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Whitney Tilson On Tesla “almost daily I’m tempted to short it”

Excerpted from Whitney Tilson‘s latest email to investors entitled “Tesla Debate”

You can ignore this email if you’re not interested in Tesla, which recently surpassed GM to have the highest market cap of any U.S. automaker. I have no position – though almost daily I’m tempted to short it – but I think it’s a fascinating company, with a fascinating debate around its stock. Below are various blurbs about the company, including a bull-bear debate among folks on my TSLA email list (reply to this email if you want to be added to it).

1) Kudos to Ycombinator, who posted this on the TSLA message board on ValueInvestorsClub.com in 2012:

 

“Obviously, the numbers/valuation are what they are, but I wouldn’t short TSLA.

 

What they did bringing the Model S to market in 4 years is nothing short of astounding and Elon Musk is the right kind of crazy, like Bill Gates, Steve Jobs, Jeff Bezos kind of crazy.

 

I wouldn’t go long either, making cars is a tough business, but there’s crazy, visionary entrepreneur risk here for the shorts.”

 

2) Mark Spiegel discusses TSLA with other investors on the SumZero message board:

 

Managing Member

$100M – $500M HEDGE FUND

APRIL 09, 2017

Count me as someone who thinks Elon is a genius… and simultaneously a snake-oil salesman. What do you think it takes for Tesla to grow into this valuation? I know a lot of bears on the stock including myself but the bulls I know are smart as well. I guess the real question I’m asking is — at what point

——————

Mark Spiegel

STANPHYL CAPITAL

APRIL 09, 2017

 

When it comes to cars, at least, Musk’s ONLY “genius” is as a snake-oil salesman (and a glommer of government subsidy and regulatory largesse). To grow into its valuation Tesla would profitably have to sell MILLIONS of cars a year, and yet by the end of the current quarter (Q2 2017) you’ll see four straight quarters of ZERO sequential Model S&X growth and that’s BEFORE the onslaught of luxury EV competition arrives in 2018. Meanwhile, the Model 3 will be a money-losing disaster that may very well bankrupt the company.

 

You think the Tesla bulls are “smart”? The bulk of the stock is in the hands of the PMs at Fidelity, T. Rowe, Baillie Gifford and Tencent. Maybe those guys are smart about SOME things, but read interviews with them about Tesla and you’ll see how absolutely clueless they are about the emerging competitive landscape in EVs, batteries and autonomy. (And no, I haven’t seen any interviews with the PMs at Tencent, but I know Chinese people who tell me they’re equally clueless about Tesla.) When this bubble implodes anyone who bought into it with OPM despite hundreds of facts thrown in their faces should take up his rightful career as an Uber driver (except Uber may implode by then too, so they may just have to be REGULAR cab drivers).

 

That said, my timing on this presentation has admittedly been awful as the stock was in the $180s when I gave it. (My fund’s blended basis is probably somewhere in the low $200s.) But time is NOT on Tesla’s side and meanwhile its debt (and losses) keep accumulating!

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Managing Member

$100M – $500M HEDGE FUND

APRIL 09, 2017

Let’s say, Tesla sells 500k cars against all expectations. What’s the revenue? 25b+ — does the market even care if it’s profitable? I’m just trying to figure out how much more pain you might have to take before the thesis starts working. Does it trade at 3x sales at that point?

 

Frankly, to say his only genius is as a leech is pretty dismissive. This one company has pushed every car manufacturer to now create EVs and play catch-up. SpaceX is at the forefront of engineering and rocket technology. He’s upended at least 2 industries and made the smartest people believe things are now possible that were thought impossible just a few years back. How many Tesla bears said there’s no way they produce a Model S, there’s no demand for the Model S, the model X is vaporware? The thesis has changed just as often for the bulls as for the bears.

 

Again, I am a bear but I don’t know what the path is – maybe it’s $500 first. Corporate governance is awful – maybe the worst I’ve ever seen for such a large company. If they produce a Model 3 in quantity I believe there will be demand for it. I have little doubt that people will step up to fund capex when they ask for more money. The questions become – can they build it without any hiccups? and is there a case for 1mm cars of demand? I hope I am putting in a top by asking these questions :)

——————

Mark Spiegel

STANPHYL CAPITAL

APRIL 09, 2017

@Managing Member

I said “when it comes to CARS his only genius is selling snake oil.” I don’t really know enough about the rocket company to comment, except that for a very long time the web site proudly declared it was profitable and then the WSJ found it he was lying about that too!

