Tesla's $4.2bn convertible bonds are now all in the money. What does this mean for Tesla?
1) The converts can be converted by holders within 3 months of maturity but Tesla can choose to repay the converts in cash (at the value of the equivalent shares) or a mix of cash and stock.
1) The converts can be converted by holders within 3 months of maturity but Tesla can choose to repay the converts in cash (at the value of the equivalent shares) or a mix of cash and stock.
2) Tesla has hedged the call option on each bond (by buying call options itself) so it can fund these payments & avoid any new share issuance & dilution. Tesla partly funded buying these call options by selling warrants at higher strike prices.
3) It is only above these warrant strike prices (in the $561 to $655 range) where we will have to see dilution. The call options Tesla owns (and the value of the call option feature on the converts) is currently $2,587m. The value of the Warrants Tesla sold is currently $1,291m.
4) On the 1.25% $1,380m Mar-2021 converts, conversion price is $360 (3.8m shares). The call option feature on these is currently worth $570m. Tesla owns calls of this value to hedge potential dilution, but it has also sold warrants with a $561 strike (currently worth $235m).
5) On the 2.38% $978m Mar-2022 converts, conversion price is $327.5 (3m shares). The call option on these is currently worth $580m. Tesla owns calls of this value to hedge potential dilution, but it has also sold warrants with a $655 strike (currently worth $221m).
6) On the 2.0% $1,840m May-2024 converts, conversion price is $310 (6m shares). The call option on these is currently worth $1,438m. Tesla owns calls of this value to hedge potential dilution, but it has also sold warrants with a $607.5 strike (currently worth $835m).
7) Some converts are held by investors who want the equity exposure to Tesla but most are bought by debt funds who delta hedge equity exposure. Assuming 80% of converts are delta hedged, this convert hedge is now 8.4m shares ($3.9bn) of the ~24m Tesla short position.
8) How does conversion work in practice?
For the Mar-21 bonds, if the stock price is at $450 in March 2021, convert holders will choose to convert their $1,380m bond into 3.8m shares worth $1,725m. Tesla's call option hedge will be worth $345m & the warrant it sold worth 0.
For the Mar-21 bonds, if the stock price is at $450 in March 2021, convert holders will choose to convert their $1,380m bond into 3.8m shares worth $1,725m. Tesla's call option hedge will be worth $345m & the warrant it sold worth 0.
9) Tesla can either choose to pay the bondholders $1,725m in cash or it can issue them 3.8m new shares. If it issues them 3.8m new shares, it will eliminate $1,380m debt off its balance sheet & also close its call options to raise $345m new cash on balance sheet.
10) Alternatively it can choose to pay cash, here it will sell the calls and eliminate the debt and give the bondholders $1,725m, but cash balance would be depleted by $1,380m.
In this case it is quite likely they issue normal bonds to fund the $1,380m.
In this case it is quite likely they issue normal bonds to fund the $1,380m.
11) Alternatively if stock price is $600 in Mar-21 the convert holder's 3.8m shares will be worth $2,300m & Tesla's call option hedge worth $920m. The $561 strike warrants will be in the money & Tesla will have to issue 3.8m shares to warrant holders (at issue price of $561).
12) So here if Tesla chooses to repay the convert in cash. It will sell the calls, pay the convert holders $2,300m & deplete cash balance by $1,380m. It will then issue 3.8m new shares to warrant holders & receive $2,132m cash in return.
13) So overall it will have eliminated $1,380m debt and increased cash balance by $752m while diluting stock by 3.8m new shares.
14) It can also choose double dilution and repay both the convert holders and warrant holders in new shares. In this case it will see 7.6m dilution, eliminate $1,380m debt and raise $920m + $2,132m = $3,052m cash.
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