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Options

Cboe - Vol 411: August VIX Expiration


Host Kevin Davitt, Cboe Senior Instructor, discusses the SPX, rates, and expiration in the August cycle.

Options involve risk and are not suitable for all investors. Prior to buying or selling an option, a person must receive a copy of Characteristics and Risks of Standardized Options. Copies are available from your broker, or at www.theocc.com. The information in this program is provided solely for general education and information purposes. No statement within the program should be construed as a recommendation to buy or sell a security or to provide investment advice. The opinions expressed in this program are solely the opinions of the participants, and do not necessarily reflect the opinions of Cboe or any of its subsidiaries or affiliates. You agree that under no circumstances will Cboe or its affiliates, or their respective directors, officers, trading permit holders, employees, and agents, be liable for any loss or damage caused by your reliance on information obtained from the program.

Copyright © 2018 Chicago Board Options Exchange, Incorporated.   All rights reserved.

Information posted on IBKR Traders’ Insight that is provided by third-parties and not by Interactive Brokers does NOT constitute a recommendation by Interactive Brokers that you should contract for the services of that third party. Third-party participants who contribute to IBKR Traders’ Insight are independent of Interactive Brokers and Interactive Brokers does not make any representations or warranties concerning the services offered, their past or future performance, or the accuracy of the information provided by the third party. Past performance is no guarantee of future results.

This material is from Cboe and is being posted with Cboe’s permission. The views expressed in this material are solely those of the author and/or Cboe and IBKR is not endorsing or recommending any investment or trading discussed in the material. This material is for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IBKR to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.


19899




Technical Analysis

Nasdaq - Technical Take


Technicals ‘Trump’ing the Dollar

President Trump is being credited with today’s weakness in the US dollar following his remarks yesterday criticizing rate increases by Chairman Powell and the Federal Reserve.  While this is not the first time the President has weighed in with his opinion on the Fed’s hawkish monetary policy, seen by most as taboo towards the Fed’s independence, the timing of his latest remarks comes just days ahead of this year’s meeting of global central bankers at Jackson hole, Wyoming which we highlighted on Friday.

However it may not be fair to give the President all the credit for dollar weakness. Today is actually the fifth consecutive session in which the US dollar index (DXY) is in the red. Just last week we noted the DXY’s technical conditions were exhibiting signs of forming a top over the intermediate term.

At the time, a bearish topping pattern had formed over the daily and weekly time frames while momentum indicators were entering “overbought” levels over both daily and weekly frames. The recent pullback looks more like a textbook “retest” of a clearly defined resistance level which in this case the DXY broke out from back in early August at the 95 – 95.50 range.  Typically a re-test is seen as constructive, corrective price action allowing an instrument’s momentum readings to reset to normalized levels before then resuming the prior trend.  For the DXY the daily and weekly RSI’s have already pulled back to 51 and 62 from recent highs of 72 and 70.

While the President’s comments could certainly cause some to blink, particularly given the extreme long dollar positioning evidenced in the weekly COT data, the longer term direction is more likely to be driven by the macro and central bank policy, both locally and overseas. 

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Nasdaq's Market Intelligence Desk (MID) Team includes: 

Charles Brown is Associate Vice President on the Nasdaq Market Intelligence Desk with over 20 years of equity capital markets experience. Charlie has extensive knowledge of equity trading on both floor and screen based marketplaces. Charlie assists with the management of The Market Intelligence Desk and works with Nasdaq listed companies providing them with insightful objective trading analysis.

Steven Brown is a Managing Director on the Nasdaq Market Intelligence Desk with over twenty years of experience in equities. With a focus on client retention he currently covers the Financial, Energy and Media sectors.

Christopher Dearborn is a Managing Director on the Nasdaq Market Intelligence Desk. Chris has over two decades of equity market experience including floor and screen based trading, corporate access, IPOs and asset allocation. Chris is responsible for providing timely, accurate and objective market and trading-related information to Nasdaq-listed companies.

