.11

So, 57.80 million shares held by miscellaneous non-institutions (including us).

So miscellaneous non-institutions plus institutions which aren't Bailie Gifford (hereafter referred to as "miscellaneous stockholders") amount to 142.44 million shares. Of those, short-sellers will have to redeem 33.74. The remainder is 108.70 million shares. If all of them want out (which is ridiculous), it'll cost $45.65 billion dollars.

If half of the miscellaneous stockholders want out, that's 71.22 million shares, of which the short-sellers have to redeem 33.74, leaving 37.48 million for the go-private consortium to buy back; that's $15.7 billion.

If as Musk guesses "2/3" of all stockholders stay on, that means 1/3 * (170.59 + 33.74) = 68.11 million shares want out. This is surprisingly close to half of miscellaneous stockholders; the short-sellers have to redeem 33.74, leaving 34.37 million shares or $14.4 billion.

If only 25% of miscellaneous stockholders want out, that's 35.61 million shares; after the short-sellers redeem their shares, that's 1.87 million shares, or $785.4 million! This seems unduly low, though.

So there's your likely range of costs: $1 billion to $45.65 billion. Guessing $20-$25 billion seems eminently reasonable, though that may be on the high side.

-----

Despite the fact that it would seem to make sense to wait for the buyout at $420, I suspect a bunch of "weak longs" are bailing out now (perhaps because they don't trust Musk). This is probably something which makes Musk happy as he doesn't like to have traders who aren't committed in his stock.

But the *side effect* is that the new owners buying now are more and more likely to be owners who want to keep their shares through the go-private process. If they actually can keep their shares through this, this effect is continuously reducing the amount the go-private deal will cost. (As well as increasing the chances of the yes vote.)

The other sort of new owner who might be buying, of course, is merger arb traders who would want out. But I don't think that's particularly likely to be a large percentage of new buyers because most merger arb traders do very shallow research and bet on a lot of merger arbs, so they're likely to believe the FUD and not think the deal will go through. Only the sort who researches individual deals and makes big bets on them would be going in.

---
To be clear, I think Musk is hell-bent on going private and will do it if it is at all possible. If this means some of us are forced out, he'll do it (though he'd like to minimize that and has good reason to minimize that). If this means a higher deal price, he'll do it if he can line up the money. If it means a lower deal price, he'll do it. If it means borrowing money against his SpaceX stock, he'll do it. He is clearly stressed out and completely sick of the disinformation campaign, the short-sellers, the market manipulation, the lot of it. And I can't blame him at all.

 

[ggr]

Mod: Bump. Because this was an old post, the new thread appeared a long way down. Discussion here, not in Market Action, please. --ggr

 

[Unpilot]

First ...thanks Neroden for the work you put into this.
Second I hope that the shorts that help spread all the crazy misinformation roast ...slowly.

 

[neroden]

So, essentially, the cost of going private is largely driven by how many existing shares want to / can stay in TSLA when it goes private. The short-sellers have made it so the first ~34 million shares bought back are "free"; the remainder have to actually be bought back.

The unanswered question is how many existing shares *can* stay in TSLA when it goes private, and how many want to.

I have no doubt that Musk believed that the Saudis had agreed to funding, and I have no doubt that they said they could fund it, but whether they would need to put in so much that the deal would get stopped by CFIUS? I don't know that, because I don't know who'd stay through to the private company.

This is why I ran a bunch of different scenarios.

 

[Sudre]

What I haven't figured out if the deal goes thru.... Doesn't TSLAP buy all the shares that want out at $420? Like a massive limit order? Anything $420 and under goes to the first bidder which is TSLAP.

If a short wants to jump in and buy shares would they not have to place a buy at $420.01 (or more) and hope?

 

[neroden]

Yes, the short-sellers would have to place buy orders at $420.01. The fact is, people would take the extra penny, so as long as there are enough shares who don't want to go private, that's what they'd have to pay.

If there aren't enough shares who don't want to go private, then it becomes a bidding war...

 

[neroden]

So, I'm copying this over here so it doesn't get lost in general discussion.

This is why I think Tesla going private will massively reduce the smear campaign.

I don't think the smear campaign will ever completely end -- we have Big Oil (by which I mean the market-listed oil companies, not the national oil companies), the National Automobile Dealers Association, the incumbent automakers, and probably Russia running smears. But I've become convinced that the biggest smear campaign *is* from short-sellers and other financial manipulators. Why?

The timing. They've been releasing their smears to coincide with planned bear raids, such as the July 4th weekend bear raid (done two years in a row). Or, in this case, they're reacting to Musk's proposing to go private. Big Oil, NADA, Russia, and the automakers wouldn't care about such timing; they would time their disinformation to match *product releases* or store openings -- and in fact, they *have* done so in the past -- or they'd just drip it out steadily. The accelerated piles of disinformation associated with *financial events* says to me that the smear campaign is primarily from financial manipulators. They are completely hysterical about the possibility that they won't be able to do more financial manipulations.

