Tesla Inc (TSLA) Dropped A Bunch Of Massive Bombshells This Month
Stanphyl Capital letter to investors about Tesla Inc (TSLA) stock.
Check out our H2 hedge fund letters here.
Friends and Fellow Investors:
For February 2018 the fund was up approximately 2.2% net of all fees and expenses. By way of comparison, the S&P 500 was down approximately 3.7% while the Russell 2000 was down approximately 3.9%. Year-to-date the fund is down approximately 8.9% while the S&P 500 is up approximately 1.8% and the Russell 2000 is down approximately 1.4%. Since inception on June 1, 2011 the fund is up approximately 82.1% net while the S&P 500 is up approximately 132.8% and the Russell 2000 is up approximately 95.8%. Since inception the fund has compounded at approximately 9.3% net annually vs 13.3% for the S&P 500 and 10.5% for the Russell 2000. (The S&P and Russell performances are based on their “Total Returns” indices which include reinvested dividends.) As always, investors will receive the fund’s exact performance figures from its outside administrator within a week or two; meanwhile I continue to waive the annual management fee until we regain our high-water mark.
As noted last month, through this entire bull market low interest rates were used to justify egregious earnings multiples on stocks, as well as being responsible for creating much of those earnings via cheap mortgages, auto loans, etc., and yet we’re now in a rising rate environment. Even before the arrival of (or perhaps anticipating) a massive amount of deficit-related U.S. debt issuance beginning later this year, the 10-year U.S. treasury bond yield appears to have definitively broken its very long-term downtrend, ending the month with a yield of just under 2.9%. Meanwhile, recent “hot” CPI data combined with mediocre growth may even be indicative of a whiff of 1970s style stagflation. So I think the catalysts are finally here for the high-multiple stock party to end, and we’re positioned for it.
We remain short shares of Tesla, Inc. (TSLA), which I consider to be the biggest single stock bubble in this whole bubble market—a company so landmine-filled that I think it can implode at any moment regardless of what the broad market does. To reiterate the three core points of our Tesla short position:
1) Tesla has no “moat” of any kind; i.e., nothing meaningfully or sustainably proprietary.
2) Tesla loses a huge (and increasing) amount of money despite relatively light competition but will soon be confronted with massive competition in every aspect of its business.
3) Elon Musk is extremely untrustworthy.
In February Tesla released its worst quarterly “earnings” report ever, with a record GAAP loss of $675 million even including a $179 million one-time injection of near-100% net margin ZEV credit sales; the loss would have been around $850 million (!) without those ZEV credits. Also, automotive gross margin ex-ZEV sales dropped to an embarrassingly low 13.8%, and remember that unlike the rest of the auto industry Tesla doesn’t include any engineering or dealership costs on that line; measured the same way as its competitors, Tesla actually had a negative gross margin on its cars. In fact, overall in Q4 (using the total net loss ex those ZEV credits) Tesla lost over $28,000 on each car it sold! Additionally, this “hypergrowth” company guided to flat 2018 sales of Models S&X and I think they’ll actually be down, as much nicer Jaguar and Audi electric cars will be in showrooms this June and November respectively. Then 2019 will be even worse for the S&X as Mercedes and Porsche will begin selling luxury EVs. Yes, Tesla did manage to juice its Q4 negative free cash flow to be not as bad as expected but that was accomplished by the aforementioned ZEV credit sale, a massive one-time inventory liquidation and the inclusion of customer deposits in “cash flow from operations.” Here’s an excellent explanation of those shenanigans. And of course the follow-up conference call was filled with the usual combination of lies, obfuscation and inadvertent hilarity—here’s a great summary of the “highlights.”
What Tesla can’t obfuscate (courtesy of its new 10-K) is the $31.4 billion in combined long-term debt and battery purchase obligations that—accompanied by its negative cash flow and massive encroaching competition—will drive it into bankruptcy. In fact, Tesla interest expense is now at a run-rate of nearly $600 million a year, which in Q4 amounted to $4884 per car sold!
And remember that in December Panasonic announced a partnership with Toyota (and possibly other Japanese automakers) that casts a spotlight on how technologically behind Tesla’s cylindrical battery format (the one with that $17 billion purchase obligation!) now is. I urge you to read this excellent summary of the event from The Daily Kanban.