Brian Joyce, CMT is a Managing Director on the Nasdaq Market Intelligence Desk. Before joining Nasdaq, Brian spent 16 years as an institutional trader executing equity and options orders for both the buy side and sell side. He also provided trading ideas and wrote technical analysis commentary for an institutional research offering. Brian focuses on helping Nasdaq’s Financial, Healthcare and Transportation companies, among others, understand the trading in their stock. Brian is a Chartered Market Technician (CMT).

Michael Sokoll, CFA is a Senior Managing Director on the Nasdaq Market Intelligence Desk with over 25 years of equity market experience. In this role, he manages a team of professionals responsible for providing Nasdaq-listed companies with real-time trading analysis and objective market information.

Information posted on IBKR Traders’ Insight that is provided by third-parties and not by Interactive Brokers does NOT constitute a recommendation by Interactive Brokers that you should contract for the services of that third party. Third-party participants who contribute to IBKR Traders’ Insight are independent of Interactive Brokers and Interactive Brokers does not make any representations or warranties concerning the services offered, their past or future performance, or the accuracy of the information provided by the third party. Past performance is no guarantee of future results.

This material is from Nasdaq and is being posted with Nasdaq’s permission. The views expressed in this material are solely those of the author and/or Nasdaq and IBKR is not endorsing or recommending any investment or trading discussed in the material. This material is for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IBKR to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.


19896




Stocks

Nasdaq Market Intelligence Desk - Equity Market Insight August 21, 2018


TRADING VOLUMES CONTINUE TO LAG DESPITE 'LONGEST BULL RUN' EXCITEMENT

Tuesday, August 21, 2018, 10:15 AM, EST

  • NASDAQ Composite +0.58%Dow +0.35%S&P 500+0.41%Russell 2000+0.62%
  • NASDAQ Advancers:1411Decliners:512
  • Today’s Volume (vs. yesterday)+6%

U.S. equity markets edged higher at the open and are trading solidly in the green as the S&P 500 continues to march towards a record high (2,872.87 on 1/26/18). Trading volumes continue to lag despite continued chatter of the “longest bull run” in modern history. Currently 8 of the 11 S&P 500 sectors are trading higher with Energy and Consumer Discretionary the best performing sectors. Crude oil and Gold both trade higher. The dollar is lower while the yield on the 10-yr has increased to 2.8496 after yielding more that 3% to start the month.

  • U.S. gold futures are trading near $1,200 an ounce, rallying on the back of a weaker dollar, after President Trump said he was "not thrilled" with Fed Chair Jerome Powell for raising interest rates at a recent Hamptons fundraiser. The dollar made a 52 week high last week while many base metals made 52 week lows. It makes sense that copper, zinc and aluminum are all rallying this week as the dollar slides…
  • Bloomberg has a story that the percentage of non-US members in the Bloomberg World Index currently in a bear market has risen steadily through the year and is now just below 28%.  By comparison, just 8% of the U.S. stocks in the index are down 20% or more in 2018.  The article notes that the Bloomberg World Index has fallen about 2% YTD compared to a 6% gain in the S&P 500 Index.  We had not looked at U.S. outperformance in this way before.  The article attributes a robust domestic economy, buoyant tech stocks and strong dollar for the relative attraction of U.S. equities. 
  • The S&P 500 will tie the record for the longest U.S. bull market in history today rising more than 330% since March, Stocks are considered to be in a bull market when prices rise by at least 20%, following a 20% decline. It's a record few would have predicted when stocks struggled following the more than 50% dive during the financial crisis (2008-09). While there are plenty of bearish warnings out there as analysts & economists debate the future, many investors continue to plow into U.S. equities as it is seen by many as the only game in town. Put another way a $10,000 investment in the S&P 500 at the start of the bull market is worth roughly $42,500 today. If the S&P 500 finishes today in positive territory that would be 3,453 days without a 20% drop.
  • The Office of the U.S. Trade Representative (USTR) started holding public hearings yesterday regarding proposed tariffs on approximately $200 billion worth of Chinese products in Washington, DC. The USTR will hear from multiple businesses and trade organizations such as Nasdaq listed Dollar Tree (DLTR), iRobot (IRBT) and Hooker Furniture (HOFT).  The USTR stated “The proposed tariffs are a supplemental action in response to China’s unfair trade practices ... Tariffs on $34 billion in goods from China are currently in effect, and tariffs on an additional $16 billion will take effect on August 23, 2018.”

