Insider purchases can often be a strong buy signal; when insiders buy stock shortly before an earnings release, that can be an even stronger indication of strength to come.
On the surface, this logic would apply to a recent move at Tesla (TSLA, Financial), whose CEO and co-founder Elon Musk recently purchased 532,000 shares of Tesla stock at about $192 per share. It wasn’t great timing; Tesla shares have plummeted since then.
In fact, Elon Musk lost about $25 million in two weeks. But volatility happens, right? And since Musk bought the shares just a couple of weeks before today’s earnings call, that must mean he’s expecting a strong outperformance thanks to strong fundamentals at his company. Right?
Not exactly.
Unlike many Tesla shareholders, Musk is not buying and holding these shares to make a short-term (or even long-term) profit. As the company’s CEO and as a strong personality whose reputation depends on the success of Tesla, his relationship to Tesla’s share price is very different than yours or mine.
Additionally, he didn’t exactly buy these shares with his own money. These were exercised options that were given to him as part of his executive compensation. While he did shell out over $50 million to exercise the options and pay taxes, he also expanded his personal net worth by about $52 million by exercising those options.
This is important for Musk because his net worth on paper is crucial to help him access credit, and Musk uses a lot of credit. As Reuters recently reported, Musk has pledged 7.4 million shares to secure personal credit worth about $1.6 billion, essentially leveraging his personal ownership in Tesla to access cash.
When Tesla was trading at $200 per share, his collateral was significantly more valuable than the credit he received, with a margin of safety of about 48%. Now, though, his pledged shares are worth $1.10 billion, leaving a margin of safety of about 9.5%.
This is a problem because the credit Musk received contains clauses that could require Musk to sell shares and redeem for cash if the banks demand it. Tesla warned shareholders of this in August when it issued 2.1 million shares and also disclosed this detail:
“Mr. Musk borrowed funds from affiliates of certain of our underwriters and has pledged shares of our common stock. ... The forced sale of these shares pursuant to a margin call could cause our stock price to decline and negatively impact our business."
That “forced sale” would only happen if Tesla’s shares got cheap enough to trigger an order from Musk’s shareholders. No one knows exactly how low Tesla shares need to go for this to happen.
How does this relate to Musk’s options exercise? Possibly, he exercised those options now to increase his paper net worth to satisfy creditors who grew nervous after seeing Tesla shares lose 32% of their value from July 2015 to January of this year. They are surely more nervous after seeing Tesla stock decline another 23% in the span of two weeks.
If this is the case, Musk may be required to exercise more options or possibly look for other accounting tricks to boost his net worth to satisfy creditors. If he cannot do these things, he may be forced to sell shares, as the company’s SEC filing warns. According to the filing, Musk cannot use more shares as collateral to borrow more money to pay off what he already owes. Musk can buy more shares, exercise more stock options and do other things to increase his ownership of Tesla –Â which in turn would give his creditors access to more shares to sell in case of a steep downturn.
If Tesla shares fall enough and the banks force him to sell, this could create a vicious cycle of more selling from other shareholders. This is also a risk about which Tesla warned shareholders in its filing: "Any sales of common stock following a margin call that is not satisfied may cause the price of our common stock to decline further.”
With these warnings in mind, Tesla’s recent price declines and Musk’s stock option exercise may mean that he isn’t expecting a phenomenal quarter; instead, he may be worried that the recent decline in his paper worth is putting his shares at risk. As Tesla falls further, that worry will only grow.