 

As for Tesla, why is it genius to sell $1 of product for .80 cents? Yes, we bears underestimated the market size (I never thought he’d sell 90,000 S&X a year) but (at least when I started shorting this) even a number that big didn’t change how grossly overvalued it was at the time. And now it’s a lot more grossly overvalued and those sales are stalled out and in 12 months Jaguar and Audi roll out much nicer cars for considerably less money and Mercedes does the same in 18 months.

 

If people NEVER care about profits I can’t tell you what will happen with the stock. But Tesla needs billions of dollars a year in fresh capital infusions and it’s one thing to find “dumb money” but something else entirely to find “deep-pocketed dumb money.”

 

As for other OEMs catching up to Tesla, in fact Tesla is now behind all the OEMs in safe autonomy and is using an obsolete battery format– all the new clean-sheet EV designs had the option of wiring together 7000 or so small cylinders as Tesla does (and HAD to do when it designed its battery pack around 2006 or so). Instead, they’ve all chosen to go with large-format prismatic cells that weren’t available with sufficient energy density at sufficiently low cost when Tesla pioneered the market. So Tesla is Commodore, Palm Pilot, Iomega and Blackberry all in one.

 

And sure there may be demand for the Model 3, but Tesla has almost $80,000 in variable cost at a $104,000 ASP for the S&X, so with a slightly smaller battery pack (maybe 60kWh instead of an average of 80kWh or so) please explain how it will make money pricing a car with a $35,000 base! Hell, even Musk essentially admitted on the last conference call that for a while it will have negative GROSS margins! My guess is that even on well optioned Model 3s Tesla will lose an average of $6000 to $8000 per car on a VARIABLE basis, before even accounting for the massive increase in SG&A required to support and service them.

 

All that said, can I tell you the stock won’t go to $500? No! Hell, people are always asking me when the Tesla bubble will finally implode and I always tell them the same thing: I’m absolutely sure it will pop no later than December, 2015! So you can look for reversal days here and stop yourself out each time it sets a new high, or you can just sit patiently on the sidelines and wait to (as Fleckenstein would say) “shoot it in the back.”

——————

Managing Member

$100M – $500M HEDGE FUND

APRIL 09, 2017

Thanks – I appreciate the commentary. I do agree that they are screwed on autonomous driving. They are playing a game with Level 3 that Google et al are just skipping and going to Level 4-5.

 

I am looking forward to the Audis and Jaguars and the mission e :) What do you think steady state operating margins are of EVs? Higher?

 

If you haven’t read the Ashlee Vance biography of Musk, you should. It will confirm many of your views of him (obnoxious, slippery, poor interpersonal skills) and challenge others (true belief in what he’s doing, deep understanding of many fields from a standing start). http://amzn.to/2nvbrEJ

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Mark Spiegel

STANPHYL CAPITAL

APRIL 09, 2017

Right now EV margins are unquestionably LOWER. Variable cost on an EV power train is probably more than double that of a conventional one. But the conventional guys can eat that to avoid buying ZEV credits and meet European emission standards. Tesla doesn’t have conventional cars to cross-subsidize those losses.

——————

John Buethe

ARSURUS LLC

APRIL 10, 2017

I have been long and short Tesla at various points in time. Can’t argue with the bear logic or your work. But hasn’t logic left the building long ago on this one? I keep coming back to an anecdote from near the lows this past fall when Morgan Freeman was on one of the talking-head financial media shows, saying that the one stock he owns and checks is TSLA. Morgan. Freeman…

 

Retail isn’t going to move the needle dramatically here in terms of ownership here but when you now have institutional investors who are singing the same song, I wonder if fundamentals will ever matter in a reasonable short investment time horizon? Couple weeks ago it was Tencent. Next time there will be another large institutional “believer” popping up out of the woodwork to buy on any secondary or any material pullback. As that keeps happening, doesn’t this become reflexive? Believers are going to keep believing. Their unrelenting commitment of capital, even in the face of considerable operating risk, gives Elon enough cash cushion to ride out all but the most calamitous of blow ups. I believe that to be the case — and this makes quantifying downside risk difficult and the stock effectively uninvestable.

 

Thanks for your very interesting work, debate, and perspective on this one.

——————

Mark Spiegel

STANPHYL CAPITAL

APRIL 10, 2017

@John Buethe

Yes, logic undeniably “left the building a long time ago” for Tesla! In fact, one could argue it left approximately $300/share ago, lol. (It’s in the $311s as I type this.) Sure, Musk may be able to raise more cash but then this will be cash-rich company (until he burns it) that will STILL be a bubble. Remember how many cash rich tech companies there were after the “bursting of 2000” that traded down 90% but had great balance sheets? (And by the way, Tesla has an AWFUL balance sheet, with around $7 billion of debt and debt equivalents, and it’s no tech company– it’s a low margin manufacturer of products that use no more technology than myriad competing products, and in some ways LESS).

