The corporate bond market seems to be betting that the going-private transaction mooted by Tesla Inc. Chief Executive Elon Musk earlier this week will not materialize, or at least not in any conventional way.
Tesla TSLA, -4.83% bonds, which unusually for debt tend to track the stock’s performance, initially jumped after Musk shocked investors with a tweet saying he had secured funding for a possible deal at $420. They have retreated now and are nowhere near a price that would suggest bondholders expect any deal to take place.
The 5.300% notes that mature in August of 2025 were last trading at 91.175 cents on the dollar to yield 6.910%, or at a yield spread of 397 basis points over Treasurys, 18 basis points wider on the day. The bonds traded above 93 cents on Wednesday at their peak.
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The bond’s covenants, the provisions that are supposed to protect the bondholders, include a mechanism that would give the holders the right to sell their bonds at 101 cents on the dollar if certain conditions are met.
That mechanism, a change of control put, would only be triggered if any person or group ends up owning more than 50% of the voting stock of Tesla or a newly created holding company, and if two of the major bond ratings agencies, S&P Global and Moody’s Investors Service, were to downgrade the debt below the agencies’ issue-date rating.
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At issuance, the $1.8 billion of notes were rated at B- by S&P and B3 by Moody’s, both of which are below investment-grade status, making them high-yield, or “junk” bonds. They are currently rated at B- and Caa1, as Moody’s downgraded Tesla's debt in March citing liquidity concerns.
On Thursday, Moody’s said the plan is credit negative, as the company will still need to tap capital markets to fund itself and repay debt, but it will not affect its ratings for now.
Tesla bonds should be trading much higher if the bond market was assigning a good chance that the deal would go through with a change of control.
In most buyout deals a change of control “is clearly triggered,” as usually a private-equity firm would swoop in and take more than 50% of the company, said Justin Smith, a managing director at Xtract Research, a firm specializing in covenant research.
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Tesla bonds are unusual in the debt world, likely reflecting an investor base that includes Tesla fans and admirers, some of whom are not conventional bond investors. That’s one reason they have tended to track the stock. The notes are Tesla’s only pure bonds—the company has issued convertible bonds too—and were sold in August 2017.
At the time, many traditional bond investors balked at the lack of compensation for the high risk of a loss-making car maker with unreliable cash flows and for lacking many of the customary bondholder protections.
“We never thought this business should be debt financed,” said Bill Zox, chief investment officer at Diamond Hill Capital, a Columbus, Ohio-based investment company. Musk “does strange things with (Tesla),” and the company doesn’t seem the kind of business bond money would finance, he said.
Bondholders tend to be tightly focused on an issuer’s financials and especially its cash flows, to be sure that it can and will make its interest payments. That close attention to the balance sheet is one reason the bond market is often considered to be “smarter” than the stock market.
“The holders of these bonds are looking at things differently,” Zox said.
They were “somewhat irrational” before the going-private talks and after the talks, he said. They seem to be relying on market capitalization to support their positions rather than cash flow, he said.
After its initial euphoria, the stock market appeared Thursday to have less confidence in the proposed deal, with Tesla shares down more than 4%.
The stock rallied 11% on Tuesday following Musk’s tweets and comments, but are now off around 6% from Tuesday’s $379.57 close. Many are questioning whether funding that would come to tens of billions of dollars and easily dwarf previous buyouts was lined up as firmly as Musk suggested in his tweets.
The U.S. Securities and Exchange Commission has inquired about Musk’s first tweet, although it was unclear whether an official investigation had been opened, according to a report on The Wall Street Journal that cited unnamed sources.
Musk has indicated that he did not expect that his Tesla ownership stake of around 20% would change following the take-private deal, “suggesting any shares tendered for $420 in cash need to be replaced by a new equity holder, i.e. a strategic acquirer offering to buy a large number of outstanding shares, as opposed to Tesla raising new equity or issuing debt to buy out shares,” analysts at Bernstein said in a note Wednesday.
“The question then is, who would be willing to buy TSLA shares at $420, when the stock has never traded at such a level, and was trading ~$300 a week ago? Clearly someone who wants a majority (or very large) stake,” they said.
That would leave only a few deep-pocketed investors worldwide. Recent news reports citing unnamed sources have said that two of the more bountiful coffers that could be involved in the deal, SoftBank Group Corp. 9984, -0.38% and Saudi Arabia’s sovereign-wealth fund, are not interested.
“We believe Tesla will need to secure three to five investors prepared to write multibillion-dollar investments,” analysts at Evercore ISI said in a note Thursday.
At $420, Tesla’s enterprise value would be around $72 billion, excluding debt. Estimates vary on how much money would be needed to pull off a deal, with consensus emerging around $40 billion.
Tesla shares have gained 13% this year, compared with advances of 7% and 3.4% for the S&P 500 index SPX, -0.14% and the Dow Jones Industrial Average. DJIA, -0.29%
Ciara Linnane in New York contributed to this story.
