The End Of Tesla’s Convertible Era?

Tesla
March, 1st 2021 marks a historic day for Tesla. It’s the day in which holders of Tesla’s convertible bonds issued back in 2014 will convert those bonds into shares, realizing whopping gains of more than 800%. It is also a day that likely marks the end of Tesla’s extensive convertible bonds issuance.

Since 2013, Tesla has financed its expansion and growth using convertible debt, or bonds that could be later converted into common stock if the stock price appreciates enough. As I explained back in September:



“It issued $600 million dollars of convertible bonds in 2013, $2 billion dollars’ worth in 2014, $850 million worth in 2017, and an additional $1.6 billion worth in 2019.

What is behind Tesla’s obsession with convertible debt? Well, it turns out that Tesla is almost the poster child of convertible bonds issuers. The typical convertible issuer is a non-investment grade, high growth company that isn’t a traditional straight debt issuer. And Tesla falls precisely into the category of a speculative grade technology company. In fact, when Tesla issued its first convertible bond back in 2013 it was not even rated by one of the major credit rating agencies. …By issuing convertible bonds Tesla was able to get away with offering its investors a very low coupon—that is, the annual interest rate paid until the bond reaches maturity. For example, its 7-year convertible bond issued in February 2014 that is maturing on March-1st 2021 offered investors a coupon of 1.25%, while its 5-year convertible offering in 2014 was able to attract investors with a coupon as low as 0.25%!

[Investors] agreed to those ultra-low coupon rates since they were attracted to the possibility that they could convert the bonds into stocks if Tesla’s stock price appreciated enough.  Unfortunately, for the holders of the convertible bond that was issued with a coupon of 0.25% – they saw their bonds mature when Tesla’s stock price fell way below the conversion price of $359.87. This was good news to Tesla, which was able to raise capital at only 0.25% with no need to dilute its equity! ”



But now it’s a different story. When the 2014 convertible bond was issued, Tesla’s stock price—adjusted for its 5-for-1 stock split—was $50.5, and it had to appreciate at least 42.5% (to $72) for the stock price to surpass its conversion price and for the option be “in the money.” Seven years later, boosted by the run-up over the last twelve months, Tesla’s stock price has appreciated by an incredible 1,346%! Many of the investors have already converted their bonds: Tesla has paid out $958 million in cash and issued 11.1 million shares to holders of those bonds. But there’s $419 million in bonds left to be converted into a total of 5.8 new shares worth more than $3.9 billion. Investors who bought bonds in 2014 and held them to maturity have earned a return of more than 840%!

Tesla still has several other convertible bonds outstanding that were issued a few years ago, but it now seems that Tesla’s affair with convertible bonds has ended. After a remarkable run-up in its stock price, it may be difficult for Tesla to keep offering convertible bonds. With a market cap of almost $650 billion, which some argue is way overvalued, investors may be wary of buying deeply out-of-the-money options embedded in new convertible bonds.

Tesla had a good run with convertibles and is now a textbook example for how to use them well.  But now that Tesla has matured, with a credit rating only two notches below investment grade and a spot on the S&P 500, it is time for Tesla to use less complicated forms of financing. Similar to how Tesla shifted its production from the expensive convertible Roadster supercar to the affordable pedestrian Model 3, it’s time for Tesla to move from fancy convertible bonds to good old plain-vanilla bonds.

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