 

But as I wrote earlier, it’s very tough to pick an entry point in a stock that becomes so decoupled from reality that $200 is the same as $300 is the same as $400. So you can always wait to “shoot it in the back”– there are a near-infinite number of “shots on goal” here (in the negative sense), and at any time one of more of them could pop this thing.

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Managing Member

$100M – $500M HEDGE FUND

APRIL 10, 2017

C’mon! Let’s all just employ a creative valuation methodology and buy some Tesla. It helps if you’ve driven one for 7 months or so.

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Scott Preston

MAVEN GROUP LLC

APRIL 10, 2017

I think the biggest catalyst is likely some sort of customer dissatisfaction with the Model 3.  There is about as much hope built up for this car than any other consumer product in history.  Remember all good Ponzi schemes suck everybody in first before they give up the ghost

 

3) A friend’s comments, followed by others’ back and forth on TSLA:

 

I read the Bloomberg piece on Tesla — by Tom Randall — at the beginning of the week (www.bloomberg.com/news/articles/2017-03-27/tesla-model-3-ramp-up-aims-to-crush-bmw-and-mercedes).  It reads like a very uncritical propaganda piece.

 

Granted, the Model 3 looks great and seems like a most rational design in almost every way.  I even like the interior concept, even though it surely won’t be to everyone’s tastes.  You can’t win them all.  But yes, many key parts of the product make sense and look good — come to think of it, just like all other new cars that are being launched this year and next.

 

So the car is good.  Tesla’s problems, however, are at least threefold:

 

  1. Lack of profitability.
  2. Insufficient quality testing.
  3. Competition is coming, big-time.

 

  • Lack of profitability

 

Tesla is operating at a loss.  Yes, they claim anywhere from 19% to 30% gross margin, depending on the model and the quarter, but the gross margin calculation is deceptive in comparison with how other automakers calculate theirs.  It does not include things in COGS that all other automakers do, including development cost and distribution/sales expense.  Once you adjust for those, Tesla’s gross margin is perhaps barely above 0%, if even that.

 

Of course, you can’t look at the business that way.  On a net basis, Tesla continues to produce hair-raising losses, and they aren’t going down as sales volumes are going up.  Why are Tesla’s “overhead” expenses rising as fast as revenue?  Because some of them are really variable expenses.

 

Eventually, that may change, at least in part, but for the rest of this year and probably well into 2018, the losses are increasing.  We could be talking about annualized losses of close to $2 billion.  Mind you, cash flow will be a lot worse than that, considering capex.

 

Every automaker would sell a lot more cars too, if they could sell a dollar for 60 cents.  How many more cars would BMW and Mercedes sell if their $70,000 cars could be sold for $42,000?

 

But even so, sales of Model S and X have stalled.  They’re sitting still around 23,000 – 24,000 units per quarter.  No sustained growth since the middle of 2016.  In the first five days of April, Tesla will likely report yet another quarter with sales in the general 23,000 – 24,000 range, plus or minus a hair.

 

Tesla’s balance sheet liabilities hit $16.8 billion as of year-end 2016, up dramatically from only a few months prior.  That number is likely to rise meaningfully in 2017, with the only offset being yet another possible capital raise.  All logic points to the company will be reorganized, possibly in a Chapter 11, within two years from now.  In such a scenario, the equity would likely be worth zero.

 

  • Insufficient quality testing

 

Tesla has basically admitted that it’s bringing the cars to market with only a few months of testing, most of which will be done by employee-civilians, in turn mostly on balmy California commuter duty.

 

All the other automakers laugh at this.  They will do at least 12 months, in some cases more like 18 months, of rigorous torture-testing by professional drivers 24/7 in the coldest and hottest climates around the world.  They all also have superior proving grounds to shake them apart.

 

And this is why Teslas fail so often — doors, windows, suspensions, motors, batteries, you name it.  So far the customers reaction to these epidemic quality failures has been survivable thanks to the 8 year and unlimited mile powertrain warranty, but that game could soon be up.

 

  • Competition is coming, big-time

 

Tesla is losing money before competition showed up.  They’ll naturally lose even more once hundreds of competitive models are offered at loss-making prices.  Here is the Jaguar, for example: http://www.autoblog.com/2017/03/31/jaguar-i-pace-production-spy-shots/?hcid=hp-tile-small-4

 

The Jaguar hits in mid-2018 and has already undergone torture-testing with over 200 Betas around the world.  And that’s one year before production starts.  This is how you avoid Tesla’s catastrophic quality issues.

