Market dislocations occur when financial markets, operating under stressful conditions, experience large widespread asset mis-pricing.
Welcome to this week’s edition of “World Out Of Whack” where every Wednesday we take time out of our day to laugh, poke fun at and present to you absurdity in global financial markets in all it’s glorious insanity.
While we enjoy a good laugh, the truth is that the first step to protecting ourselves from losses is to protect ourselves from ignorance. Think of the “World Out Of Whack” as your double thick armour plated side impact protection system in a financial world littered with drunk drivers.
Selfishly we also know that the biggest (and often the fastest) returns come from asymmetric market moves. But, in order to identify these moves we must first identify where they live.
Occasionally we find opportunities where we can buy (or sell) assets for mere cents on the dollar – because, after all, I’m a capitalist.
In this week’s edition of the WOW we’re covering Tesla Motors
Let’s revisit a business school 101 lesson – just to re-establish a sound footing, if you know what I mean.
A business can be one of two things: it can make and sell a product or it can provide a service. When it does this the difference between its revenues and its expenses determines whether it survives or fails. No matter the revenue it generates, if its expenses exceed its revenues, it goes out of business. Profits allow for sustainability.
Enter Tesla Motors which in 13 years of operation has not once made a profit.
How can this be?
According to many analysts covering the stock they will yell and scream at me that, “No, indeed Tesla did in fact make profits.” But what I’m talking about is a real profit, not some accounting, non-GAAP “fustercluck of numbers”, pretending to be anything other than obfuscation.
Since I’m short the stock I thought I’d bring it to your attention. In a strange set of coincidence, two days after I took out a small short position, a buddy who I spoke with pinged me saying he was going short. Usually when we come to the same conclusion it’s a good thing. Time will tell…
Now to be clear, I’ve been burned by Tesla before. I shorted them in mid-2013 and was stopped out as Tesla screamed higher. The reason I’ve gone short again is based on the probability of 3 things. But note that I don’t need all three to take place:
- I think the US will enter a recession shortly and the disastrous deal with SolarCity has the potential to bring to light the problems with the company and its valuation. Time will tell on this one.
- As mentioned last week, the probability of a Trump victory grows every day. This is potentially bad for Tesla which I’ll cover shortly.
- And lastly, for the same reasons that I disliked the company 3 years ago (and this now looks even worse with the Solar City deal): burning through a whopping $3.2bn in the last 2 years, it is massively unprofitable; uses aggressive, unrealistic accounting; and relies heavily on the “superman” status. When the market realises that Elon Musk isn’t going to be mining Kryptonite then the admiration and “Musk” premium can dissipate, leaving us with the cold, hard, and extremely troubling numbers.
The problem I mentioned over 3 years ago is that Tesla relies in no small part to generous subsidies. Take those away and it’s hard to see how they would manage to make a go-kart, much less the super slick machines that roll of the production line, and believe me, they are slick. The product looks amazing, but then again, Concorde was an amazing machine too.
Take these subsidies away and Mr. Musk would be sweating worse than Mike Tyson in a spelling bee.
You see, Musk is no fan of Trump and a Trump victory could be very bad for Tesla (remember those subsidies?). Perhaps this is why Musk is seeking Chinese tax payer subsidies? One needs a plan B after all…
Market participants, knowing that the game is rigged and understanding that it’s often easier to “join em when you can’t beat em”, have in turn invested heavily into the company’s equity. Other investors are just following momentum and CNBC and so they buy Tesla blindly.
I really did scratch my head when first hearing about the marriage between Tesla and SolarCity. Setting aside the fact that Musk owns 22% of SolarCity and his cousin runs the company – red flags if ever there were any.
When asked about why the deal is being sold to investors, Musk has floated this idea that it’s better when Tesla customers can get solar installation and battery installation in a seamless way and tied together to their cars. Huh?!
Now for starters, they should just hire me and I’ll put together a solid JV deal for them, saving them millions in transaction costs, and Tesla customers will get all the “seamless installation” they can handle. I’ll take 10% of the cost savings as a fee. It’s a win-win for everyone.
Secondly, taking two hemorrhaging companies with opaque accounting and blending them together like one of Brad Pitt’s newly adopted ethnic children increases the leverage and risk with no identifiable upside.
No, it’s far more likely that there are problems at Tesla that can be covered up with this deal. What we do know is that SolarCity have been struggling to raise equity and Tesla solves this problem for them because Tesla is still a Wall Street darling. Just focusing on the deal, it quite makes no sense for Tesla at all. If it’s not a bailout then I don’t know what is.
To give you a sense of how absurd some of the accounting is: SolarCity has forecast it will generate “positive cash” by year’s end.
But if we go read the Q1 shareholder letter, we realise that “positive cash” doesn’t really mean “positive cash”. It’s neither positive nor is it cash. What it is in fact is cash obtained via financing sources such as “tax equity”, cash equity”, and “non-recourse debt”. I’ve been doing this all wrong – working away investing, trading, building businesses, and doing it all for cashflow. Enlightened I am now!
What I do know is this is a crappy deal for Tesla shareholders as Tesla will issue 0.11 shares for each SolarCity share. The mainstream media are reporting this as a deal with an equity value of about $2.6 billion.
But the true cost is much higher. Why?
In the last reported financials we can see that sitting quietly on SolarCity’s balance sheet is a concoction that few sane investors would want to take on, at least not at the current price being offered.
Namely, $1.3 billion in long-term debt, over $200 million in so-called solar bonds, then there is about $900 million in convertible debt, and another $625 million in solar “asset-backed notes”.
“Ok, Chris but that’s the liability side. What about the other side of the ledger?”
Well, considering SolarCity’s cash burn of $65 million per month (based on 2015 operating cashflow numbers of -$790 million) and the $362 million that was in cash in March of this year, I’d say that this looks like a terrible deal.
Tally it all up and it’s more like a $5.2bn deal, not a $2.6bn deal. Like the rest of the accounting, it’s all smoke and mirrors.
Quite simply, I don’t see how Tesla can survive without:
- Continued generous subsidies, and
- Generous equity injections from
In my research where I was trying to actually find bullish arguments for Tesla in order to stress-test my bias, I came across some excellent Tesla research done by the Devonshire Research Group. I don’t know these guys but the analysis is very good.
One thing that they mention which I’d not considered or thought about is that Tesla will need desperately to squeeze its supply chain. But this is unlikely since sophisticated suppliers (most notably, Panasonic) will fight for their share of the profit.
Also, current suppliers of numerous, strategic high-tech components have little IP and export to the US. Tesla has exactly zero patents held on these components. They also make the point that many Chinese suppliers are vulnerable to patent infringement accusations and could face ITC injunctions.
Let me know what your thoughts on Tesla are.
Investing and protecting our capital in a world which is enjoying the most severe distortions of any period in mans recorded history means that a different approach is required. And traditional portfolio management fails miserably to accomplish this.
And so our goal here is simple: protecting the majority of our wealth from the inevitable consequences of absurdity, while finding the most asymmetric investment opportunities for our capital. Ironically, such opportunities are a result of the actions which have landed the world in such trouble to begin with.
“Really pay attention to negative feedback and solicit it, particularly from friends. … Hardly anyone does that, and it’s incredibly helpful.” — Elon Musk
Author Disclaimer: I’m short Tesla but, as is my right, I can and will change this whenever I please and for whatever reason. You’ve been warned. Do your own due diligence.
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