This says to me that it actually will stop most of the smears if Tesla goes private.

 

[Rarity]

On the whole, I agree. However, I believe that shorts will find ways to incentivize themselves into smearing a private Tesla. You could probably call up Goldman Sachs and have them write a contract against private Tesla in some fashion.

 

[neroden]

On the whole, I agree. However, I believe that shorts will find ways to incentivize themselves into smearing a private Tesla. You could probably call up Goldman Sachs and have them write a contract against private Tesla in some fashion.

How?

I think the only way to do that would be literally just a bet on the stock price change, and *those are flat-out illegal in the United States*. You could probably write such a contract in Europe, where bucket shops were never banned, but I'm not sure the European banks would humor people who wanted to do this on an unlisted stock -- because there's no quoted price to pay off on. Maybe the gambling houses in Monaco would allow for some sort of gambling on the outcome of the annual reports, but it seems unlikely...

 

[Rarity]

@neroden -- how? I'm not Goldman Sachs, so I don't know.

The Big Short was a bit of a revelation. They made a way to short the MBS market, so I'd imagine they are creative enough to make a way to short Tesla in some fashion. Gamblers will find a way to gamble. One method that readily comes to mind is credit default swaps. Of course, those wouldn't be ideal because I think Tesla will not be in danger of having a credit event. But you might be able to lever up on those to get your gambling fix.

 

[neroden]

@neroden -- how? I'm not Goldman Sachs, so I don't know.

The Big Short was a bit of a revelation. They made a way to short the MBS market, so I'd imagine they are creative enough to make a way to short Tesla in some fashion. Gamblers will find a way to gamble. One method that readily comes to mind is credit swaps. Of course, those wouldn't be ideal because I think Tesla will not be in danger of having a credit event. But you might be able to lever up on those to get your gambling fix.

Good thought. Credit default swaps are definitely used for heavy gambling operations. The people who deal in those are a fairly esoteric group -- would they really be affected by the FUD the way stock traders are? The bond traders seem to have been much less affected by the FUD than the stock traders in general...

 

[Rarity]

Good thought. Credit default swaps are definitely used for heavy gambling operations. The people who deal in those are a fairly esoteric group -- would they really be affected by the FUD the way stock traders are? The bond traders seem to have been much less affected by the FUD than the stock traders in general...

Because they are human beings, I would assume that they would be affected by the FUD, at least on the margins. Then just use leverage on that margin. But the FUD effect might be of a somewhat different fashion. The gamblers would have to figure out that market, but I assume it could be done. The pace of their adaptation might be increased or decreased by how the go-private process plays out.

 

[vgrinshpun]

So miscellaneous non-institutions plus institutions which aren't Bailie Gifford (hereafter referred to as "miscellaneous stockholders") amount to 142.44 million shares. Of those, short-sellers will have to redeem 33.74. The remainder is 108.70 million shares. If all of them want out (which is ridiculous), it'll cost $45.65 billion dollars.

If half of the miscellaneous stockholders want out, that's 71.22 million shares, of which the short-sellers have to redeem 33.74, leaving 37.48 million for the go-private consortium to buy back; that's $15.7 billion.

If as Musk guesses "2/3" of all stockholders stay on, that means 1/3 * (170.59 + 33.74) = 68.11 million shares want out. This is surprisingly close to half of miscellaneous stockholders; the short-sellers have to redeem 33.74, leaving 34.37 million shares or $14.4 billion.

If only 25% of miscellaneous stockholders want out, that's 35.61 million shares; after the short-sellers redeem their shares, that's 1.87 million shares, or $785.4 million! This seems unduly low, though.

So there's your likely range of costs: $1 billion to $45.65 billion. Guessing $20-$25 billion seems eminently reasonable, though that may be on the high side.

I believe there is an error in your approach, @neroden, in that it does not account for the fact that after going private deal is closed, there is going to be only outstanding shares remaining under ownership (171 M), not the total shares owned by the holders now (171 + 35 = 206 M).

Below is an alternative take on this calculation - please take a look to see if you agree.

If I am right, there is a profound practical implication.

With all of the attention to WHO provides secured funding, everybody seem to overlook how MUCH funding is actually needed, which is surprisingly little. If we are to accept Musk assumption that 2/3 of all current shareholders will choose to stay (2/3 excludes Musk), the total required funds would have been less than $9B - to buy 21.2 M shares. However, more than 21.2 shares - 34.6 M will need to be bought by short sellers.

So it seems that actually NO funding is required! In fact , it seems that the break-even point for any required funding is that less than 47.83% of all current shareholders decide to stay private. So given Musk assumptions, funding is indeed secured - from short sellers.

 

[MP3Mike]

So it seems that actually NO funding is required! In fact , it seems that the break-even point for any required funding is that less than 47.83% of all current shareholders decide to stay private. So given Musk assumptions, funding is indeed secured - from short sellers.

