Deals

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

There was a time when SolarCity's convertibles were like shiny Mustangs cruising with the top down. These days, they're more like a Camry with a broken tail-light. Still, they've had a little more vroom recently, courtesy of an altogether different vehicle.

That New Car Smell
SolarCity's convertibles have been revived somewhat by Tesla's acquisition offer
Source: Bloomberg

Tesla's bid for SolarCity is a lifeline to a company that, as SolarCity's latest results showed, faces a trifecta of high costs, ballooning debt and faltering growth. Yet the all-stock nature of the deal means SolarCity's convertibles will, assuming the deal goes through, be hitched to Tesla's shares -- which brings complications of its own.

Tesla offers more safety than SolarCity, with the caveat that this is all relative. Tesla is much bigger and, crucially, still has fans in the stock market willing to provide more capital to fund CEO Elon Musk's expansive vision. Even so, taking on SolarCity piles further pressure on Tesla, which is also burning cash.

Doubling Up
Taking on SolarCity almost doubles Tesla's debt
Source: Bloomberg
Note: Pro forma figures shown by year of maturity. Includes bonds, convertible bonds, term loans and amounts drawn on revolvers.

And unless those holding SolarCity's convertibles feel especially bullish, it doesn't seem likely the deal will shift that paper to looking like anything other than debt. While the exact conversion ratio will have to be worked out, using the deal's stock ratio -- 0.11 Tesla shares per SolarCity shares -- the implied strike prices on Tesla stock for the convertibles look ... ambitious:

  • $230 million due in 2018: $561
  • $566 million due 2019: $759
  • $113 million due 2020: $300
  • Current Tesla price: $226

While SolarCity's convertibles have perked up since the deal was first mooted, the same can't be said for Tesla's. Here's how its biggest convertible issue -- $1.38 billion due in 2021 -- performed along with its stock this year up until the announcement:

Best Buds
Tesla's convertibles have traded roughly in line with the stock, as you might expect
Source: Bloomberg
Note: Indexed to 100.

That changed after June 21.

Back Seat
Tesla's convertibles have lagged behind since the SolarCity deal was announced
Source: Bloomberg
Note: Indexed to 100

While the stock market has apparently recovered from its initial dismay at the deal, bondholders haven't.

There's likely an element of standard bond vigilantism at play here. Tesla's 2018 convertibles have a conversion price of $124.52, only about half the current stock price . Yet, in Tesla's latest quarterly filing, it disclosed that holders of $411 million of those bonds, more than 60 percent of the principal outstanding, had filed notice to convert after the quarter ended -- and, it should be pointed out, after the SolarCity deal was first broached.

In the Moebius-strip world of convertible bonds, though, there is something else going on, linked to trading in Tesla's stock. Bill Feingold, co-founder of Hillside Advisors and specialist in convertibles, points to the uptick in shorting of Tesla's stock since the deal was announced. Roughly a quarter of Tesla's float is now sold short, according to data compiled by Bloomberg. For holders of the convertibles trying to hedge their own exposure by shorting the underlying stock, that means higher costs -- as you can see here:

Lender's Market
The cost of borrowing Tesla's stock to sell short has jumped since the SolarCity deal was announced
Source: S3 Blacklight, Bloomberg
Note: Weighted mid-market rate.

Like anything else -- a Mustang, say -- if the cost of insuring those convertibles shoots up, then the price you're willing to pay for them goes down. SolarCity's bondholders have been thrown a lifeline. But in pulling on it, they'll also help it to unravel. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. Tesla has two other convertible bonds outstanding. One is a $920 million issue with a coupon of 0.25 percent, due in 2019. The other, with principal of $1.38 billion, matures in 2021 and carries a coupon of 1.25 percent. Both convert at about $360, about 60 percent higher than the current stock price.

To contact the author of this story:
Liam Denning in San Francisco at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net