 

--

Nasdaq's Market Intelligence Desk (MID) Team includes: 

Charles Brown is Associate Vice President on the Nasdaq Market Intelligence Desk with over 20 years of equity capital markets experience. Charlie has extensive knowledge of equity trading on both floor and screen based marketplaces. Charlie assists with the management of The Market Intelligence Desk and works with Nasdaq listed companies providing them with insightful objective trading analysis.

Steven Brown is a Managing Director on the Nasdaq Market Intelligence Desk with over twenty years of experience in equities. With a focus on client retention he currently covers the Financial, Energy and Media sectors.

Christopher Dearborn is a Managing Director on the Nasdaq Market Intelligence Desk. Chris has over two decades of equity market experience including floor and screen based trading, corporate access, IPOs and asset allocation. Chris is responsible for providing timely, accurate and objective market and trading-related information to Nasdaq-listed companies.

Brian Joyce, CMT is a Managing Director on the Nasdaq Market Intelligence Desk. Before joining Nasdaq, Brian spent 16 years as an institutional trader executing equity and options orders for both the buy side and sell side. He also provided trading ideas and wrote technical analysis commentary for an institutional research offering. Brian focuses on helping Nasdaq’s Financial, Healthcare and Transportation companies, among others, understand the trading in their stock. Brian is a Chartered Market Technician (CMT).

Michael Sokoll, CFA is a Senior Managing Director on the Nasdaq Market Intelligence Desk with over 25 years of equity market experience. In this role, he manages a team of professionals responsible for providing Nasdaq-listed companies with real-time trading analysis and objective market information.

Information posted on IBKR Traders’ Insight that is provided by third-parties and not by Interactive Brokers does NOT constitute a recommendation by Interactive Brokers that you should contract for the services of that third party. Third-party participants who contribute to IBKR Traders’ Insight are independent of Interactive Brokers and Interactive Brokers does not make any representations or warranties concerning the services offered, their past or future performance, or the accuracy of the information provided by the third party. Past performance is no guarantee of future results.

This material is from Nasdaq and is being posted with Nasdaq’s permission. The views expressed in this material are solely those of the author and/or Nasdaq and IBKR is not endorsing or recommending any investment or trading discussed in the material. This material is for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IBKR to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.


19895




Macro

New Constructs - Stupid Money Risk Is Real


One of the biggest risks to a short thesis is what we call “stupid money risk.” This phrase refers to the risk that an already highly overvalued firm gets acquired at the current, or even higher, valuation, thereby wiping out all shorts. Recent examples of stupid money acquisitions include Microsoft (MSFT) buying LinkedIn for $26 billion and Salesforce (CRM) buying Demandware for $2.9 billion.

Now, we have the surge in stupid money acquisition risk rising for Tesla (TSLA), as Elon Musk publicly announced he wants to take the firm private. In light of this ongoing saga, we examine possible motives as well as how stupid money acquisitions can hurt acquirers even more than the short sellers. For example, just last week, Steinhoff International and Newell Brands (NWL) saw misguided acquisitions come back to bite them.

