I'm updating these convertible debt numbers as $TSLA's rapid share price rise has significantly increased potential positive impact from its convertible bonds & call option hedges.
Tesla's $4.20bn convertible bonds are now all in the money. What does this mean for Tesla?
Tesla's $4.20bn convertible bonds are now all in the money. What does this mean for Tesla?
1) The converts can only 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. At 50% IVM the call options Tesla owns (& value of the call option feature on the converts) are worth $6,245m. The value of the Warrants Tesla sold is currently $4,173m
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 $1,661m. Tesla owns calls of this value to hedge potential dilution, but it has also sold warrants with a $561 strike (currently worth $1,069m).
5) On the 2.38% $978m Mar-2022 converts, conversion price is $327.5 (3m shares). The call option on these is currently worth $1,434m. Tesla owns calls of this value to hedge potential dilution, but it has also sold warrants with a $655 strike (currently worth $835m).
6) On the 2.0% $1,840m May-2024 converts, conversion price is $310 (6m shares). The call option on these is currently worth $3,150m. Tesla owns calls of this value to hedge potential dilution, but it has also sold warrants with a $607.5 strike (currently worth $2,269m).
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 12.0m shares ($9.4bn) of the ~24m Tesla short position.
8) How does conversion work in practice?
For the Mar-21 bonds, if stock price is at $780 in March 2021, convert holders will choose to convert their $1,380m bond into 3.8m shares worth $2,990m. Tesla's call option hedge will be worth $1,661m & the warrant it sold worth $1,068m.
For the Mar-21 bonds, if stock price is at $780 in March 2021, convert holders will choose to convert their $1,380m bond into 3.8m shares worth $2,990m. Tesla's call option hedge will be worth $1,661m & the warrant it sold worth $1,068m.
9) Tesla can either choose to pay the bondholders $2,990m in cash or it can issue them 3.8m new shares. If it pays in cash, then Tesla will sell its call options for $1,610m and deplete its cash balance by $1,380m while eliminating $1,380m debt on balance sheet.
10) But Warrant holders also have right to buy 3.8m shares at $561. So from the warrants Tesla would suffer 3.8m dilution but raise 3.8*$561 = $2,151m cash. If it chooses it can use this cash to buy back $2,151m/$780 = 2.8m shares. And overall dilution could be just 1m shares.
11) Alternatively Tesla can choose to pay the converts back with 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 $1,610m new cash on balance sheet.
12) But again Warrant holders will also have the right to buy 3.8 million shares at a price of $561m. So from the warrants Tesla would suffer 3.8m dilution but raise 3.8*$561 = $2,151m cash.
13) So the overall impact of the Mar-21 converts would be 7.6m share dilution, $1,380m debt elimination and $1,610m + $2,151m = $3,761m cash on balance sheet. Again it can use some of this cash to buy back shares if it wants to reduce dilution.
14) But at current share price it is possible for Tesla to reduce recourse debt by $1,380m and raise cash by $3,761m from the Mar-21 convert maturity alone if it chooses to accept max dilution of 7.6m shares.
15) This is relative to gross recourse debt of $7,263m & net recourse debt of $995m at 4Q19.
So net recourse debt of $995m today could turn to net recourse cash of $4,146 in Mar-21 if Tesla chooses to (ignoring free cash flow in next 5 Qs).
So net recourse debt of $995m today could turn to net recourse cash of $4,146 in Mar-21 if Tesla chooses to (ignoring free cash flow in next 5 Qs).
16) I don’t think there is anything necessarily stopping Tesla selling the $6.3bn of call options (across all 3 bonds) it owns today & increasing cash balance today to $12.6bn.
17) This would however leave Tesla exposed to double dilution of 12.8m shares on the 3 converts & 12.8m on the warrants. I doubt they will unhedge the converts as they likely still see the company as undervalued.
18) Tesla could also choose to close both the $6.3bn calls it owns and $4.2bn warrants it sold to raise cash of $2,073m today. This would however still leave it exposed to 12.8m dilution on the converts (if it does not find other ways to pay these back in cash).
