Tesla’s Convertible Bonds – What You Need To Know

Peter Sayles |

Tesla could be the most polarizing stock of all time.

It’s in the news almost every single day – for good or for bad.

Elon Musk – the founder and CEO – has a cult-like following. He’s a “man of the people.” A genius who’s changing the world for the better.

But there’s also the bears – investors who don’t think Tesla stock should be valued anywhere near the $50 billion market cap it has today.

We lean towards the latter. We’ve shorted – betting the stock would fall – twice already. 

The first time we made 25.6% back in August 2018 – when Elon lied about Tesla having “funding secured” to get acquired. 

Our second short position – which we initiated October 2018 – is still open (Although we closed half of the position for an 11% gain). But we don’t plan on closing our ½ position any time soon. 

Why? Because Tesla has two massive debt payments it has to make. The biggest one is its $920 million convertible bond due March 1, 2019. 

This bond payment means everything to Tesla and its investors. We’ll show you why. But first, let’s define what a convertible bond is. This way, you’ll understand why it’s such a big deal to bulls and bears alike.

What Is A Convertible Bond?

Investopedia defines it as “A convertible bond is a type of debt security that can be converted into a predetermined amount of the underlying company’s equity at certain times during the bond’s life, usually at the discretion of the bondholder.”

In layman’s terms, it means someone who owns a bond who can convert it into shares at a certain price. A convertible bond doesn’t have to be converted all into stock.

It can be divided into cash and stock, depending on the bond.

Tesla’s March 2019 Convertible Bond

Tesla issued a $920 million convertible bond due March 1, 2019.

The terms state bondholders can convert their debt into stock at $359.87 per share.

The question that probably pops up in your head is, “Why would bondholders convert their debt to Tesla stock at $359.87 if shares currently trade around $300.

The answer is… they wouldn’t.

Shares haven’t traded around $360 since a quick run up this past December. And August before then. 

There’s a couple unique caveat’s in this convertible bond which CFA Paul Huettner dives deep on here. (We consider this a must-read).

But the basics still apply – bondholders will want to get paid in full if Tesla’s stock isn’t over $359.87 by March 1. That’s 16.5% higher than it is today (Jan 31, 2019). 

Why Tesla’s Convertible Bond Is A Big Deal

This convertible bond is making all the financial waves for a simple reason.

Can Tesla afford to pay $920 million in full?

The answer is: yes, it can. But at a huge cost.

For starters, Tesla barely makes any money today. It squeaked out just $139 million in net income this past quarter. 

However, it still lost $1 billion in fiscal 2018.

It hasn’t earned a net profit in an entire year in its history.

Tesla has relied on capital and debt raises to keep the lights on. But this $920 million bond payment is the real test on whether investors will continue to trust Elon’s grand vision.

We don’t think so.

Tesla’s credit rating is already considered “junk.” And it already has $9 billion in long-term debt on its balance sheet.

The interest rates creditors would ask for from Tesla would be enormous if Elon tried to tap the debt markets today.

And share prices would tank if Elon issued stock to fuel his expansion plans.

The real question: How does a company who burns through billions each year afford a $920 million bond payment?

What Will Happen If Tesla Bondholders Don’t Convert To Stock?

Let’s say all bondholders don’t feel like taking the risk on Tesla’s stock. And all of them asked to be paid back in full instead of converting to shares.

Tesla has $3.6 billion in cash on its balance sheet. So it’s not like the $920 million payment would send them into bankruptcy.

But Tesla needs as much cash as possible at all times. 

Remember, Tesla has never been profitable for an entire year. And it doesn’t look like they will be any time soon. 

They’re building a multi-billion gigafactory in China. They’re building an all electric semi-truck. They’re still losing millions on solar panels – which they have barely rolled out. And too much more to name.

So it needs the cash to fuel all of Elon’s goals.

Paying bondholders in full would take its cash balance down to $2.6 billion. 

If Tesla loses $750 million next year (a 25% improvement from 2018), it would give them 3.5 years of runway. 

Not bad… except when you look at the next bond payment coming due.

Does Tesla Have Other Convertible Bonds?

Yes. Tesla has a couple other convertible bonds. But the one you need to know about is the $1.4 billion convertible bond due March 1, 2021.

If investors around the world are figuring out what bondholders will do for this $920 million bond payment coming due in a month… what do you think will happen when the $1.4 billion bond comes due in two years?

We think the outlook is dire for Tesla for a couple reasons.

First, we don’t think Tesla will make a net profit in two years – due to Elon’s bold vision.

Second, Tesla lost its first mover advantage. Every major car company now produces electric vehicles. People stick to the brands they love. We don’t see many lifelong BMW, Mercedes, Porsche, Ford, GM drivers switching to Tesla… not if they sell electric cars already.