 

Tesla Going Private Screams Stupid Money Acquisition

Musk’s buy out idea is a publicity stunt. Musk aims to distract from the company’s ongoing production woes and cash burn by portraying it as under siege by short-sellers and the media (a tactic reminiscent of Elizabeth Holmes and Theranos). A war with short-sellers could be easier to win than the battle against the existing auto giants. As Jim Chanos put it in an interview on CNBC:

“The short position is the best thing the stock has going for it. ‘Musk vs The Shorts’ is a far better narrative than ‘Tesla vs Mercedes/Audi/Porsche.’”

The fact that Musk can even play the “take Tesla private card” is a stark reminder of the limitations of the efficient market hypothesis (EMH). Academics who accept market efficiency as dogma ignore the role that noise traders[1] can play in distorting prices from their fundamental value. Musk is a reminder that noise traders can also be CEO’s making buyout offers based on ego or misaligned incentives. As we’ll show below, when executives act as noise traders, shareholders of the acquiring firms tend to suffer far, far worse than the short-sellers.

 

Steinhoff’s Stupid Money Acquisition Hurts Shareholders 10x More than Short Sellers

Figure 1 shows the decline in the return on invested capital (ROIC) of Mattress Firm in the years leading up to its acquisition by South African retail giant Steinhoff International. From 2012 to the trailing twelve-month period prior to acquisition, Mattress Firm’s ROIC declined from 10% to 4%.

Figure 1: Mattress Firm’s ROIC from 2012 to Acquisition

Sources: New Constructs, LLC and company filings

Despite its declining ROIC, Mattress Firm continued to invest in the business and -$1.6 billion in free cash flowfrom 2013-2016. In light of such underwhelming performance, it’s hard to imagine what value a potential acquirer could see, but Steinhoff decided to acquire the company at $64/share, more than double the stock price from a few months earlier when we called Mattress Firm dangerously overvalued and put it in the Danger Zone.

Steinhoff didn’t appear to care too much about Mattress Firm’s fundamentals, as it spent just five days on due diligence and didn’t even acknowledge the company’s $1.4 billion (58% of market cap) in off-balance sheet debt.

As the business continues to decline, Mattress Firm is now reportedly considering bankruptcy in order to get out of its leases and close underperforming stores. The company’s woes were easy to spot back in 2016, but Steinhoff’s managers did not appear to consider doing proper due diligence a priority.

When we put Mattress Firm in the Danger Zone a few months before the acquisition, there were 7.2 million shares sold short. When the stock price increased from ~$31/share to the acquisition price of $64, those shorts lost ~$240 million. Meanwhile, Steinhoff paid $2.4 billion for a company that may not have any equity value remaining, meaning its loss could be up to 10x worse than the short sellers’.

 

Newell’s Stupid Money Acquisition Hurts Shareholders 100x More than Short Sellers

Bill Ackman’s appearance at the 2015 Sohn Conference is best remembered for his long thesis on a pharmaceuticals company called Valeant (VRX) that was growing rapidly through acquisitions and covering up its losses with shady non-GAAP accounting. We all remember how that turned out.

Fewer people remember that Ackman also pitched another company that followed a similar strategy. Consumer products company Jarden, another Ackman holding at the time, was also spending big on acquisitions while seeing its ROIC and cash flows steadily decline.

Fortunately for Ackman, Jarden got bailed out by another company following the same strategy in Newell Rubbermaid (NWL). Our analysis of the deal showed that Newell should only have paid about half of the $23 billion it spent on Jarden, and we eventually put the combined company in our Focus List – Short Model Portfolio.

The Jarden acquisition has been a significant loser for NWL shareholders, who have seen their share price decline by 60% over the past year. The company now seems to be recognizing the failure of the deal and is selling off many of the pieces acquired in the Jarden acquisition.

However, Figure 2 shows that the acquisition worked out well for Newell’s executives, who saw their compensation nearly triple in 2016 after the deal was completed.

 

Figure 2: Compensation for Top Newell Executives: 2012-2016

Sources: New Constructs, LLC and company filings

CEO Michael Polk’s compensation grew from $14 million in 2015 to $22 million in 2016, while president Mark Tarchetti’s pay tripled from $6 million to $18 million.

