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.

This is what disbelief looks like:

Yeah, Riiiiiiight
SolarCity's stock now trades almost a fifth below Tesla's (reduced) takeover offer
Source: Bloomberg, Tesla Motors
Note: Data through July 29th reflect mid-point of range for exchange ratio proposed initially.

The question is: Disbelief in what, exactly?

The straightforward explanation for a chart like this is that investors are losing faith in Tesla actually acquiring SolarCity. Why else would you be unwilling to pay more than $18.06 for shares that are, under the terms of the all-stock offer, nominally valued at $22.19 by Tesla?

But then nothing about the Tesla-SolarCity deal -- with its family ties centered on Elon Musk, dubious industrial logic, and interesting timeline -- is that straightforward.

Normally, when a deal like this gets announced, merger arbitrageurs take positions in the two stocks. A typical trade is to buy the shares of the target and sell the acquirer's shares short in order to lock in the spread between them. That's tricky in this case because almost a quarter of Tesla's float is sold short already, so borrowing the stock is expensive.

Yet, as Louis Meyer, Director of Event Driven Research at Oscar Gruss, points out, short interest at Tesla has actually been coming down in recent weeks, even as the discount in SolarCity's stock has widened. You can see this in the data:

Short Story
After spiking on news of the deal, the cost of borrowing Tesla's stock to sell short has dropped by half
Source: S3 Blacklight, Bloomberg
Note: Weighted mid-market rate.

Similarly, while short interest in SolarCity remains high -- about 29 percent of its float according to data compiled by Bloomberg -- it has also been coming down in recent weeks.

Short interest falling in both stocks casts some doubt on another possible explanation for what's going on, namely that SolarCity is being used as a proxy to sell Tesla short.

The idea here is that, as SolarCity's stock will convert into Tesla's when the deal goes through, some may be selling SolarCity short in the expectation Tesla's stock will have fallen substantially -- current prices would imply almost a fifth -- by then. 

Meyer's hunch is that, while some brave souls may actually be actively shorting the deal itself -- that is, selling SolarCity short and buying Tesla on the expectation the merger never happens -- many simply want nothing to do with the situation. And without the arbs, "There's no pressure on the spread to stay tight" he says.

He cites any number of reasons for them to steer clear. One is the sheer volatility in both stocks. Another is the volatility of the bid itself, which began, unusually, with Tesla providing an offering range that it then cut by 10 to 16 percent just over a month later.

Since then, SolarCity has looked more and more like a potential millstone than the no-brainer opportunity Musk claims it to be. That much was hammered home by SolarCity's dreadful quarterly results call and the news that Musk and other insiders are buying most of the company's latest slug of bonds.

Tesla, which has an expensive Gigafactory to build and a global car industry to overturn, hardly needs the extra hassle -- especially as it says it will be tapping investors for yet more cash later this year. So on top of deal-related risk, there's also financing risk at both the target and the acquirer.

The big question, as it has been all along in this saga, concerns the attitude of Tesla's shareholders.

With SolarCity owing money to SpaceX -- Musk's unlisted rocket developer -- and insiders, and Tesla needing cash itself, the electric-vehicle maker's highly valued shares are critical. In a rational world, holders of those shares would consider SolarCity's wide discount alongside the fact that, despite this apparent bargain, no other bidders have emerged, and conclude Tesla is clearly overpaying and they should vote the deal down.

One twist they have to contend with, though, is that, in the absence of near-term profits, the value of Tesla's stock is inextricably bound up with belief in the abilities and vision of Musk himself. While the decision to buy SolarCity may have dimmed that aura somewhat, a potential collapse at SolarCity if the deal doesn't go through could be even more damaging -- one of those damned if you do, damned if you don't situations. Nothing is simple once you've entered the Muskplex

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

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

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