Some folks don’t like it when I write about investments that aren’t low-cost index funds. The thing is, when I find something intriguing, I like to dig deeper and then keep a record my findings. That way I can look back later and see how things turned out and compare with my opinions at the time. Just because I write about something doesn’t mean I recommend it, you have to read the entire post.
SolarCity is a company that installs and finances solar panels on commercial and residential properties. Back in October 2014, they started to allow individual investors to buy senior, unsecured corporate bonds directly from them online. You could invest as little as $1,000 in these SolarCity SolarBonds and pay no trade commissions or fees. The critical feature is that these “solar bonds” were backed only by the claims-paying abilities of the issuing company. If SolarCity fails, then you could lose your entire principal as well as any interest owed.
In general, the more confident you are that you’ll be paid back, the lower the interest rate the borrower has to pay. Other factors will come into play, such as the overall interest rate environment. With this in mind, check out the history of these bonds:
- In 2014, SolarCity was issuing 7-year bonds paying a 4% annual interest rate.
- In mid-2015, SolarCity was issuing 5-year bonds paying a 5% annual interest rate.
- Currently in August 2016, SolarCity is offering a 18-month bond paying 6.5% annual interest rate. Ends August 30, 2016.
Supposedly, SolarCity is passing on the savings of doing things in-house and not having to pay investment banker fees. I still declined to write about these SolarCity bonds in the past because the yield and term lengths were not good enough to grab my interest. But 6.5% in 18 months? Okay, you’ve at least gotten my attention.
Consider that as of 8/24/16, an 18-month Treasury bill yields approximately 0.70%. The highest 18-month FDIC-insured CD pays roughly 1.35%. Investment-grade (A) corporate bonds are averaging ~1.15% for a 2 year maturity. Even a junk bond ETF like JNK may have a 6.5% yield but an average maturity of over 6 years.
What’s happening? Well, SolarCity is struggling in several areas. It’s been losing money reliably, every year. Here’s the stock price chart:
Perhaps more importantly, it has some big bills that are coming due soon. According to this TheStreet article, SolarCity has $3.25 billion in debt, with $1.23 billion due by the end of 2017. Note that date. At the same time, Tesla has offered to buy SolarCity in an all-stock deal.
Obviously Elon Musk and his SolarCity co-founder cousins want it to happen, as it has been widely-reported that they bought a big chunk of these bonds on their own. See Fortune, WSJ, and MarketWatch.
Why would they buy these bonds? My wild-guess opinion is that it looks like SolarCity is trying to extend its debt long enough so that Tesla can safely buy the company and then refinance things on better terms. I would say that if the deal closes, then these 6.5% bonds will pay off. I believe that Tesla will still be around in 18 months. However, if the deal doesn’t close for some reason, then SolarCity might be in big trouble.
Are these 6.5% bonds worth the risk? Given that Elon Musk and his cousins are a big shareholder in both companies and just bought $100 million of these bonds, that would seem to place your interest in line with theirs at this point. I’d actually rather hold these bonds for 18 months than be a shareholder for 18 months. However, you are still faced with the chance that the deal will hit some unforeseen obstacle, so it all depends on your confidence level. For me, the reward just isn’t high enough to justify the risk of permanent principal loss (I’d rather have a house as collateral), so I am going to pass and wait to see how it turns out.
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Are the bonds callable?
From what I read in the prospectus, the bonds are not callable and not transferrable.
Instead of buying the 6.5% bonds, another option is to sell an Oct 19 put contract in Solar City. That is an obligation to buy 100 shares of Solar City stock at $19/share. Solar City stock last traded around $22.50, so your obligation is to buy the stock at a 16% discount to the current price.
What do you get for selling this put? The premium you receive his about $80 for 1 put contact. That is a 3.5% return on a investment that expires in 57 days, which is around 22% annualized. Is there risk? Yes, of course. If Solar City drops below $19/share in the next 57 days, you could be assigned and buy the stock at $19/share. But the popular Black-Scholes derivative model indicates there is a 71% probability this put contract will expire worthless.
the black sholes derivative model assumes a standard distribution curve–which stock return emphatically are not. Stock returns have notoriously fat tails
Selling puts on Solar City seems a bit sketchy. Solar City lost 250 MILLION DOLLARS.. L A S T quarter.
Guess what happens to Solar City is the Tesla deal doesn’t go through? I might buy puts, but selling them? Way risky.
It’s been a couple of months since Jonathan’s post as well and my suggestion about a 22% annualized return by selling the October 19 put in Solar City. Back in late August I wrote that there was a 71% probability that the put contract would expire worthless, and yes, in fact, it did expire worthless with Solar City stock closing last Friday at $19.99 after reaching $20.58. That was a nice 3.5% return for an investment of less than 60 days, over 20% annualized. My money was tied up for less than 2 months, not even close to the year and a half term of the 6.5% bonds.
something fishy about these bonds. This looks like a desperate move to save SolarCity . Musk is just trying to save his cousin’s ass.
Also, states have started re-writing the laws so that homeowners no longer save as much money from electric bills. That makes a number of these projects that were cost beneficial previously suddenly a loss to the homeowners. I think thats the real answer. If they could suddenly do things cheaper they would return money to the shareholders, not bondholders.
It looks like Tesla got approval. http://arstechnica.com/business/2016/08/antitrust-regulators-approve-tesla-deal-to-buy-solarcity/
I recommend that anyone contemplating the purchase of these bonds to carefully read the latest quarterly report of SCTY, especially the balance sheet, the income statement, and the debt descriptions on pages 17 – 22. Here’s a direct link to the June 30, 2016 10Q – http://investors.solarcity.com/secfiling.cfm?filingID=1564590-16-23725&CIK=1408356
Unlike most other corporations, I could not find any trade-able SCTY bonds. It would have been useful to see how the bond prices fluctuate over time….
The bonds are not a great investment. Equity-like risk + bind return = fail
1) If the company struggles/defaults/fails, you take a loss and possibly a near total loss.
2) if the company becomes the next Google, bond holders capture minimal (if any) upside.
The bonds are for unsecured subordinated debt. Plus, the Affiliated Investors will control your rights with respect to defaults and negotiations with the debtor. #nothanks
Why not just buy a HY bond fund?