the Tesla (TSLA) convertible issue

The new TSLA convertible issue came to market yesterday.  Demand was so strong that the company raised an extra $400 million in seven-year notes (yield = 1.25%), bringing the total amount raised, before underwriting fees, to $2.0 billion.  That breaks out into $1.2 billion in seven-year notes + $800 million in five-year (yield = 0.25%).

The conversion premium is a whopping 42.5%!

If the underwriters exercise their overallotment, the total will rise to $2.3 billion.  (The underwriters actually sell more securities to their customers in an offering than the headline amount.  They use this extra to absorb any selling by buyers who intend to “flip,” or sell quickly.  The idea is to stabilize the issue price during the period immediately following the offering.  Sounds weird.  Yes, it’s price manipulation.  Yes, it’s legal.  In this case, the overallotment is $300 million.)

Clearly, no one is in this issue for the interest payments.   It’s all about possible capital gains if the TSLA price can rise by more than 42.5% before the bonds mature.

Tells you something about what bond managers think the prospects for straight bonds are.

At the same time, the issue proceeds take TSLA’s gigafactory–which will ultimately enable the company to sell 500,000 cars, it says–out of the realm of pie in the sky.  Say the company can make $2,000 in profit per car (a number I plucked out of the air).  That would mean that TSLA could be earning $1 billion a year by, say, 2020 – 2021.  At a price of $250, TSLA is currently trading at 30x that figure.  To me, this means two things:  buyers must have a rosier future than this in mind for TSLA, and academics who insisted that at $80 a share TSLA was priced for perfection (>10x earnings at maturity) had no idea what they were talking about.

As a practical matter, anyone who thinks the company will make $5000 per car would at least be content to hold.  Is that possible?  I don’t know.  As I mentioned yesterday, if I hadn’t sold too soon, I’d be selling now.

Tesla (TSLA) is proposing a $1.6 billion convertible bond offering

TSLA, the electric car company whose stock has risen over 12x since its IPO in late 2012, has just announced a $1.6 billion convertible bond offering.   Proceeds will be use to build the company’s “gigafactory” plant.   The deal could be being priced as I’m writing this.

The offering will be divided into two tranches, half of the bonds repayable in 2019, the other half in 2021.  Proposed interest rates will be negligible–around those of comparable Treasury securities.  The conversion premium for each will likely be about 40%, meaning the owners will only make money by converting into TSLA common if the stock price rises above $350 a share.

Two points:

–the deal could be transformative for TSLA, giving the company a large cash infusion at an earlier than expected date

–who would buy a bond like this rather than the stock?  After all, a convertible is just that–a deferred issue of stock.  It’s like buying TSLA at $350 today in return for the promise of a 1% dividend for each of the next few years.  For an equity investor, this sounds crazy.  But there are two groups of potential eager buyers.

—-bond fund managers, who are desperate for anything that can provide a little zip to their returns.  Even a deal like this one is better than buying a straight bond.  Putting the stock issue in a bond wrapper allows bond managers to buy it without violating their mandate to invest only in fixed income.

—-convertible funds.  They, too, have a mandate.  They can only invest in convertibles.  If they don’t participate and the Tesla bonds rise sharply, they may fall behind in the performance race to their rivals who do.  And there aren’t that many new issues in any given year.  So there’s considerable pressure on these managers to take part in every convertible offering,

In any event, this is good news for current TSLA holders.   (Note:  I bought the stock at $120 and sold it at $175.  If I still held it, I’d be selling now.)

Netflix and Comcast

Netflix just agreed to pay Comcast an undisclosed amount to ensure that the video rental company’s customers can access subscription content rapidly through the Comcast network.  In doing so, Netflix belatedly joins high internet traffic-generating firms like Google, Yahoo and Amazon in paying ISPs to get enough bandwidth that their offerings function correctly on subscribers’ computers or tablets.

Terms have not been disclosed.

why now?

Three factors are likely at work:

–a Federal appeals court recently ruled that the rules for net neutrality laid down by the FCC in 2010 exceed that agency’s authority, meaning it’s not clear what obligation, if any, Comcast has to make sure Netflix works right.

–inability of Netflix subscribers (like me) to access “House of Cards” when it first came out led to numerous customer complaints.

