Tesla Going Private Could Hit Many ETFs

Today, Tesla CEO and founder Elon Musk took investors by surprise when he tweeted that he was considering taking the company private, should Tesla's share price hit $420.

The legitimacy of Musk's statement is anybody's guess. (The number 420, for example, is commonly associated with marijuana enthusiasts.) Regardless, the news sent Tesla share prices soaring, even leading to a midday trading halt at $367/share.

As of Tuesday afternoon, Tesla had published an email Musk sent to employees stating that a final decision to take Tesla private had not yet been made. But the possibility alone leaves investors, particularly ETF investors, in an uncertain place.

All together, 103 ETFs hold some 4.8 million shares of Tesla, worth a combined $1.45 billion. If Tesla goes private, what happens to those holdings?

When A Stock Goes Private

Public companies going private again is unusual, but not unheard of. For example, in 2005, KKR, Bain Capital and Vornado took Toys 'R' Us private; in 2013, Dell Technologies went private, only to go public again last month.

To transition a stock from the public markets back to private status, first, a group of investors must purchase the majority of the company's outstanding shares. Then the company delists from public exchanges.

From a regulatory standpoint, this is typically a much easier process than launching an IPO. In fact, the hardest part of going private is usually coming up with a tempting-enough offer for the company's existing shareholders, so that the majority is willing to sell their shares to the private bidder.

Often, that private bidder ends up paying a substantial premium above the stock's current market value to acquire the majority of shares.

Furthermore, once the tender offer for the public shares is made, the shareholders and the board of directors still need to approve the buyout. (Musk alluded to this in the letter he wrote to employees, stating that his proposal would "ultimately be finalized through a vote of our shareholders" first.)

Institutions Have Major Say

Naturally, larger shareholders have more sway about how the buyout process unfolds than mom-and-pop investors. "It's actually institutions, including mutual funds and ETFs, that own big blocks of stock that would be most likely to dictate the terms," said Dave Nadig, managing director of ETF.com.

In this particular case, no single ETF holds a significant amount of shares outstanding or market value of Tesla. The greatest market value held by any one ETF is $389 million, by the Invesco QQQ Trust (QQQ). That's just 0.64% of Tesla's total current market value of $61 billion.

Other ETFs with significant monetary stakes in Tesla include four massive Vanguard funds, including the $102 billion Vanguard Total Stock Market ETF (VTI); the $36 billion Vanguard Growth ETF (VUG); and two ARK ETFs, the ARK Innovation ETF (ARKK) and the ARK Web x.0 ETF (ARKW).

But ETFs aren't the only products offered by big beneficial owners like Vanguard, BlackRock or State Street Global Advisors. Enormous asset managers own Tesla stock across a range of investment vehicles, including mutual funds, ETFs, private accounts and so forth.

Mutual fund giant T. Rowe Price owns 9% of Tesla, according to the most recent 13-F filings; while Fidelity owns 8%. Vanguard and BlackRock each own 4%. (In contrast, Elon Musk himself owns 22% of the company.)

Should these large beneficial owners band together, they would be in a position to demand the tender offer most favorable to their interests—and to the interests of their clients.

(Conceivably, these shareholders could also challenge the proposed privatization in court if they felt there was a good reason not to take the company private. However, that would be a difficult case to win, especially given that Musk later tweeted that he would establish a special purpose fund so that investors could remain invested in the company.)

What Comes Next?

Once an acceptable tender offer has been made and accepted, the ETFs would be left with a Tesla-shaped hole in their portfolios that would need to be filled.

In the case of passive funds, most index rules state that the index should immediately be rebalanced as of the time of a corporate action, just as with a split, bankruptcy or merger.

"In practice, however, this kind of process would take some real time to enact," said Nadig.

Active ETFs without a benchmark, meanwhile, would have more leeway in how and when to rebalance their portfolios.

"It'll be interesting to see what the ARK funds, for example, do in terms of their ownership over the next few days, since they can immediately cut or increase shares," said Eric Balchunas, senior ETF analyst for Bloomberg. "If at the end of the road they made more money than passive funds, then it could be a good feather in the cap for active management."

How Much ETF Impact?

Given the low relative proportion of Tesla stock held by ETFs, however, "not a lot is going to happen" for most investors, says Balchunas. He added that ETFs own a "shockingly low amount" of Tesla shares outstanding, currently around 3%.

"But that's sort of what you sign up for with an ETF," he added. "You don't feel as much of these single-stock shocks to the system."

The higher percentage of an ETF's portfolio is held in Tesla, the more turnover there would be in its holdings. In this case, the $161 million ARK Industrial Innovation ETF (ARKQ), the $91 million VanEck Vectors Global Alternative Energy ETF (GEX) and the $97 million First Trust NASDAQ Clean Edge Green Energy Index Fund (QCLN) would have some substantial rejiggering to do should Tesla go private; these funds currently hold 11%, 9% and 8% of their portfolios in the company, respectively.

The 10 ETFs with the highest percentages of their portfolios in Tesla are listed in the table below

Tables sources: ETF.com, FactSet; data as of Aug. 7, 2018

Though ETF ownership is small, some funds would be more impacted than others, particularly environmental, social and governance (ESG) and tech funds.

Thirteen socially responsible ETFs hold Tesla, including the three largest funds in the space: the $1.2 billion iShares MSCI KLD 400 Social ETF (DSI), the $754 million iShares MSCI U.S.A. ESG Select ETF (SUSA) and the $532 million iShares MSCI ACWI Low Carbon Target ETF (CRBN).

Meanwhile, only five technology sector ETFs hold shares of Tesla, but four of them are fairly popular: the $2.4 billion iShares Exponential Technologies ETF (XT), the $989 million SPDR NYSE Technology ETF (XNTK), the $688 million ARK Web x.0 ETF (ARKW) and the $161 million ARK Industrial Innovation ETF (ARKQ).

Contact Lara Crigger at [email protected]