Third, Elon still has yet to come up with any viable plan to make the Model 3 an affordable car for the masses… something he’s promised for years now.

Fourth, it looks like the world is heading into recession. It’s not a guarantee. But the last thing people do in recessions is buy new cars. 

Five Other Concerning Things You Need To Know About Tesla In 2019

Tesla Just Laid Off 7% Of Its Workforce

“We are making this hard decision now so that we never have to do this again.”

This wasn’t Elon in January. This was Elon in June 2018. Yet here we go again.

This is the second round of layoffs in the past eight months.

Why is Tesla laying off thousands of workers if things are going so well? We keep hearing about strong demand. Layoffs say the exact opposite.

But this last set of layoffs (Jan 23) was the most concerning.

The cuts came across all departments, but many from its sales and delivery teams for the Model S and X – aka the people who make and sell the cars. Tesla is likely considering stopping production on these models altogether.

Tesla’s Chief Financial Officer – Deepak Ahuja – Is Retiring

Elon dropped the bombshell at the end of the earnings call January 30.

He told investors Ahuja was retiring. This the second time Ahuja decided to step away from Tesla as CFO – his first departure was in 2015. He came back two years later.

That means this is the fourth CFO in as many years.

Zack Kirkhorn – aged 34 – is set to take over the role. It’ll be his first executive role. A tough task for a first time executive to take over the most polarizing $50 billion company in history. (We’ll see how long he lasts).

The instability at the executive level is amazing. And we’re not just talking specifically about the CFO role. Business Insider even started a list of all the executive departures in the last two years.

Tesla’s Model 3 Still Isn’t Profitable At $35,000

We’ve got to give Musk credit. 

He could be under the biggest microscope in the world of finance. The standard he’s held to is unlike any we’ve ever seen.

Not even Jeff Bezos is expected to over deliver as much as Musk.

But a lot of that is brought on himself. Musk continues to make absurd projections and claims in press releases and tweets alike. 

A lot of the criticism is warranted. CEOs should be held to a higher standard. And shouldn’t be leading on investors to these farfetched claims.

The one that comes to all the short sellers’ minds was the Model 3.

Elon has been telling investors he’s on the cusp of creating an affordable $35k Model 3 for the past three years.

The starting Model 3 price is $36,000… completely bare bones. And it’s only if you pay cash in full. Getting autopilot is an extra $5,000. Any interior changes are $1,000 bumps.

The point we’re making is for Elon to just settle down. Stop making these lofty goals for yourself. Then the short sellers – us included – wouldn’t be so hard on him.

Oh, and here’s a quote from Elon from this past earnings call (emphasis added):

“The demand for Model 3 is insanely high. The inhibitor is affordability. It’s just like people literally don’t have the money to buy the car… They just don’t have enough money in their bank account. If the car can be made more affordable, the demand is extraordinary.”

Hmmm….

The Saudi Public Investment Fund Hedged Its Entire Tesla Stake

The Saudi Arabia Public Investment Fund owns 4.9% of Tesla’s shares outstanding.

It hedged almost all of its stake in Tesla through JPMorgan on January 17 – the day before it fell 13%.

Coincidence? Who are we to speculate?

If Saudi Arabia is hedging all of its stake (A $2.5 billion position) in January, then we should take note and proceed with caution.

Clearly they don’t see things working out like they once did.

Tesla Earned $7 Million In Net Income On $3.6 Billion

Remember we told you Tesla has $3.6 billion in cash on its balance sheet?

Not all of that is technically cash. Companies tend to put a lot of their cash in short term treasury bonds.

They then earn interest on those bonds. Just like bondholders earning interest on debt.

Well, if we look at Tesla’s income statement, we see that Tesla only earned $7 million in interest income in the fourth quarter.

Wait, what?

Tesla earned just $7 million in income on $3.7 billion in cash? That means it earned less than 1% interest on its cash.

The yield on a 2-month U.S. Treasury bill is 2.4%. 

You do the math.

Conclusion

The world is watching Tesla’s share price. It needs to trade above $360 by March 1. If it doesn’t, we’d assume most bondholders will want to be paid in full.

Tesla can afford to pay the bond. But that’s not what’s concerning.

What’s concerning is that Tesla is trying to self-fund all of its endeavors. Paying $920 million is a huge inhibitor.

But $920 million isn’t the end of Tesla’s worries. It has a $1.4 billion bond due in 2021.

Meanwhile, it looks like the global economy is starting to show cracks. Even if Tesla meets all of its goals, it’ll struggle to make this payment just two years from now.

We continue to recommend our readers short Tesla.