Summary
Company issues $125 million in new convertible notes to a division of New York-based hedge fund 3i Management LLC.
As debt terms incentivize noteholders to short the company's stock, shares are likely to remain under pressure.
Even worse, with a floor price of just $0.38 and another $200 million in convertible notes waiting in the wings, Monday's selloff might have been just the beginning.
Given the massive overhang from the new convertible debt and ongoing open market sales, investors should consider selling existing positions and moving on.
Tramino
Note:
I have covered Nikola Corporation $Nikola Corporation(NKLA)$ previously, so investors should view this as an update to my earlier articles on the company.
Three weeks ago, recent amendments to Delaware General Corporation Law resulted in ailing zero-emission transportation start-up Nikola Corporation ("Nikola") finally gaining shareholder approval for doubling the number of authorized shares from 800 million to 1.6 billion:
Manatt.com
Not surprisingly, the company wasted no time capitalizing on the recent momentum by aggressively selling newly issued shares into the open market.
Between August 1 and August 18, Nikola issued approximately 76.9 million additional shares, based on disclosures made in connection with Monday's $125 million convertible notes offering. As a result, outstanding shares increased by almost 10% to 856.3 million.
Unfortunately, existing shareholders will likely have to prepare for more near-term dilution, as the terms of the new convertible notes incentivize noteholders to short the company's shares in advance of conversions (emphasis added by author):
At any time on or after August 21, 2023, all or any portion of the principal amount of each Note, plus accrued and unpaid interest, any make-whole amount and any late charges thereon (the “Conversion Amount”), is convertible at any time, in whole or in part, at the noteholder’s option, into shares of Common Stock at a conversion price per share (the “Conversion Price”) equal to the lowest of (i) a “reference price” of $2.94, subject to certain adjustments (the “Reference Price”), (ii) the greater of (x) a “floor price” of $0.38 (the “Floor Price”) and (y) the volume weighted average price (“VWAP”) of the Common Stock as of the conversion date, and (iii) the greater of (x) the Floor Price, and as elected by the converting noteholder, (y) either (x) depending on the delivery time of the applicable conversion notice, (1) the VWAP as of the applicable conversion date or (2) the VWAP immediately prior to the applicable conversion date and (y) 95% of the average VWAP for the three trading days commencing on, and including, the applicable conversion date, subject to adjustment in accordance with the terms of the Notes.
So, how does this work out for convertible noteholders?
One likely course of action would be to deliver a conversion notice to the company and aggressively short the company's shares in order to decrease the volume-weighted average price ("VWAP") as much as possible and cover the short position at a substantial gain. Delivering additional conversion notices in subsequent days would result in ongoing selling pressure.
In addition, buyers of the convertible notes might choose to employ delta-neutral convertible arbitrage strategies by establishing a corresponding short position in the shares.
Under the most beneficial scenario, buyers of Monday's convertible notes offering have already used the recent momentum to establish a large short position in the company's shares and simply look to cover without the requirement to purchase shares in the open market.
In fact, the terms of the convertible notes provide a hint to this issue (emphasis added by author).
Acknowledgement Regarding Buyers’ Trading Activity.It is understood and acknowledged by the Company that (i) following the public disclosure of the transactions contemplated by the Transaction Documents, in accordance with the terms thereof, none of the Buyers have been asked by the Company to agree, nor has any Buyer agreed with the Company, to desist from effecting any transactions in or with respect to (including, without limitation, purchasing or selling, long and/or short) any securities of the Company, or “derivative” securities based on securities issued by the Company or to hold any of the Securities for any specified term; (ii) any Buyer, and counterparties in “derivative” transactions to which any such Buyer is a party, directly or indirectly, presently may have a “short” position in the Common Stock which was established prior to such Buyer’s knowledge of the transactions contemplated by the Transaction Documents;
Considering the fact that 3i, LP, a sister company of Tumim Stone Capital LLC ("Tumim Stone") is stated to be the sole buyer of the convertible notes, I would expect the fund to have established a substantial short position in the shares before approaching the company for another financing deal.
Concurrently, Nikola has agreed to terminate the existing common stock purchase agreement with Tumim Stone.
Adding insult to injury, the agreement with 3i LP includes an option for the issuance of up to $200 million in additional convertible notes (emphasis added by author):
Subject to certain conditions being met or waived, at the option of the Company or an Investor, one or more additional closings for up to the remaining principal amount of Notes may occur. The aggregate principal amount of Notes that may be offered in the additional closings may not be more than $200,000,000, and the option to sell additional Notes will be exercisable until the 18 month anniversary of the date of the Purchase Agreement (the “Additional Closing Expiration Date”). The Investors’ obligations to purchase the Notes at each additional closing are subject to certain conditions set forth in the Purchase Agreement. Under the Purchase Agreement, the Investors will be required to purchase Notes in the additional closings if such conditions are met or waived. The Notes contain restrictions on the issuance of securities, except for shares of Common Stock issuable pursuant to the Company’s amended and restated equity distribution agreement with Citigroup Global Markets, Inc., a public offering of Common Stock not to exceed $300 million, and, with the approval of required holders, a private placement of Common Stock not to exceed $75 million.
With the floor price for share conversions set at a measly $0.38, dilution for common shareholders is likely to continue unabatedly.
Generously, assuming an average conversion price of $1.50 for the initial $125 million in convertible notes would result in outstanding shares to increase by approximately 10%.
Even when ignoring Nikola's most recent BEV truck disaster, the company's decision to revert to convertible debt financing rather than limiting share issuances to its recently amended $600 million equity distribution agreement with Citigroup $Citigroup(C)$ doesn't bode well for common equity holders.
Given this issue, investors should consider selling existing positions and moving on.
Risks
Considering the fact that Nikola needs to raise more cash in due course, it's difficult to see near-term risks to my thesis, particularly as the company is still nowhere near the $600 million threshold allegedly required to fully fund the revised business model.
Only the upcoming Nikola Tre FCEV truck being an overwhelming success right out of the gate could potentially generate sufficient momentum to overcome the overhang from short sales related to the new convertible bonds and ongoing open market sales under the company's equity distribution agreement.
Bottom Line
Nikola Corporation's common shareholders are likely to suffer materially from the company's decision to revert to convertible debt rather than limiting its capital raising efforts to open market sales for the time being.
With convertible noteholders being incentivized to short the shares, selling pressure is likely to persist for the time being.
Even worse, with a floor price of just $0.38 and another $200 million in convertible notes waiting in the wings, Monday's selloff might have been just the beginning.
Given the massive overhang from the new convertible notes and ongoing open market sales, investors should consider selling existing positions and moving on.
Source: Seeking Alpha
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