 

From the VW Group (including Audi and Porsche) to Mercedes, Volvo, GM, Ford, Nissan, Hyundai and many others, the net profitability of even the most economical competitors will be around 10% at best.  Those with lesser economies of scale, no offsetting profitable products (regular gasoline / diesel trucks and SUVs), will be bleeding red ink for years to come.

 

Summary

 

The Tesla story could have life if there’s some sort of new government subsidy program being launched to bail out electric car profitability.  But if not, at some point in the next 9-18 months, things begin to crumble radically.  And that’s assuming capital markets hold up until then, as Tesla will need billions of more dollars of financing well before the middle of 2018.

 

Electric cars are great.  We will have over 100 EVs among the main players in the Euro-American auto markets by 2022.  Most likely, none of them will make any money selling them, least of all the players (not only Tesla, but for this valuation exercise, Tesla is the main focus) that sell *only* electric cars.
Tesla may be the single most overvalued stock in the market today.  Of course, it could still go a fair bit higher, before the almost-inevitable 80% or greater drop.  The question is really when.  I’m thinking within 18 months from now, once people have fully realized that the Model 3 never made Tesla any profits, despite very solid demand for what is without a doubt a beautiful product penned by the ex-Mazda designer.

 

Another friend responded:

 

This is a 95% good summary of the bear case.  I completely agree with the three primary problems and agree that TSLA stock is currently very overvalued.  But he does leave out one huge bull piece and significantly overstates two points.

 

The missing bull case is the potential upside from things other than the Model 3 working out well, including, potentially, things that we aren’t even imagining right now.  As an analogy, for much of its public life Amazon stock was highly overvalued even assuming it was going to conquer the world of retail as it has.  No one was imagining that it would build a separate business called AWS that would be worth more than the retail piece.  Tesla is employing and attracting large numbers of the brightest and most creative tech people in the world, and Musk is part charlatan/stock-promoter but also part genuine innovative genius.  I think the odds of Tesla out-innovating the legacy OEMs in auto design in some significant way are probably <20% — but how much is the company worth if it does?  20% odds of even a three-bagger is worth 40 percentage points of expected value.  How much is it worth if Musk is even half right about how much they can improve the manufacturing process (separately from the car design)?  Or might they not actually pull off something valuable in batteries?  Also, when I did work on SCTY long ago, with the stock in the $30’s, it was blindingly obvious that there were scenarios in which the stock was worth zero but equally obvious that there were scenarios in which the stock was a multi-bagger.  Now that is inside Tesla, too.

 

Again, these are all the potential upsides I can actually list today, there are others I can’t even imagine.  Assigning some value to imagined-but-low-odds upsides and unimagined upsides is necessarily fuzzy, but for TSLA unlike for most stocks, that number is well above zero.

 

That feeds into the two overstatements:

 

(1) It is highly unlikely that TSLA is going to declare bankruptcy in the next two years, even assuming the market is disappointed by the financial outcome of the Model 3.  Tesla has a proven ability to raise $billions of capital at will.  The likely downside case is that they sell many Model 3s at large losses and continue to raise capital at lower valuations.

 

(2) There is no way TSLA is the most overvalued stock in the market today, unless the metric is absolute dollars of overvaluation instead of % downside.  On % downside, it is certain that some publicly-traded stocks will literally go to zero via bankruptcy in the next two years, even if we can’t currently identify which ones.  TSLA won’t go to zero, if for no other reason than because of its what-if value and the capital-raising ability.

 

My comment:

 

Per his point about optionality, that’s largely what I got wrong about Google when I called it wildly overvalued shortly after its IPO – see page 15 of the presentation I gave there a year and half ago, A Google Skeptic Eats Crow: www.tilsonfunds.com/TilsonGoogle.pdf

 

Another friend’s comment:

 

Your buddy’s response is essentially a blue sky what if the unimaginable takes place. That’s not analysis; only in a bull market top do you get valuation in maybe awesome things happen that I can’t even identify–sign of our times…sell!

 

Another:

 

Google was ALWAYS a GREAT business. Tesla has always been a SHIT business. Amazon in its entirety was (and still is) a mediocre business. Neither Google nor Amazon started as a “shit business” and “changed” and neither of them at any time (as far as I know) had financial statements that clearly had them on a path to bankruptcy. But hey, if that guy wants to believe in dreams, more power to him. Just remind him that when the 2000 bubble burst even AMZN was -95% peak-to-trough and -75% during the 2008 crash, and again it was never the kind of shit business Tesla is.