Would you like to see a few more examples—courtesy of Tesla’s 10-K- of what a horrible business (i.e., one with no or negative scale) looks like? Here you go:
Then immediately after Tesla’s disastrous February conference call two additional bombshells dropped: first, its Global President of Sales & Service became the latest among scores of C-level execs to leave the company, then its web site quietly announced that the “$35,000 Model 3” (which I’ve been saying since 2014 would never be offered in any quantity because Tesla would lose $10-$15,000 on each one) will be delayed for at least a year and in my opinion will never be offered except in token amounts. The latter may finally be causing many deposit holders/shareholders to realize that Musk is the securities fraudster we’ve always known him to be, and is likely to result in hundreds of thousands of demands for deposit refunds as potential buyers flock to alternative vehicles. In fact, after delivering only around 8000 Model 3s in total, Tesla is now offering quick delivery of the $49,000+ configuration to fill reservations from non-Tesla owners, indicating a massive number of either cancellations or postponements from current owners. And watch those reservations really vanish when the $7500 tax credit goes away later this year (one quarter after Tesla sells its cumulative 200,000th U.S. car) while over 100 competing new EV models entering the market over the next few years will still enjoy it. And finally, remember that almost nothing can be done in the Model 3 without a multi-step process on the touchscreen—not even changing the windshield-wiper speed, adjusting the air vents or opening the glovebox. Thus, operating a Tesla Model 3 may potentially be as dangerous as texting while driving.
Also in February, Seeking Alpha published a terrific article explaining why Tesla’s so-called “Superchargers” (and battery format!) are about to be obsoleted by far better technology used by competitors. And speaking of Tesla “technology,” remember that in January Navigant Research published a new “Leaderboard Report” for autonomous driving, in which Tesla tied for dead last among 19 contenders. In fact unlike the rest of the industry, apparently Tesla has NO patents whatsoever related to autonomous driving!
As for the heavily promoted “$180,000, 500-mile” Tesla electric truck, I (and many others) estimate that a 500-mile electric truck will require a 1000/kWh battery pack and—with its fancy carbon fiber cab and chassis– will thus cost at least $250,000 to build. Additionally, Tesla is guaranteeing to cap electricity rates at .07/kWh for the first million miles of the truck’s usage; as national rates average around .12/kWh, I estimate this will cost Tesla—on average—an additional $100,000 for each truck it sells, meaning it will supposedly charge $180,000 for a product that will cost around $350,000 to build and subsidize– a typical Musk “business proposition” if I’ve ever seen one! In other words, the Tesla semi-truck will either never be built and sold (hey by the way—where’s the factory and assembly line for that “2019 product”?) or the real price (with the lifetime .07/kWh electricity subsidy) will be over $400,000 (vs. $120,000 for a conventional truck) and all those big-name “reservations” will disappear even faster than the proceeds from a Tesla financing. And oh, by the way, Tesla is actually behind much of the industry in developing an electric truck.
And hey, speaking of Tesla being “behind,” read this Bloomberg article about its China situation, then click on the “China competition links” below.
Meanwhile, Tesla is increasingly besieged by a wide variety of lawsuits, for labor discrimination, union-busting, autopilot fraud, sudden acceleration, lemon law violations (including an interesting new one), investor fraud and, undoubtedly, many others of which I’m not yet aware. And that’s even before it brings in the (inevitable) bankruptcy lawyers!
So here is Tesla’s competition in cars (note: these links are continually updated)…
And in China…
Here’s Tesla’s competition in autonomous driving…
Here’s Tesla’s competition in car batteries…
Here’s Tesla’s competition in storage batteries…
And here’s Tesla’s competition in charging networks…
Yet despite all that deep-pocketed competition, perhaps you want to buy shares of Tesla because you believe in its management team. Really???
So in summary, Tesla is losing a massive amount of money even before it faces a huge onslaught of competition (and things will only get worse once it does), while its market cap exceeds that of Ford and GM despite a $2.5 billion annualized net loss selling a bit over 100,000 cars while Ford and GM make billions of dollars selling 6.6 million and 9 million cars respectively. Thus this cash-burning Musk vanity project is worth vastly less than its approximately $70 billion fully-diluted enterprise value and—thanks to its roughly $31 billion in debt and purchase obligations—may eventually be worth “zero.”
Elsewhere among our positions…
We continue (since late 2012) to hold a short position in the Japanese yen via the Proshares UltraShort Yen ETF (ticker: YCS) as Japan continues to print nearly 10% of its monetary base per year after more than tripling that base since early 2013. In February Prime Minister Abe reiterated his commitment to continue this massive printing and not only re-nominated money-printing BOJ head Kuroda but also nominated a deputy governor who’s even a bigger money-printer. The BOJ’s balance sheet is now larger than the entire Japanese economy– it owns over 40% of all government debt and over 75% (!) of the country’s ETFs by market value and Japan’s bond market is now paralyzed by the distortion of the BOJ’s buying. Meanwhile Prime Minister Abe’s October landslide reelection gave him the green light to continue this path of fiscal and monetary irresponsibility from which there is no longer any escape.
Just the interest on its debt consumes 9.2% of Japan’s 2018 budget despite the fact that the country pays a blended rate of less than 1%. What happens when Japan gets the 2% inflation it’s looking for and those rates average, say, 3%? Interest on the debt alone would consume over 27% of the budget and Japan would have to default! But on the way to that 3% rate the BOJ will try to cap those rates by printing increasingly larger amounts of money to buy more of the debt (in fact it’s already happening), thereby sending the yen into its death spiral.