–Comcast has bid for Time Warner Cable.  If the deal survives Federal anti-trust scrutiny, Comcast will have considerably more market clout than it has today.  If so, terms would probably be better today than after the merger closes.  Also, in the meantime, Comcast presumably doesn’t want Netflix arguing against the combination.

what changes?

My guess is that in terms of profits the deal makes little difference to either Netflix or Comcast.  Before, Netflix didn’t pay Comcast and Comcast didn’t allocate capital to improving its ability to transmit Netflix.  Now, Comcast gets money, but will have to spend on equipment to support Netflix.  Presumably some people who had avoided Netflix previously will become customers.

I’m not sure whether I’d bet the farm that this is so, but given that as outsiders we have very little information, I think the safest assumption is that the deal doesn’t move the profit needle much for either party.

What I find interesting, though, is the way that Comcast wants its relationship with Netflix to evolve.  Until now, Netflix has been using third parties to route traffic.  They also attempt to smooth traffic’s flow as they connect Netflix to “last mile” ISPs like Comcast.  According to press reports, both Netflix and Comcast want to stop using such intermediaries.   Although the precise form of, and rationale for, the new working arrangement isn’t clear (to me, at least), the gist is that money formerly paid to middlemen will now go into Comcast’s pockets.

Maybe the structure of the new deal will unfuzzy itself after the government rules on the proposed Time Warner Cable merger.  Maybe not.  But the main investment conclusion I see is that Comcast is true “owner” of its internet customers and will continue to use that power to shift money away from middlemen and toward itself.

a short reprise of the Zynga (ZNGA) IPO

King Digital Entertainment, PLC  is the maker of the fabulously successful mobile-centered game Candy Crush Saga.  The firm has filed a form F-1 in preparation for an IPO.  King (proposed ticker: KING) intends to raise around $500 million.

Not surprisingly, the KING offering has reawakened bad memories of the 2011 IPO of ZNGA, which was led by Morgan Stanley and Goldman (no shock, either, that neither of those firms has a role in the KING IPO).

I haven’t yet read the KING offering document.  It’s possible that I won’t.  But I still thought it might be useful to look back at the characteristics of ZNGA that, in my view, made that stock an unattractive investment from the start.

1.  Virtually all the traffic coming to ZGA’s games was generated by Facebook.  This made it difficult to tell whether ZNGA’s games were successful because they were great games, or because they were being featured on FB.  If the latter–which subsequently proved to be the case–FB held the economic power in their partnership.  Any lessening of FB’s marketing efforts would quickly translate into a reduction in ZNGA’s profits.  A big weakness of ZNGA, not a plus.

2.  A reasonable way of assessing social games is to measure:

–the time needed to reach the peak number of players,

–the number of peak users, and

–the rate at which the number of users fades from the peak.

Even prior to the IPO, ZNGA offerings launched after its signature game, Farmville, were peaking faster than Farmville, and at lower numbers of users than Farmville.  In addition, they were as fading from the peak more quickly.  In other words, none of them had anything near the oomph of Farmville. This was all bad news.

3.  The actions of  the lead underwriters, both before and after the ZNGA IPO were quite odd, in my view.

For one thing, according to the New York TimesMorgan Stanley mutual funds bought  $75 million worth of pre-IPO shares of ZNGA in February 2011 at $14 a share.  Some have suggested that this was done to help persuade ZNGA to choose Morgan Stanley as a lead underwriter.

For another, the underwriters released the top management of ZNGA, as well as some venture capital investors, from IPO share “lockup” agreements that prevented their sale of stock prior to May 29, 2012.   Instead, a sale of 49,4 million shares at $12 each raised close to $600 million in early April for these high-profile holders.  By the original lockup expiration, the stock was trading at little more than half that level.

My overall impression is that the underwriters (incorrectly) thought that the heyday of tech investing was over.  This would imply that they and the companies they were moving to initial public offerings had only a short time to cash in before the rest of the world figured this out.  As a corollary, the traditional rules of trust and fair play between underwriter and professional portfolio manager/wealth management client no longer held–because there would be no follow-on business that once-burned clients would shy away from.

relevance for KING?

Again, I should mention that I haven’t yet analyzed KING.  Candy Crush Saga may well prove a fleeting fad and KING a one-trick pony.  On the other hand, the underwriters are different this time.   And I don’t sense the same IPO-before-it’s-too-late urgency that was in the air in 2011.