Tesla (NASDAQ:TSLA) recently issued convertible bonds due in 2022 with a 2.375% coupon. Due to the low coupon, at first glance, it sounds like bond markets are wide open to Tesla. 2.375% for a 5-year bond is barely above the yield of equivalent-maturity Treasuries. Sounds like Tesla has a credit quality close to that of the US Government?
However, we have to take into account the value of the conversion factor. This conversion factor provides a large portion of the value to the bond. Luckily for investors looking to value this security, Tesla fully hedged itself from the dilution of the bonds, effectively providing us the value to the conversion factor. Using this knowledge, we can calculate the yield investors are expecting with a simple DCF. From the Prospectus, Tesla received net proceeds of $710.3 million, which is the $850 million par value minus the $131.5 million cost to hedge (also note that the actual cost to Tesla was even higher, considering the bonds were issued at a price of 98.86 to the underwriters).
The yearly interest cost to Tesla will be slightly over $20 million ($850*0.02375) and the final maturity will cost the full par value of $850 million. Putting this all together into a DCF gives the following cash flows (in millions):
Bond Cash Flows
The IRR to these cash flows is 6.09%, which is the yield to maturity an investor could get taking the exact opposite side to each of these trades (buy bond and sell dilution hedge) to end with a fully hedged bond with no exposure to Tesla's stock price.
To be able to compare this bond with a 5-year maturity to bonds with other maturity profiles, first we can convert the yield into a spread over Treasuries. From the Treasury.gov yield curve, a 5-year maturity Treasury had a yield to maturity on 3/15 of 2.02%. This means the Tesla bond's spread over Treasuries is 4.07%.
What are the closest comparables to this spread? From the WSJ bond benchmark page, Barclay's triple B index has a spread over equivalent duration Treasuries of 1.46%. Considering this is the lowest rating in investment grade, Tesla is nowhere near investment grade. If we instead look to the Merrill Lynch high yield constrained index, we can see that the spread over Treasuries of 4.04% is much more comparable. Therefore, to the bond markets, Tesla has roughly equivalent credit risk to the average junk bond.
For another point of comparison, a recent article favorably compared Tesla's convert with a 5-year maturity to the issuance of General Motors' (NYSE:GM) debt with a 20-year maturity, ignoring the differences in options and duration. Instead, if we look to the GM bonds with 5 years remaining until maturity, we can find that there is a GM bond maturing just weeks after the Tesla convert. From TRACE, the most recent yield to maturity of that bond was just 3.1%. So, after stripping out the conversion factor and finding an equivalent maturity security, a real calculation shows that GM's cost of debt is half of Tesla's.
As a final point, this bond issuance alone does not make Tesla a poor investment. The bond yield does not indicate a market that expects near-term default. "High-yield" is quite different from "in grave danger." This article was just to correct some misconceptions about the cost of the debt to Tesla.
Disclosure: I am/we are long GM.
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: I may initiate a short position in TSLA.