 

P.S. Have you ever seen a long interview with Bezos? I did a couple of months ago, at the Economic Club of New York. (I think you can find it on-line– Charley Rose did the interview.) He’s pretty much the smartest CEO I’ve ever seen, and probably has 30 IQ points on Musk, who has NEVER run a company profitably!

 

Another:

 

It is correct in principle that there is upside optionality in Tesla.  The question is only how much and on what is it realistically based.  I sense that there is too much belief that Tesla actually has the ability to come up with something dramatically new that will impact profitability in a majorly positive way.  Too many people drawing analogies with tech companies who are not involved in manufacturing, liability exposure and 10-year warranties on weapons rolling on four wheels.

 

Basically, it appears to me that many of the people invested in TSLA long have little or no experience in the automotive industry.  I know, for I was one of them myself only a few years ago.  I went from a Bull (2012-2013) to a Bear (2014-onwards) once I started looking beyond Tesla and electric cars, into the automotive industry as a whole.

 

Now, it’s certainly true that Tesla has some major positives — software, Supercharging network, a beautiful set of designs — but once one learns about the competitive responses and pair that with Tesla’s already-horrific economics, one arrives at the conclusion that there is no getting back up to the surface for this U-boat.

 

To respond specifically to the suggested upside options:

 

  • Manufacturing

 

Tesla is by a wide margin the worst automobile manufacturer in the world right now, whether measured by quality or by productivity.  I know Musk likes to say that he has decided to become the best on all metrics.  Well, I guess the issue has been settled, then.  Basically: I’m sure Tesla sort of knows where it needs to go, but is there any reason you would believe that it’s realistic anytime soon?  A quick visit to the “other side” of the Fremont factory and its minimum-wage alcoholics and other drug users manning the assembly line, would scare any fund manager stiff.  Which is why always go there on the North Korea-style guided tours.

 

Tesla did hire its new head of production from Audi, in the middle of 2016.  I think that tells you where it hopes to arrive, one day.  It took Audi, Toyota and others decades to get there.  Can Tesla get there in a few years, instead of a few decades?  Maybe.  Will the market have patience for the Model 3 having quality issues and losing a fortune, come July 2018?  I don’t know.

 

  • Battery innovation

 

Call Panasonic.  It’s their battery cells.  Tesla builds a box around them.  Just like all the other automakers do — except those other automakers have LG, Samsung AND Panasonic as suppliers, playing them against each other in a reverse auction on any given Thursday afternoon.

 

Tesla being the landlord in the Nevada desert for Panasonic installing machines has got to be the biggest valuation joke this side of Pets.com.  By that standard, EVERY automaker could “make” a 10:1 “valuation return” by erecting a building in which they are the landlord for a supplier, and get a multiple on that as a boost to their market cap.  This is so crazy that I don’t know where to begin.  I have spoken to the managements of many of the largest automakers, and they look at this thing alternatively laughing and crying.  They think it’s so logically insane they wonder how someone can get away with such a blatant “valuation trick.”

 

There is of course a non-zero chance that Tesla will pull it off, and somehow survive.  I think the most likely scenario would be one or several government subsidy programs, particularly in the U.S.  I don’t see the U.S. happening right now (Republican Congress), but you never know.  Crazier things have happened, and if that happens, Tesla will go up — and possibly survive.

 

I think the biggest case for the short side right now is that TSLA is full of longs who don’t have a clue about what the other automakers are bringing to market in the next 1-2-3-4-5 years, and what that will mean to margins and market share.  I can count 140 models by American, European, Japanese and Korean brands, that will be in the market by 2022 — up from 20 models by the end of 2017.

 

A more arbitrary — or otherwise highly uncertain — factor would be the U.S. Congress canning the $7,500 Federal tax credit for EVs, sooner than the currently planned phase-out.  If that happens — and we may know this in the next few short months — that alone will deflate the Tesla bubble by 30%-40%, and that’s before any further negative knock-on effects of such a move by Washington DC.

 

Tesla is a tricky stock, but there is good money to be made both on the long and short side, depending on the day or the week.  That’s been the situation for years now.

 

Short of a U.S. dollar collapse yielding massive (hyper)inflation, there will very likely be a moment in the next 9-18 months when TSLA will be down much more than 50%.  I hope I can time that moment correctly.

 

I guess you could say:

 

  • Reason to be LONG TSLA:

— It’s a very crowded short.

 

  • Reasons to be SHORT TSLA:

— The longs are financially illiterate.

— The longs are uneducated about the other automakers.

4) Lastly, here’s a NYT article:

Tesla Has Something Hotter Than Cars to Sell: Its Story