So to put it in simpler words you are saying that if the deal is decided and everyone that wants to stay with Tesla going private just sits on their shares, and recalls any shares they have lent out, the shorts will have to buy, and retire, more shares than are required to go private. In fact the shorts will need to buy ~12 million shares from people that want to keep their shares, so they might have to pay a lot for them. (I know that they will to get their grubby little paws on mine.)

To put that yet another way Elon needs to get a group together that would be willing to buy out the people that can't/won't go private, get board approval, get shareholder approval, but the group likely won't need to actually spend their money. (Unless the shorts manage to cover with shares from people that wanted to stay with Tesla going private.)

The one thing left out, and I don't know if it should be left out or not, is does the Tesla's debt need to be bought out or refinanced as part of this deal?

@vgrinshpun It seems like you dropped 7.8 million shares from the retail holders, shouldn't that number be 53,395,484?

 

[vgrinshpun]

@MP3Mike, yes, thanks for the correction (inadvertently subtracted Saudi shares twice). This error does not affect any of the conclusions. Here is updated snap shot:

 

[Reciprocity]

There is another group that needs to be factored in. Index funds and some ETFs will be forced to sell, but they MUST hold until the deal is done and the stock is delisted. They are infact just a basket of stocks and not actively managed. This will remove a fairly large chunk of the "sellers" that you would assume would help shorts that must but to cover. Nothing on the offer of 30M shares but the QQQ has a pretty big chunk. This assumes that they must cover on the open market. I was a bit confused About the idea that they could cover after the deal closes?

 

[neroden]

@MP3Mike, yes, thanks for the correction (inadvertently subtracted Saudi shares twice). This error does not affect any of the conclusions. Here is updated snap shot:

View attachment 327471

This looks correct up to the line for "Retail", but after that it gets squirrely.
-- We don't know whether Musk meant 2/3 of all shareholders except him, or 2/3 of all shareholders including him.
-- The number of shares other than Musk, Tencent, and the Saudis who need to "go private" in order for the deal to cost nothing is, of course,
97,879,977+53,395,484-34,585,642 = 116,689,819

You're double-counting the short-sellers. They need to buy back their fabricated shares, and then they're out. You can't subtract their buyback from the 170K shares outstanding; that's not how it works.

To understand this, the way to think about it is this: first the short-sellers all capitulate and buy their positions back (from institutions, probably). Then whoever's left either goes private or gets bought out.

FWIW, I think we can assume that Bailie Gifford (13,171,801 shares) will go private with Musk if at all possible, based on Mr. James Anderson's statements. So the number of institutional shares in hands other than Musk, Tencent, Saudis, and Bailie Gifford is 84,708,176. The number in "retail" hands is still 53,395,484. The number which need to go private (in addition to Musk, Tencent, Saudis, and Bailie Gifford) in order for the deal to cost nothing is 103,518,018. This is 74% of the shares which are not held by Musk, Tencent, Saudis, or Bailie.

We're not going to get that many people going private, if only due to index funds. A fairer guess would be that half of the "remaining" institutional shares will go private and half of the retail shares will be able to go private, which would mean 69,051,830 shares which don't go private -- subtract the short-sellers' 34,585,642, and this is 34,466,188 shares, or 14.5 billion dollars to go private. It's gonna be somewhere in that ballpark, plus or minus 10 billion dollars!

 

[Reciprocity]

Another thought that I had.. calls.. if you have itm and otm calls and you execute those calls in the middle of a squeeze, they have to get those shares from somewhere? Do they have to buy them on the open market? How didd Delta hedging work in this scenario.

This stuff is too complicated, that is why Goldman can charge so much in fees to unwind all this crap.

FYI: during the VW squeeze, Porsche had bought enough calls to make up 31% of the float which caused the float to baloon to 125% of all outstanding shares. Think about this. What if Elon says 420... Funding secured to nuke the value of $450+ contracts, then buys 500,000+ of them to gain control of an additional 30% of the company at that price. In a squeeze, the shorts would be required to buy those shares at over $6xx, $7xx, $8xx...... The resulting proceeds would be used to buy back shares at 420 after the deal is closed. It would only cost $50M to buy those contracts today.

 

[Sancho]

These calculations assume no other buyers other than the shorts covering.

But I’d invest $420 (and more) in a private Tesla. Since Goldman is not going to ask me to join the buyer group, I’ll have to buy in the public market (which I will do when the deal seems like a lock).

A private Tesla is a very attractive investment (see, e.g. SpaceX). There could be a lot of buyers competing with the shorts covering between the time the deal looks firm and the deal is effectuated.

 

[neroden]

This is a standard pre-deal phenomenon. The long holders who don't trust management are getting out while the people who want to be in to go private are getting in. Merger arb players could also be getting in, but right now I don't think they are, based on what I've read about the most common merger arb strategies.

But we don't really know how many people want in on the go-private deal who aren't going to be part of the buyer group, so we still don't know how many shares have to be bought out. A *minimum* would be the shares held by index funds, but that's less than the number of shares fabricated by short-sellers.