Musk Thrusts Tesla Holders Into Legal, Financial Limbo as SEC Probe Goes Formal

Elon Musk has stirred up a hornet's nest with his controversial proposal to take Tesla private. 

Whichever way a potential deal goes - whether it's a leveraged buyout (highly unlikely) or a deal with the Saudi Arabian Sovereign Wealth Fund - Musk could have an issue either with Tesla's (TSLA) debtholders or with the company's equity holders. 

The Securities and Exchange Commission has subpoenaed Tesla, the Wall Street Journal reported, and is seeking information from each Tesla board member. This is now a formal investigation, a step up from what previous reports said was a mere inquiry the SEC put in to Tesla. The SEC declined to comment upon request. 

There are two issues playing out as a result of Musk's take-private tweet. One is the legal issue, with the SEC investigating what many lawyers to believe are real legal questions. The other issue is the financial feasibility of a transaction. It's pretty clear at this point that this likely won't be a 100% takeover by one private equity firm, that would have to use heavy debt to finance a roughly $70 billion record deal for a company that has never been profitable. But even in the event that the Saudi Arabian Sovereign Wealth Fund adds significantly to its position in Tesla, which could delight those selling their shares, some of those who would remain owners might not be so thrilled. 

Musk said in his blog post on the Tesla website earlier this week that roughly two-thirds of Tesla shareholders would have to roll their shares into private ones if a transaction happens.

"If you go private, your ability to get out reduces significantly because there's no liquidity," analyst Gordon Johnson of Vertical Group, meaning that if public shareholders rolled their shares into private ones, it would be hard to sell because they'd have to actively seek a buyer since the company wouldn't be traded on the public market. "I think it's going to be hard for them {Tesla} to do anything transactionally," Johnson said. 

An investor, who requested anonymity, told TheStreet he would not be interested in owning shares in a private Tesla because he would lose so much liquidity. He holds a very small position in Tesla for his clients, but would not want to participate in a private share investment. 

Two of the car company's largest institutional shareholders, T. Rowe Price Group (TROW) and Fidelity Investments (FNF) both slashed their positions in Tesla by more than 20% after Tesla's quarter ending in June, according to Factset. 

And in a scenario in which one party owns a controlling stake - meaning a position of 51% or more - Tesla would have to immediately repay the debt it owes to some of its lenders at a premium to its face value. Tesla raised $1.8 billion in debt in August of 2017 at an interest rate of 5.3%. Because of a provision in the agreement, if a take-private transaction involves a buyer taking a controlling interest, Tesla would stop paying the interest, but repay the principal plus 1%. Important to note, the transaction Musk speaks of does not seem to involve a buyer interested in a controlling stake. 

One bond analyst said the repayment triggered by the change of control provision would be credit positive for Tesla, while others think it would be hard for Tesla to pay that amount right now, and that it might have to raise more debt to do so. 

Raising more debt, for any purpose, would be credit negative for Tesla, according to a note from Moody's investor Service (MCO) .