When we first entered this position USD/JPY was around 79; it’s currently in the 106s and long-term I think it’s headed a lot higher—ultimately back to the 250s of the 1980s or perhaps even the 300s of the ‘70s before a default and reset occur.
We continue to hold a short position in the Vanguard Total International Bond ETF (ticker: BNDX), comprised of dollar-hedged non-US investment grade debt (over 80% government) with a ridiculously low “SEC yield” of 0.86% at an average effective maturity of 9.2 years. As I’ve written since putting on this position in July 2016, I believe this ETF is a great way to short what may be the biggest asset bubble in history, as with Eurozone inflation now printing approximately 1.2% annually these are long-term bonds with significantly negative real yields, and the ECB is now buying half as many of them as it had been as recently as December. The borrow cost for BNDX is only around 2% a year (plus the yield) and as I see around 5% potential downside to this position (vs. our basis, plus the cost of carry) vs. at least 30% (unlevered) upside, I think it’s a terrific place to sit and wait for the inevitable denouement.
Finally, we remain short the Russell 2000 index (IWM) which, with a trailing GAAP PE of 132 (no, that is not a misprint) is easily the most egregiously overvalued of the major U.S. equity indexes.
And now for the long positions…
We added a bit this month to our position in Aviat Networks, Inc. (ticker: AVNW), a designer and manufacturer of point-to-point microwave systems for telecom companies, which in February reported a Q4 2017 roughly in-line with previous guidance. Following extensive restructuring, Aviat is now a GAAP profitable company with around $250 million of annual 32% gross margin revenue, $6 million in free cash flow, $33 million of net cash and approximately $340 million of U.S. NOLs, $16 million of U.S. tax credit carryforwards, $232 million in foreign NOLs and $4 million of foreign tax credit carryforwards. Assuming 5.4 million shares outstanding and valuing the company at just 50% of revenue on a EV basis plus adding in just $30 million for all the NOLs and tax credits makes this a mid-$30s stock vs. our basis in the $15s. The company has an ongoing process to investigate “strategic alternatives” and may sell itself, buy something that can utilize the NOLs or return some cash to shareholders, or it could decide to simply follow its current course of gradual improvement. I’m comfortable owning it at our price basis in any of those circumstances.
We continue to own the PowerShares DB Agriculture ETF (ticker: DBA), bought in December when I looked around for the most beaten-down sector I could find that wasn’t a “buggy whip” (something on the way to obsolescence) or cyclical from a demand standpoint, and came up with “agricultural commodities.” How beaten down is this sector? Since its last peak in mid-2011 through the mid-December date I put on the position (at a blended basis of $18.26/share), the “DBIQ Diversified Agriculture Index Excess Return” on which DBA is based was down around 40% while the S&P 500 was up around 100%: in fact, when we bought DBA its underlying index was the lowest it had been since 2003. Here’s an interesting argument as to why many ag commodities have gotten as cheap as they have (crop insurance allowed debt-fueled overproduction) and why they probably can’t get much cheaper (production is now capped by maxed-out farmer balance sheets). Agricultural products have always been cyclical and—considering the general inflation we’ve had since prices were last here in 2003 (the CPI is up around 35%)—this could be the washed-out bottom of the cycle, and now we may have weather on our side. Also, ag prices can be a great counter-cyclical to stocks and you know how I feel about the current price of those.
We continue to own Echelon Corp. (ticker: ELON), an “industrial internet of things” networking company with approximately $32 million of annual 53% gross margin revenue and an enterprise value of only around $3 million. In February Echelon reported Q4 2017 revenue of $8 million (up slightly vs. Q3’s $7.8 million) and guided to a roughly flat Q1 2018, with operating cash burn disappointingly continuing at a bit over $1 million per quarter. Echelon is now focusing its growth on “smart” commercial & municipal LED lighting (although its fab-less chip business has apparently now stabilized after a long decline), and if the lighting business accelerates (and it could, due to recent sales force hires and new products), I think there’s a chance it can hit a break-even annualized revenue run-rate of $40 million by Q4-2019 (pushed back from my earlier hoped-for timeline) at which point—assuming $14 million of remaining net cash (vs. $19 million at the end of Q1 2018) and 4.7 million shares outstanding (vs 4.52 million today), an enterprise value of 1x revenue on this 53% gross margin company would put the stock in the mid-$11s per share. Additionally, Echelon has approximately $255 million in federal NOLs and $127 million in state NOLs, worth tens of millions of dollars if it can utilize them. So if it can pull this off (and theoretically, the market for the networking of commercial and municipal LED lighting should be huge between the U.S. and Europe), this stock can be a home run for us. So far though (as noted above) there seems to be little sign of improvement, although revenue at least has stabilized and that flush balance sheet does give it a long runway to succeed. In September the company hired a new V.P. of Sales; maybe it’s now time to hire a new CEO!
Thanks and regards,
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