Tesla’s (TSLA) stock could actually benefit from recalls, but not the ones you are thinking

If you are wondering how come Tesla’s stock price is performing relatively well in the past week despite all the bad publicity following a recent fatal accident while a Model S driver was using Autopilot, an NHTSA evaluation that could lead to a recall and an important delivery miss for the last quarter, Ihor Dusaniwsky, Head of Research at the financial analytics firm S3 Partners, has an interesting theory explaining the situation.

It actually has something to do with people hating Tesla’s stock and actively betting against it in masses.

To understand Dusaniwsky’s theory, you need to understand short selling. Here’s a quick summary in case it’s not something you are familiar with:

If someone thinks that a stock is overvalued and they want to benefit from the price falling, they will initiate what is called a ‘short position’. It consists of borrowing the stock through a broker and selling (or short selling) it at the current price, which the person thinks is overvalued, and later buying the stock back, hopefully for them at a lower price then they sold it when borrowing it, in order to give it back to the lender.

Tesla’s stock has a long history with short sellers and it has often been the most shorted stock on the NASDAQ. On Friday, the short position on the company’s stock reached a record high worth almost $8 billion – Tesla’s entire market capitalisation is $31.5 billion.

Tesla Recall Pressure May Produce a Short Squeeze $TSLA #tesla $SCTY #solarcity @CGrantWSJ @S3Partners #shortsqueeze pic.twitter.com/7KRsEXl9M7

— Ihor Dusaniwsky🇺🇦 (@ihors3) July 5, 2016

Brokers collect rates when lending stocks to short sellers which some brokers give back in part to the stockholders in order to incentivize them to loan their shares, but they are still just so many shares available to lend.

Dusaniwsky’s report indicates that the inventory of Tesla shares available to be borrowed is virtually nonexistent aside from “occasional” blocks of 10,000 and 100,000 shares. The rates have also significantly increased and now short sellers are paying up to 40% to initiate a short position while  existing short positions are being charged 15% to 18%, according to Dusaniwsky.

Now here’s the interesting part. The stockholders lending their shares can always recall them if they need to sell them or to vote on them if they had to relinquish voting rights through the lending agreement. When the shares are being recalled, if short sellers are unable to find another lender through their broker, which currently is often the case, they are forced to close their short positions.

@Brianmrtz probably unwise

— Elon Musk (@elonmusk) April 5, 2016

Dusaniwsky found through his analysis that there were already over 1.5 million shares of Tesla’s stock recalled yesterday and almost 1 million shares recalled on July 1st, which the researcher links to the upcoming vote on a possible merger between Tesla and SolarCity.

He adds that he expects to “see recalls increase the closer we get to the shareholder vote”:

“If these recalls continue in size, short side pressure on the stock will diminish and buy to covers will outnumber new short sales. There may be a significant short squeeze rally in Tesla the closer we get to voting on the SCTY merger.”

We don’t know yet exactly when shareholders will hold the vote. SolarCity’s board is still reviewing Tesla’s offer. It certainly creates an interesting and fairly rare situation.

A short squeeze is when short sellers are closing their positions in masses resulting in a lot of buying pressure on stock, which increases the price. Events of short squeezes have been associated with Tesla’s important period of short increases in the past.

In 2012, Elon Musk warned that anyone holding a stock position against the company will have a “tsunami of hurt” coming for them. During the 12 following months, Tesla’s stock price increased by 461%, a lot of which was attributed to a short squeeze after Tesla reported its first quarterly profit in Q1 2013.