The jump in pay came from the acquisition putting the company in a larger peer group and helping executives hit their sales growth and adjusted EBITDA metrics. By tying executive compensation to metrics that don’t consider capital allocation, Newell failed to align their interests with shareholders and incentivized them to overpay for Jarden.

When we put Jarden in the Danger Zone, there were 10.9 million shares sold short. When the stock price increased from $47/share to $60/share, those short sellers lost ~$140 million. On the other hand, when the Jarden acquisition was completed on April 15, 2016, Newell had a market cap of $21.3 billion. Since then, it has lost $11.7 billion in market value, more than half its value. NWL investors lost ~100x as much as short sellers.

Both the Newell/Jarden and Steinhoff/Mattress Firm deals were easy to identify as overpriced at the time, by both ourselves and others. However, in both cases managers’ incentives were not aligned with shareholders. These management teams acted as self-interested noise traders, overpaying in their respective acquisitions to benefit themselves at the expense of shareholders.

As a result, short sellers that attempted to profit from the overvaluation of Jarden and Mattress Firm took big losses, but investors in Newell and Steinhoff that ignored those short sellers’ warnings lost anywhere from 10x to 100x more. Meanwhile, short sellers could recoup their losses by continuing to short the stocks of these acquirers.

 

Back to Tesla

What do a consumer goods manufacturer and a South African retailer have to do with Tesla, you might ask? Simple: both companies illustrate the dangerous feedback loop that can occur when both traders and executives make decisions based on noise rather than fundamentals.

In the case of Newell and Jarden, Bill Ackman acted as a noise trader, buying into Jarden’s acquisition-driven growth while ignoring its declining profitability. His pitch attracted a host of self-directed investors that bought into the story and propped up the price to the point that Newell’s executives, motivated by their own misaligned incentives, bought in.

Elon Musk and a large portion of Tesla’s shareholders are engaged in a similar feedback loop. Musk’s outlandish promises and insults to analysts  drive away institutional investors and attract self-directed traders that buy into his cult of personality. These traders don’t appear to care about the fundamentals anyway, so Musk spends even less time worrying about cash flows and more time sharing memes that make fun of short-sellers.

This feedback loop is how we get an offer to take Tesla private at $420/share, a valuation that implies the company will immediately achieve pre-tax margins of 10% – slightly better than Toyota (TM) – and grow revenue by 29% compounded annually for 10 years, at which point it would earn more revenue than GM did in 2017 with margins that are 200 basis points higher). See the math behind this dynamic DCF scenario.

A valuation of $420/share implies that the market is confident that Tesla can simultaneously achieve superior margins than the most profitable major automaker in the world and sell more vehicles than the largest automaker in North America. These expectations are so disconnected from the fundamentals of Tesla’s business (burning $8bn in cash over the last 3 year and struggling to manufacture 5,000 Model 3’s in a week while GM sells over 180 thousand vehicles in a week) that the idea of anyone paying $420/share is absurd.

The bottom line is that most die-hard Tesla bulls don’t care about fundamentals, and the stock’s surge has forced many asset managers to get on board rather than risk missing out on its run and underperforming their benchmark. Noise traders, not fundamentals, are in control of Tesla’s stock price. Being a noise trader can be profitable in the short term, but it usually ends badly in the long term.

As the Tesla noise gets more ridiculous, even the noise traders might get cold feet about the stock’s dangerously high valuation. Tesla is one of several stocks we see in a “Micro-Bubble” that could burst soon.

Overall markets remain mostly efficient, but that efficiency can come at great costs to sophisticated investors. Noise traders make it harder for fundamental investors to justify the cost of performing proper due diligence on securities. What’s the point of spending all the time poring through 10-Ks and 10-Qs to understand a company’s cash flows if noise traders are just going to ignore the cash flows anyway?

