🤡 Musk's $162 million Joke!
JP Morgan is currently suing Tesla because of a joke Musk made in 2018? Want to know what it was? ReadOn!
We've all cracked lame jokes from time to time. Usually, these PJs earn us eye rolls or slow claps. But Elon Musk is different. The world's richest man's joke has earned him a $162 million lawsuit from JP Morgan.
Sounds insane? Well, let us break it down how this happened.
You can also watch our video for an easy explainer (in Hinglish) 👇
Year 2014
Our story begins in 2014 when Tesla wasn't the uber-successful company that it now is. It needed cash and decided to sell convertible bonds. What are those?
Convertible bonds are like loans. They give you an interest, but with an added benefit. You get the company's shares in the future at a discount!
But to get the discount in the future, you need to pay a higher price now.
Tesla issued such convertible bonds worth $1.38 billion in 2014 at a 42.5% premium on its stock price. What does this mean?
Share price in 2014 = $252.54
Buying right in future (2021) = $252.54 + 42.5% = $359.87 (strike price)
So, bond holders would get Tesla's shares at $359.87 after 7 years, irrespective of the going market rate. This ensured that bondholders would get 3.8 million shares on conversion. And if the stock prices go higher than $359.87 they will be able to make good profits out of it.Â
But Tesla was not satisfied. It wanted a higher premium on its convertible bonds. Why so?
A higher premium would mean that it would have to give lesser shares.Â
So, the company went to investment banks like Goldman Sachs and JP Morgan Chase to see if it could get a sweeter deal.Â
On one hand, it sold the right to purchase shares at $359.87 to bond holders. On the other, it bought the right to purchase shares at $359.87 from the Investment Bankers. Yes, the same price at which it offered shares to the bondholders.Â
And just like that Tesla successfully hedged itself.Â
But what do the bankers get from this deal? Isn’t this a big risk for them?
So Tesla had to offer them a right to purchase shares at $560.63. Thus, Tesla's effective conversion price became $560.63. A 122% premium as against the 42.5% premium that they were getting before.   Â
You see what’s happening? Banks bought the right to purchase at $560.63. But sold the rights at $359.87. Although the loss was now lower than before, a loss is a loss.Â
So to protect themselves from any future risks, they added a clause. The clause states that if Tesla or its shares don't perform well, then the banks can change the strike price ($560.63 in this case).
This is the clause over which JP Morgan is suing Tesla. But what went wrong?
Fast forward to 2018. Twitter enthusiast Elon Musk, who has a reputation for posting tweets that move markets, decided to crack a joke. He tweeted that he was considering taking Tesla private when share prices hit $420 (Get it?).
If this was true, our banker buddies would be at a loss. The company would go private and its share price would never reach the strike price of $560 which they were anticipating.
Now, most banks understood that this was probably a joke on Musk's part. But JP Morgan didn't want to take such a risk. So, it took advantage of the clause and reduced the strike price of the stock warrant to $424. The implication of the move?
Whenever the conversion of the share will happen, it will be able to corner an extra profit of $136 (560-424) per share.
Back to the Future
And now back to 2021. This year, Tesla's convertible bonds and stock warrants matured. Its stock price at the time was around $718.43 (after a stock split of 5:1, so the equivalent price would be ~$3,590).Â
Bondholders and banks happily cashed in. But when JP Morgan tried to do so in June-July, Tesla disagreed with the reduction they had made in the strike price. In fact, Tesla called this move "opportunistic." It offered the banks shares according to the previously agreed-upon strike price.
Basically:
But JP Morgan is sticking to its guns and is now suing Tesla.
And to be fair JP Morgan had no way to know that Musk was actually joking. He was the company's CEO, the chair of its board of directors, and its largest shareholder! It would be crazy not to pay heed to a major public announcement from him.
So, who do you think will win this legal battle? And do you think this episode will finally make Musk stop tweeting Tesla updates?
P.S. Tesla's stock went for a 5:1 split. So the current price of $1,000 is actually $5,000 equivalent. Divide all prices we mentioned by 5 to compare with current market prices.
Share this with your friends on WhatsApp and Twitter and help us grow :)
If you are coming here for the very first time: Don’t forget to join us on WhatsApp to get daily updates! 👇
Why would Investment Bankers agreed to such deal of buying shares at $520 rather than buying the convertible bonds directly?