Worm Capital likes Tesla Motors Inc. (NASDAQ:TSLA) but is it making a mistake?
Worm Capital, a small relatively unknown registered investment advisor is having yet another impressive year. Accounts managed by the firm, which is led by founder, CIO and Portfolio Manager Arne Alsin is up 6.34% for the year to October 31, outperforming the S&P 500 by 0.46% for the period. Since inception (July 1, 2012) the hedge fund has produced a return of 24.49% net per annum for investors turning $250,000 into $646,000 while the S&P 500 has only returned 13.2% per annum over the same period, according to a letter to investors reviewed by ValueWalk.
Worm likes to own what it calls, “world-class top tier companies” partnering with “cutting edge technology that dominates in the customer value proposition”. At the same time, Worm is avoiding “ verticals with difficult futures ahead of them. For example, we are avoiding all oil and gas companies which are over-leveraged and who are heavily tied to the market and global economy.”
“We focus mainly on dynamic industries going through disruption and/or consolidation due to innovation and technological change, often leading to outsized winners and losers and along with opportunity both long and short.”
Worm’s portfolio has a heavy slant towards tech. In a recent interview, Arne talked about some of the firm’s top positions, which include Netflix, Tesla, and Amazon. Arne believes Amazon is “effectively two of the best businesses in the world with their retail operation and the less understood Amazon Web Services.” Worm also has a position in Facebook and it seems that these four stocks constitute quite a large part of Worm’s assets under management. In the interview Arne remarks:
“I think Amazon, Tesla Netflix, and Facebook each offer diversification and a dominant position in their respective verticals we are committed to investing in only the best companies. Warren Buffett once remarked, “Diversification is protection against ignorance. It makes little sense if you know what you are doing.” In a potentially difficult market ahead of us we only feel confident holding the truly best of the best.”
Tesla: The bear case
There are some who may disagree that Worm’s team knows what they are doing when it comes to Tesla. The team believes that the company could “surprise a lot of people in the next few quarters” as it integrates with Solar City, the Gigafactory comes online, and car deliveries ramp up.
Stanphyl Capital is just one fund that holds the opposite view. Specifically, in Stanphyl’s third quarter letter to investors the fund’s investment manager Mark Spiegel writes:
“We remain short shares of Tesla Motors Inc. as I continue to believe that it’s the market’s biggest single-company stock bubble. Following a leaked memo from Tesla CEO Elon Musk (discussed extensively in last month’s letter) urging employees to artificially inflate Q3 company results, in October the company did indeed manage to report a Q3 GAAP profit thanks primarily to the one-time sale of stockpiled California Zero Emission Vehicle (ZEV) credits, without which Tesla would have booked a $117 million GAAP loss. Also helping to offset a loss were seemingly artificially low operating expenses (up just 7.4% vs. Q2 despite an 81% increase in revenue) and a (so far unspecified) reduction in warranty accruals despite the reliability issues detailed later in this letter, as well as what I suspect (but can’t prove) may be artificially high lease residual values. Tesla also proudly proclaimed itself “free cash flow positive,” a figure obtained only by massively increasing accounts payable (i.e., stiffing its vendors) and postponing approximately $500 million of capex from Q3 to Q4. Assuming Tesla spends the $1.1 billion in Q4 capex it projects and normalizes its accounts payable, I estimate that Q4 should be free cash flow negative to the tune of approximately $1.5 billion.”
Only time will tell which party is on the right side of the trade.
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