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On the SEC investigation into Tesla and the potential ‘this is fraud’

By Edward Harrison

Tesla CEO Elon Musk’s tweets about Tesla’s going private have provoked an investigation by the Securities and Exchange Commission. The SEC is looking to determine whether the information provided by Musk was truthful and to determine why the tweets were made. Given the existence of Tesla’s convertible bonds that are due in February and convert at $360 a share — just above the level where shares closed yesterday, this is a serious matter.

Former SEC attorney sees foul play

Teresa Goody, a former SEC attorney and the founder and CEO of The Goody Group, told “Bloomberg Surveillance”, Fox Business and CNBC that Elon Musk’s tweets about going private were irresponsible and reckless. So it is right that the SEC look into the matter.

She says that Musk will have to prove that he has the funding secured and these conversations have been ongoing. And she says, “otherwise this is fraud”. What does that mean though?

To me, the ‘fraud’, if there is any, would come from a determination that the tweet was purposely misleading in order to boost the stock price. If the SEC finds that the funding has not been secured and the conversations on taking Tesla private are in their infancy, then the tweets by Musk are misleading. And then the question becomes: why did he try to mislead?

The $360 conversion due in February

The most obvious reason is cash flow. Tesla is cash flow negative. And it’s dwindling cash pile means that it either needs to reduce its cash burn drastically or it needs to raise money in the capital markets.

Tesla has a $920 million 0.25% convertible bond due 27 February 2019. But that bond is convertible into common shares at a price of $359.8676 per share. So, if the stock trades below that price at the time of conversion, the holder would be better off taking cash — and would do so.

Given Tesla’s cash flow situation, that puts huge pressure on Tesla to get the stock price above $360 or it has to fork over $920 million in February.

What’s more, Tesla has another convertible bond for $1.38 billion at 1.25% that matures 25 February 2021. This issue converts at the exact same price.

Now remember, if these bonds do not convert, Tesla is highly unlikely to get another convertible deal off the ground. It will have to pay the full coupon of a junk bond rated company, if it is able to sell any bonds at all. For example, Tesla’s straight non-convertible notes due 2025, issued at 5.30%, are trading at a yield to maturity of 6.77%.

And, on top of that, they have a change-of-control provision that would make them redeemable at par. This effectively makes Musk’s go-private strategy more expensive because the 2025 debenture has to be refinanced, heaping more cash flow issues onto the company.

These cash flow issues give Musk a huge incentive to pump up the stock price and could be the impetus for his tweets.

I continue to see Tesla as a very precarious enterprise with great risk attached to it, whether you are looking at the shares or the debt.

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Edward Harrison 7783 posts 575 comments

Edward Harrison is a senior Editor at Bloomberg. He is also the founder of Credit Writedowns newsletter, a former career diplomat, investment banker and technology executive with over twenty five years of business experience. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College.

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