May 2, 2019
By Kate Duguid
NEW YORK (Reuters) – Tesla Inc should find no shortage of demand for the $1.35 billion convertible bond the electric carmaker is selling even though the terms it is offering look inferior on paper to a similar deal two years ago, bond investors said Thursday.
And Tesla’s volatile and broadly underperforming stock is one reason why, they said.
Convertible securities feature the income and protections of a low-yielding bond but offer the potential to profit far more from a jump in the stock price that triggers repayment in shares rather than cash.
In the new deal, being sold alongside $650 million in new shares, Tesla is looking to offer an interest rate below the coupon on its previous convertible from two years ago, even though interest rates today are broadly higher. There is also a higher bar for taking advantage of the stock price.
Investors, however, said the new deal in fact looks appealing when compared with Tesla’s existing convertibles, which now feature even leaner yields and, because the stock has been so wobbly, an even lower chance at striking a rich equity conversion before those bonds mature in the next three years.
“With this new bond, you have five years until the bond is supposed to pay off. They don’t have to be successful, they don’t have to hit a home run. They just have to stay in business to refinance this in five years,” said Geoffrey Dancey, managing partner and portfolio manager at Cutler Capital Management.
The fundraising – which could top $2 billion in total – is easing Wall Street concerns about the carmaker, which has struggled to maintain profitability, and its ability to overcome a drop in sales and build new product lines. Tesla shares, which had fallen by nearly 10% in the two years since its last convertible was sold, ended more than 4% higher on Thursday.
The new convertible bond is seen carrying a coupon of between 1.5% and 2.0% with a conversion premium of between 27.5% and 32.5% over the reference price for Tesla shares at the time of the sale, according to a trader who saw preliminary marketing materials for the deal on Thursday.
While those appear to be poorer terms for investors than the 2.375% coupon on the $977.5 million convertible bond maturing in March 2022, it is superior to the current yield to maturity on that 2022 bond at around 1%, Dancey said.
On its face, the conversion premium being touted, with a midpoint at 30%, also compares unfavorably to the 2022 bond’s lower conversion premium of 25%. But the underperformance of the stock, which closed at $244.10 on Thursday, means holders of the 2022 bond need at least a 34% rise in the stock to a price of$327.50 in order to trigger a conversion.
“The terms of the convertible look reasonable, and I don’t think they’ll have any issue selling,” said Dancey, who may buy some of the new bonds. He does not have an existing position.
Another boost to demand could come from the legion of short sellers of Tesla shares who often buy convertibles as a hedge, a common arbitrage used by hedge funds, said Eli Pars, co-chief investment officer at Calamos Investments. More than 25% of Tesla’s public float of stock is sold short.
“I haven’t heard anything that would make me think this would have any trouble getting done,” Pars said. Calamos has positions in convertibles from both Tesla and its solar panel-making unit, Solar City, according to its most recent SEC filing.
“With convertible bonds there are many opportunities for things to turn out OK,” he said.
Ross Gerber, chief executive of investment manager Gerber Kawasaki, known for his bullish positions on Tesla said the “noise” surrounding Tesla – including Chief Executive Elon Musk’s recent court fight with the SEC over his tweets – had rattled some of his clients.
“When we build a portfolio, Tesla will be a part of it. But what we’ll probably be doing is adding more on the convertible side not on the equity side,” he said.
(Reporting by Kate Duguid; Editing by Dan Burns and Lisa Shumaker)