[1] Shiller, Robert J., et al. “Stock Prices and Social Dynamics.” Brookings Papers on Economic Activity, vol. 1984, no. 2, 1984, pp. 457–510. JSTOR, JSTOR, www.jstor.org/stable/2534436.

Click here to download a PDF of this report.

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This article originally published on August 15, 2018.

Disclosure: David Trainer, Kyle Guske II, and Sam McBride receive no compensation to write about any specific stock, style, or theme.

Follow us on TwitterFacebookLinkedIn, and StockTwits for real-time alerts on all our research.

About New Constructs

Our stock rating methodology instantly informs you of the quality of the business and the fairness of the stock’s valuation. We do the diligence on earnings quality and valuation so you don’t have to.

In-depth risk/reward analysis underpins our stock rating. Our stock rating methodology grades every stock according to what we believe are the 5 most important criteria for assessing the quality of a stock. Each grade reflects the balance of potential risk and reward of buying that stock. Our analysis results in the 5 ratings described below. Very Attractive and Attractive correspond to a "Buy" rating, Very Dangerous and Dangerous correspond to a "Sell" rating, while Neutral corresponds to a "Hold" rating.

Cutting-edge technology enables us to scale our forensics accounting expertise so that we can cover enough stocks to cover the ETFs that hold them as well. Learn more about New Constructs. Get a free trial. See what Barron’s has to say about our research.

Information posted on IBKR Traders’ Insight that is provided by third-parties and not by Interactive Brokers does NOT constitute a recommendation by Interactive Brokers that you should contract for the services of that third party. Third-party participants who contribute to IBKR Traders’ Insight are independent of Interactive Brokers and Interactive Brokers does not make any representations or warranties concerning the services offered, their past or future performance, or the accuracy of the information provided by the third party. Past performance is no guarantee of future results.

This material is from New Constructs, LLC and is being posted with New Constructs, LLC’s permission. The views expressed in this material are solely those of the author and/or New Constructs, LLC and IBKR is not endorsing or recommending any investment or trading discussed in the material. This material is for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IBKR to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.


19894




Macro

Interactive Brokers - Convertible Bond Hedge Could Comprise Large Part of Tesla's Massive Equity Short Position


Privatization May Not Be Cure-All to the Carmaker’s Funding Needs

While Tesla (TSLA) CEO Elon Musk said on August 7 he was considering taking his electric car producer private, shareholders celebrated while certain bondholders continued to discount the company’s debt.

Musk noted on Tesla’s blog he was mulling privatizing the company at a price of US$420 per share, effectively valuing the firm at around US$66bn.

To date, TSLA’s stock has given back almost twice the precipitous gains it acquired after Musk unleashed his intentions on the blog and on Twitter, as well as after its Q2’18 earnings results.

The company’s market cap was last quoted at about US$52bn, with its shares slipping below the US$300 mark at roughly US$299.10 intraday Monday.

While Tesla’s CEO said “a final decision has not yet been made” about the privatization, he attributed part of his reason to avoiding the “wild swings” in its stock price, as well as being subjected to the quarterly earnings cycle.

Musk noted that “as the most shorted stock in the history of the stock market, being public means that there are large numbers of people who have the incentive to attack the company.”

 

The ‘most shorted stock in history’

Sam Pierson, director of securities finance at IHS Markit, noted that while “the claim of ‘most shorted stock in the history of the stock market’ is not literally true in dollar terms,” it is “fair in the sense that there has not been another U.S. equity short position greater than $10bn which lasted for more than a quarter.”

Pierson said that with US$3.8bn in convertible debt outstanding, it is “possible that a significant percentage of that value could be short the equity as a hedge.” He continued that contingent on how many of the convertible notes are hedged with equity short positions, TSLA may be closer in its short position to the second highest U.S. equity, Amazon (AMZN), which has US$8.8bn in short balances.

