The wild ride of owning Tesla Motors (NASDAQ:TSLA) stock recently prompted me to sell the stock and buy Tesla convertible bonds. The "converts" have less upside than the stock, but less downside, too. When I bought them, these bonds were rated "junk" - meaning that Tesla has a higher-than-usual chance of bankruptcy.
I don't think Tesla will go bankrupt, but I'm not sure about the valuation. My biggest concerns are 1) whether S and X demand will increase to match the planned production ramp; 2) whether gross margins on Model 3 will be high enough to yield strong earnings, and 3) how competition from Audi and others will affect sales.
At the same time, I believe that if Tesla can execute without further production delays, and if EV sales don't stall after the early adopters all buy an EV, the company could be wildly successful. (An additional potential catalyst is Powerpack sales to utilities.)
So I bought some Tesla convertible bonds, which are less bouncy than the stock. I considered the 2019 and the 2021 maturities, each with a conversion price of approximately $360 at maturity. The 2021 bond gives the holder more time for the stock to potentially exceed $360 at the maturity date, but also more time for Tesla to potentially go bankrupt, in which case the bonds could be worthless.
At a stock price of up to about $360 at maturity - as long as Tesla had not gone bankrupt - the bonds should pay off in full, at the face value of $1,000 each.
If Tesla stock were worth $400 at the convertible bonds' maturity, owners of these "converts" should receive a payment of about $1100, or about 10 percent more than the approximately $360 conversion price ($400 is about 10 percent more than $360). In contrast, Tesla stockholders who had purchased $1,000 of stock at the current price of about $250 per share (i.e., about four shares) would own stock worth about $1,600 ($400 x 4 shares). Since $1,600 is a good bit more than $1,100, that's a clear reason for Tesla optimists to own the stock instead of the convertible bonds.
Only if Tesla's stock price were well above $400 at the maturity date for the convertible bonds, would those "converts" provide significant upside.
Conclusion: Those who are less sanguine about Tesla's fortunes, yet who see potential for a strong Tesla upside, may consider the "converts" instead of the stock.
Disclaimer: Tesla's convertible bonds (as well as the stock) may become worthless at any time, if Tesla goes bankrupt. Consult a financial adviser and read the prospectus before purchasing Tesla bonds or stock. The author is an amateur individual investor and the narrative above may contain substantive errors and/or omissions - do not rely on this narrative for any investment decision. Go to the investor relations section of the Tesla Motors website to access the Feb. 28, 2014, prospectus for both bonds discussed here.
Disclosure: I am/we are long TSLA.
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.
Additional disclosure: Long Tesla convertible bonds and stock.