Here's how Daimler described it:
The objective of the transaction concluded is to protect the value of Daimler's shareholding in Tesla, [while] allowing Daimler to retain significant participation in any further appreciation of Tesla share price during the three year collar agreement.
Daimler's announcement was a little "sketchy" in details. Very little else appears anywhere, other than they used a three year "Collar" to accomplish this.
Though there is no question that Daimler's move is bullish for Tesla, the "devil is in the details." Since we don't have the details, the best one can do is to try to extrapolate from what is available. Even so, any such analysis must come under the category of "reasoned speculation."
Let's start off with understanding that Daimler desires a working relationship with Tesla. Tesla is supplying electric motors and batteries to Daimler for its Smart Fortwo electric vehicle and the new Mercedes-Benz B-Class EV, which goes on sale next year.
Daimler said in October it would like to expand its cooperation with the company. Daimler's finance chief said in a statement...."We are also demonstrating the long-term nature of our partnership and our intention to continue and to broaden the partnership in the coming years."
So, though it is clear that Daimler has interest in Tesla's technology, the hedge may represent somewhat less interest in its stock. This is made even more so after its divestiture of 40% of its stock interest last year. If we examine this hedge we may discover some support for this theory.
First, and foremost, it is very telling that Daimler used a collar. For those that are not familiar with this strategy, it is a methodology whereby one limits the downside risk by trading off some upside potential. This is a common option strategy, though it is unknown if Daimler used commercially available options or entered into a private arrangement. It's a pretty good bet that it's a private arrangement.
A second feature of any collar, is the amount of downside protection afforded and how much upside is exchanged. Also one must consider if the collar is zero-cost, net debit or net credit. If the collar is zero-cost, it usually means that the trade-off is about equal in terms of upside/downside.
That is, a zero-cost collar would typically provide, say, downside protection in excess of 10% loss in exchange for a 10% upside limit. More upside potential would either cost out-of-pocket or reduce the amount of downside protection.
Now, if an investor expected a big run up in a stock, it is unlikely they would use a collar. They would need to set the upper limit so high, that the credit received would be very small. A simple put, or bear put spread would be much more flexible and eliminate the "cap" inherent in a collar. One tends to choose a collar over a put-spread when one is more concerned with large losses and less concerned with upside.
Though we don't know anything other than the collar is of three years duration, we can get some feel for it by examining CBOE options (though I suspect any private collar would be more favorable to Daimler).
CBOE options on TSLA only run two years out, but, then again, we're just trying to get a feel for the types of choices Daimler had to make.
If an investor wanted to protect against a decline in TSLA below $150, the cost would be around $46 (almost 1/3 of the price of TSLA). If a limit on the top-end was set at, say, $210, about one-half the cost would be recovered. So, the net cost would be reduced to around $24.
Now, that means TESLA would have to rise to about $175 just to recover the cost and break even. Since there's a "cap" at $210, the potential upside is limited to only $35. If one looks at the downside protection, the current price is protected, but since it costs, net, $24, there is still a potential loss. 0f over $24.
Now, I can't see why anyone would look to TSLA for this "tight" of a collar. They could just go out and buy a stable dividend achiever and probably have a better investment potential.
So, that means Daimler likely traded off one or the other ends of the collar .... either less downside protection or more upside potential. For instance, setting the lower end of the collar to "stop loss" at $120, would match the $210 top limit and reach a zero-cost collar.
We could go on and on with iterations, varying upper and lower limits, but, for purposes of this article, it is only important that one understand the trade-offs inherent in a collar. It is simply a balancing act of the amount of protection vs. the limit on growth.
Whenever one chooses to "give up" something" to "get something", their objective is to give up as little value and get back as much value as they can in the exchange. A collar is one of many hedges and specifically one that "gives up" growth and "gets back" protection.
Now, I keep asking myself a key question...Why, specifically, a collar?
No one but Daimler knows for sure, but here are some of the reasons most commonly used to precipitate choosing a collar vs. other hedges .....
- Maintain a VOTING interest in the "collared" stock by avoiding selling the stock.
- Deferring taxable gains for a period of time, before selling.
- "Eking out" small gains with small risks.
- Setting upper/lower limits far apart, resulting in some "smoothing" but still able to enjoy a big upside at the risk of downside loss. The extent to which they "smooth" depends upon how "tight" the collar.
- Concern about a major collapse of the stock, and a willingness to either bear some downside risk in the way most investors would bear a "correction" or accept limited upside potential.
- Sometimes, investors with very large holdings can actually drive the price down as they try to liquidate. Placing a collar, protects their position while they systematically and slowly dump their holding.
I also examine very closely Daimler's statement ".... to retain significant participation in any further appreciation ...."
This is very different than saying "... to retain participation in any significant further appreciation ...." The actual statement more closely references the extent of ownership, whereas the hypothetical statement more accurately refers to potential gains from outsized growth. Is Daimler just being broad-worded or clever?
Conclusion: Only Daimler knows what it did and why it did it. I can't get "into its head." Knowing the levels that the collar was set would be most revealing, but it's unlikely that whoever provided the collar would permit that.
Certainly Daimler is sophisticated enough to have available every possible hedging strategy. So it's reasonable to assume it chose the hedge that most directly represents its view of the risk/reward profile.
Daimler chose a collar and in so doing showed a willingness to sacrifice upside in exchange for downside protection. To me that is telling. Very telling. It means Daimler would rather "cap" the gains than part with cash, or risk losses resulting from a major stock collapse.
So, I draw from what little we know, that though Daimler is bullish on the technology TSLA has to offer, I also think it means that Daimler sees enough risk in the stock to trade off growth potential to mitigate the risk. I also surmise that Daimler thinks the "Story of Tesla" may well reach clarity within three years...Yea or Nay.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.