Investors in Tesla bonds, options show skepticism on buyout

Reuters – August 2018

Investors in the debt and in the equity options of electric carmaker Tesla are betting the take-private deal described by Chief Executive Elon Musk will not materialize.

Like its stock price, Tesla bonds have given up all of the gains they made after Musk shocked investors with a tweet on Aug. 7, saying he had “funding secured” for a possible buyout deal at $420 per share.

This suggests the credit market has scaled back the chances of a deal, and data showed activity on the equities options market also indicates those investors also are skeptical.

Tesla’s high-yield debt trades at around 87.5 cents on the dollar, down from 93.0 cents on Aug. 7, according to Thomson Reuters data. Tesla’s convertible bonds due in 2021 88160RAC5=RRPS are trading around 107.20 cents on the dollar, down from 120.46 cents on the dollar on Aug. 7.

Convertible bonds give bondholders the right to trade their debt for equity after shares rise over a certain price.

Bondholders are paid back in full in the event of a buyout – at 101 cents on the dollar for the junk bond coming due in 2025 88160RAE1=RRPS if certain conditions are met. The company’s longer-dated convertible debt would earn an additional premium above par if Tesla were taken private.

“The smart trade at the moment is to short the converts and go long the high-yield bonds, because that spread will collapse” in the event Tesla files for bankruptcy, said Lawrence McDonald, founder of the Bear Traps Report.

McDonald believes bankruptcy is the path for Tesla if it does not find a buyer because of its high leverage compared to earnings before interest, taxes, depreciation and amortization.

A Tesla spokesperson declined to comment. Musk said in his second-quarter shareholder letter that the company can be sustainably profitable from the third quarter onward.

Tesla investors have raised their bets against the convertible bonds. Short positions in the three converts have risen, from $38.14 million on August 6 to $49.47 million on Aug. 16, according to IHS Markit.

Tesla’s convertible bonds due in 2021 are trading around 107.20 cents on the dollar – roughly 20.8 cents shy of where they should trade if a deal at $420 was fully priced, said Geoffrey Dancey, managing partner and portfolio manager at Cutler Capital Management.

“If these bonds were priced for a takeover, they would trade at a serious premium to the conversion value compared to when the deal was announced,” said Dancey. “The convertibles are certainly not trading as if this company is going to be taken private at $420 and they never did.”

Longer-dated convertible bonds benefit from take-private deals, which give bondholders additional shares. In a $420 per share deal, the 2021 convertible bond would receive an additional 11 percent above face value, or 11 percent more stock.

On the day of Musk’s buyout tweet, the share price hit an 11-month high of $387.46, more than $27 above the 2021 conversion rate. The highest the 2021 note traded that day was 120.46 cents on the dollar.

Now, the debt is trading below the price prior to the deal tweet, as well as below its price before its solid second-quarter earnings call on Aug. 1.

OPTIONS TRADERS UNIMPRESSED
Traders in the U.S. equity options market also appeared to doubt whether Musk can make good on his proposal, options data showed.

Data from Chicago-based volatility and options data firm ORATS showed that while traders had initially displayed some confidence Musk might be able to pull off a deal, conviction has dropped.

“Initially options traders reacted with a little bit of belief, now there is disbelief,” said Matt Amberson, founder at ORATS.

Stripped of the impact of earnings on one-year implied volatility of Tesla options, this gauge of how much traders expect the shares to move in the future is roughly back to where it was before the Musk tweet, ORATS data showed.

Had there been significant expectation for the Tesla to be taken private in the near future the volatility embedded in these contracts would have dropped, Amberson said.

By Kate Duguid & Saqib Igbal Ahmed