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.

unemployment and robots

robots are everywhere

Like just about everyone else (except my wife, who is a former president of the local chamber of commerce in our small home town), for years I’ve gone to the ATM instead of a bank teller. I don’t photo checks into our account, however, although close to 10% of American check volume is now processed this way.

I see the car commercials where computer-controlled cutting and welding machines are the ultimate symbols of manufacturing excellence.

I saw IBM’s Watson trounce those two guys on Jeopardy.

So, yes, I know that robots are taking over some tasks previously done by humans.

jobs at risk

What I didn’t know is how many jobs are potentially at risk.

Then I read an opinion piece by Martin Wolf, the chief economist of the Financial Times. It’s titled “Enslave the Robots and Free the Poor.”   Like anything Mr. Martin writes, the article is worth reading. But I mention it here because it references a paper by two professors from Oxford, Carl Frey and Michael Osborne, “The Future of Employment:  How Susceptible are Jobs to Computerization.”

The answer is “very.”  The paper concludes that 47%–that’s right, just about half, of the jobs now done by humans in the US are likely targets for replacement by robots.

How can this be?

Mssrs. Frey and Osborne divide work tasks into a matrix, according to whether the they require manual or cognitive skills, and whether they are repetitive or are non-repetitive, i.e., require some creativity, judgment or persuasive ability.

What we see in the ATM and the welding machines is repetitive manual tasks already being done by robots. We;re all used to that. The Frey/Osborne assertion is that while robots may increase their penetration of this segment of the matrix, computer scientists have become skillful enough in their algorithm fashioning that robots can now replace humans doing routine cognitive tasks. These include cashiers, waiters, tickettakers, manners of information kiosks, legal writers, medical diagnosers, truck drivers…

Is anyone safe?

Thank goodness, yes. On second thought, “Thank goodness” may not be appropriate.

–one set of “safe” jobs consists of service work that pays so little that savings don’t cover the cost of building the robot. Ouch.

–the other “safe” jobs re the ones that require a high degree of education, or that depend on creativity, or the ability to lead/persuade others, or the flexibility to respond effectively to novel situations.

fending off the robots

In the Frey/Osborne research, the two most effective ways to prevent your own robotization are to have a college degree or to be paid very poorly. Those lucky enough to qualify on both counts can breathe a sigh of relief.

timeframe

The Oxford paper gives no timeframe for this displacement. But even if the authors are off by a mile in their 47% and even if the process they describe takes half a century, substitution of capital for labor will continue to be a drag on job formation for a long while.

Frey and Osborne point out that ten years ago academics maintained that the safest possible job was being the driver of a motor vehicle.  And then along came the Google car.

IBM is refocusing itself to emphasize development of Watson, which is already being used to help make medical diagnoses.

 

Ironically, the current ultra-low interest rate regime in the US lowers the cost of investment capital—and therefore also lowering the breakeven point that must be reached to make the investment in robots.

investment significance?

Mr. Wolf’s op ed imagines the possible long-term societal implications of further mass replacement of humans by robots.  As an investor, my thought is that it may be wrong to look for the usual cyclical signs of vigor returning to the economy–signs that may never come.  Safer to focus on secular growth ideas,

 

 

problems in emerging countries (ii): financial markets

First, a small–but important–distinction.  There are emerging markets located in wealthy nations.  They focus almost exclusively on trading of local securities in countries where not many companies are listed and where locals have little interest.  Germany used to be one such backwater–and still is, to some extent.  Eastern European countries, members of the EU but with rudimentary securities markets, are another.

Then there are emerging countries, and their stock markets.  This latter group is what I’m writing about today.

emerging countries’ markets

The securities markets in emerging countries have two important characteristics that I think most investors are unaware of:

1.  There’s very little local demand for stocks or bonds.  There are usually no institutional investors, because there are no pension funds.  The average citizen works a 60-hour week to make, say, US$125.  He has no money to put at risk by buying bonds or stocks.  He may not trust his local financial institutions.  Instead, he may buy gold and bury it in the back yard.

This means that the local markets rise and fall on demand from foreigners.  When times are good, foreigners pile in and financial instruments soar.  The longer the boom, the deeper into unknown waters (smaller markets, micro-cap stocks) they wade.

Eventually, the tide turns.  The first to leave quickly exhaust local demand.  The rest can find no one to sell to.  Around 1990, for example, developed country investors “discovered” Indonesia toward the end of a long bull run in emerging markets.  After the party wound down, it was at least two years before investors with large holdings in Indonesian stocks could even begin to pare them.

2.  Local rules can change quickly.  Changes can apply either to everyone or just to foreign investors.  Capital controls can be imposed that would allow foreigners to sell securities but prevent them from exchanging the local currency they get for anything else, or would forbid them from removing sale proceeds from the country.

Or the government might simply tell foreigners they couldn’t sell   …or could unofficially tell local brokers they could not accept a sell order from a foreigner or process a completed transaction.

Not good.

active managers vs. index funds/ETFs

Veteran investors in emerging markets generally understand that the battle of wits between buyer and seller can sometimes turn into a game of Whack-a-Mole, with them in the role of the mole.  They cope either by staying completely away from the riskiest markets or holding only the safest names in small amounts.  They meet redemptions by selling some of their holdings in larger, more stable markets if they’re caught in a no-liquidity market.

This is a plus and a minus.  On the one hand, fund investors can get their money back.  On the other, by rerouting selling from risky to more stable markets, meeting redemptions ends up creating a minor kind of contagion.

Index entities, on the other hand, have little discretion.  They don’t have active managers to do selective selling.  They don’t want active managers, either.  What if the manager sells the wrong stuff and the fund/ETF underperforms, as a result?

ETF selling, which I’ve read has been quite heavy recently, exerts downward pressure on everything in the index–good or bad, sound country or not.  This ends up being another, stronger kind of contagion.

The question I don’t know the answer to is what an emerging markets index fund/ETF does with illiquid securities that its mandate (to mirror a specific index) forces it to sell but for which it can find no buyers.  My guess is that the firm that runs the index entity purchases the securities in question, after having a third party determine fair value.  I don’t know, though.

Anyway, problems in a few emerging markets can quickly spread to the whole asset class.

what to do

At some point, I think the right thing to do will be to look for an experienced emerging markets manager with a good track record, who works in a strong no-load organization.   Let him/her sort through the rubble for us.  I don’t yet feel a strong urge to do so, however.