Pierson added it is important to note, however, that “the AMZN short is likely a hedge for many short sellers, rather than an outright bet against the firm's prospects.”

IHS Markit observed TSLA reached a peak short value of just over US$13bn on August 7, the same day as its blog post, and since then the firm’s falling stock price and a 2m share reduction in shorts have taken the position down to just under US$11.5bn on roughly 33m shares. 

Meanwhile, perceptions about the firm’s creditworthiness has suffered significantly, after reports the SEC recently issued TSLA a subpoena regarding Musk’s aim to take his public company private, as well as after questions surfaced about the CEO’s health following a recent interview published in The New York Times.

Five-year CDS spreads Monday suggested the news has stoked the firm’s default probability, with an increase of over 11.5bps to nearly 590bps.

Also, its 5.3% senior unsecured notes due August 2025 were trading more than 30bps wider on the day Monday at an OAS of 476bps, or just north of US$87.50.

 

As much as shareholders seem to have placed their faith in TSLA’s management and potential future profitability, Interactive Brokers chief options strategist Steve Sosnick recently warned that if an investor is “a true believer in the company, before anything else happens they have to be able to pay back their creditors.”

Sosnick added that from a risk perspective, “if the bondholders don’t get paid, your stock is worthless or essentially worthless.”

 

Ratings downgrade, credit concerns and funding needs

Among other actions, Moody’s Investors Service in late March cut TSLA’s corporate family rating (CFR) one notch to ‘B3’ and its unsecured credit rating to ‘Caa1’ from ‘B3’, partly due to liquidity pressures stemming from “large” negative free cash flow, as well as the pending maturities of its convertible bonds (US$230m in November 2018 and US$920m in March 2019).

Moody’s noted its negative outlook on TSLA reflected the likelihood that the firm “will have to undertake a large, near-term capital raise in order to refund maturing obligations and avoid a liquidity short-fall.”

Compounding the concerns, TSLA’s US$1.8bn of 5.3% 2025 notes comes with a change of control contingency in its terms and conditions, meaning the company would need to tender the debt at 101 cents on the dollar should any investor(s) purchase a majority stake in the company, and the bonds become downgraded by credit rating agencies.

Credit analysts have been generally questioning whether the change of control contingency will be triggered in the event TSLA goes private.

 

Further challenges

In the meantime, a long list of headwinds further complicates TSLA’s debt picture, including funding needs for its new Gigafactory 3 in China, as well as adverse impacts from trade-related tariffs.

TSLA has roughly US$9bn worth of net debt and plans to heap on additional debt to help finance its estimated US$2bn, wholly-owned Gigafactory 3 facility in Shanghai.

TSLA said it expects construction on the factory to start within the next few quarters, while its initial investment “will not start in any significant way until 2019, with much of it expected to be funded through local debt.”

While construction on the factory is not slated to start for at least another year, it appears TSLA has already begun to lure potential recruits based on several senior-level position listings for the Shanghai-based facility on its website.

Meanwhile, the electric-carmaker said that although tariffs on vehicle imports to China recently fell to 15%, imports specifically from the U.S. have increased to 40%, compelling TSLA to adjust pricing in China to partially offset the increased cost. The firm warned it will likely suffer some negative impact on its volumes in China in the near-term.

Furthermore, TSLA said higher import duties on Chinese components and unfavorable currency movements are likely to cause negative pressures.

Despite many analysts’ concerns about TSLA’s liquidity, its funding needs for debt and ongoing operations, as well as expansion costs and higher import duties, TSLA said in its Q2’18 earnings report that it continues to expect to achieve GAAP profitability in Q3 and Q4.

Overall, while TSLA’s potential take-private transaction may be one option to alleviate its massive short position, it may do little to assuage bondholders given its operational and debt-service funding needs.  

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The analysis in this material is provided for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IBKR to buy, sell or hold such investments. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.


19892




1 2 3 4 5 2 1448

Disclosures

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