Stanphyl Capital letter to investors for the first quarter ended March 31, 2019, discussing their short stock and call options in Tesla Inc (NASDAQ:TSLA).
Friends and Fellow Investors:
For April 2019 the fund was up approximately 2.9% net of all fees and expenses. By way of comparison, the S&P 500 was up approximately 4.0% while the Russell 2000 was up approximately 3.4%. Year-to-date 2019 the fund is up approximately 16.0% while the S&P 500 is up approximately 18.2% and the Russell 2000 is up approximately 18.5%. Since inception on June 1, 2011 the fund is up approximately 90.8% net while the S&P 500 is up approximately 158.5% and the Russell 2000 is up approximately 109.3%. Since inception the fund has compounded at approximately 8.5% net annually vs 12.8% for the S&P 500 and 9.8% 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. (Please note that individual partners’ returns will vary in accordance with their high-water marks.)
I continue to believe that what we’ve seen since the market’s late December low is a bear market rally (albeit a fierce one), with the broad indexes in the process of forming a double-top like those of 2000 and 2007. The U.S. economic slowdown is in its early stages and we’re a long way from QE4; in fact the Fed is still removing approximately $50 billion a month from its balance sheet and—despite the taper announced in March—will continue removing tens of billions of dollars a month through September, while real short-term U.S. interest rates are positive for the first time in over a decade. Meanwhile, as evidenced by the chart below, Q1’s annualized +3.2% GDP report was much weaker than the headline number suggests:
We thus remain short the Russell 2000 (IWM), an index with a trailing twelve-month GAAP PE ratio of 43, and a declining “E” with 35% of its constituents losing money:
Is our short bias a contrarian one? It certainly seems to be, as here (courtesy of Real Vision Research) is a chart of the current (as of mid-April) combined short interest in SPY, QQQ and IWM as a proportion of all shares outstanding:
Elsewhere in the fund’s short positions…
We remain short stock and call options in Tesla Inc (TSLA), which I consider to be the biggest single stock bubble in this whole bubble market. The core points of our Tesla short thesis are:
- Tesla has no electric vehicle “moat” of any kind; i.e., nothing meaningfully proprietary in terms of design or technology, while existing automakers—unlike Tesla—have a decades-long “experience moat” of knowing how to mass-produce, distribute and service high-quality cars consistently and profitably.
- Tesla is now a “busted growth story”; demand for its existing models has peaked and it will have to raise billions of dollars to produce new ones.
- Tesla is losing a ton of money with a terrible balance sheet while suddenly confronting massive competition in every aspect of its business
- Elon Musk is extremely untrustworthy.
In April Tesla reported a disastrous Q1, with a GAAP loss of $702 million (over $900 million excluding regulatory credit sales) and just 63,000 vehicles delivered, down 30% sequentially from Q4 of 2018. Model 3 sales were down 17% despite the initial, backlog-filling sales into Europe and China, while sales of the much higher-margin S&X were down an astounding 52%, and this all happened despite massive price cuts on every model as the quarter progressed.
In the Q1 earnings press release the company blatantly lied about its Q2 guidance, claiming it will sell 90-100,000 cars when in fact it will only approximately match the delivery number from Q1, and at a much lower ASP. I thus predict that Q2’s loss will be roughly as bad as Q1’s, with lower ASP’s and regulatory credit sales offsetting Q1’s inventory write-down. (The only wild card will be if Tesla recognizes some deferred Autopilot revenue, in which the loss should still be at least $500 million.)
Following April’s awful deliveries report, word leaked that Panasonic was refusing to commit any more investment to Tesla’s Nevada battery factory, nor would it invest in Tesla’s future plant in China.
The party’s over, folks. With no growth, massive ongoing losses and tens of billions of dollars in debt and purchase obligations, the equity in Tesla will prove worthless, either quickly or—following a series of increasingly ugly capital raises—slowly. But as the stock price has yet to reflect that, I’ll continue…
Q1 Model S&X sales (Tesla’s highest-margin cars) were especially awful in Europe, and Q2 looks no better:
European S&X sales are being crushed by the recently introduced Audi e-tron and Jaguar I-Pace (the Jaguar is currently available in the U.S. and the Audi arrives in May) , and later this year come the Mercedes EQC and Porsche Taycan, with multiple additional electric Audis, Mercedes and Porsches to follow, many at starting prices considerably below those of the luxury Teslas. (See the links below and last month’s letter for more details.)
As for the Model 3, Tesla in March claimed to have finally introduced a $35,000 version, but then after grabbing a bunch of deposits to pad the March 31 balance sheet decided to make it only “available” at its (increasingly shuttered) physical stores. (No wonder, as the car uses a larger battery pack that’s software-limited and thus Tesla will lose thousands of dollars on each one it sells.) Meanwhile the cheapest Model 3 available for on-line ordering now costs $39,500 and reflects yet another price cut (the fourth this year, by my count), as it includes basic Autopilot as part of a $2000 price increase, yet that was previously a $3000 option.
Also in April…
- Tesla hosted a laughably bad “Autonomy Day” to show off its (non-existent) self-driving technology. (Keep in mind that in March Navigant consulting came out with its annual ranking of autonomous driving capabilities, and just as last year Tesla ranked dead last among active automakers and suppliers.)
- The SEC gave Musk the wrist-slap we anticipated for his clear contempt violation of the “$420 settlement.” Although this is now irrelevant re Musk as he’s already lied and frauded his way into being a “credibility laughingstock,” it sets an awful example for every other fraud-inclined CEO in America. Nice job, SEC!
- Tesla announced mechanically updated (but stylistically unchanged) versions of the Models S&X with approximately 10% more range than the current models; in my opinion this is nowhere near exciting enough to rekindle the dying demand for those cars.
- Tesla filed a proxy indicating plans to reduce its board size from eleven members to seven, with two leaving immediately and two departing over the next one to two years. Seeing as the entire board is a collection of grotesquely overpaid enablers of Musk’s criminality it’s certainly no great loss, yet on the other hand this further concentrates power in the hands of the Musk family, as Elon and his dim-witted brother Kimbal will now have two seats out of seven as opposed to their prior two out of eleven. And here’s what Tesla shareholders get for their money from their new figurehead of an “independent” Chairwoman:
In mid-March Tesla rushed out an ill-prepared Model Y unveiling on extremely short notice, inspiring its chief engineer to immediately quit. Supposed to be a small electric SUV/crossover, the event showed only a fake clay model and a bodywork-disguised Model 3, and was a complete embarrassment beautifully summarized here by Zero Hedge. By the time the Model Y is available in late 2020/early2021 (if Tesla is still in business then), it will face superior competition from the much nicer Audi Q4 e-tron, BMW iX3, Mercedes EQC and Volvo XC40, while less expensive and available now are the excellent new all-electric Hyundai Kona and Kia Niro, extremely well reviewed small crossovers with an EPA range of 258 miles for the Hyundai and 238 miles for the Kia, at prices of under $30,000 inclusive of the $7500 U.S. tax credit.
Meanwhile, Tesla has the most executive departures I’ve ever seen from any company, a dubious achievement that continued in full-force in April-- here’s the astounding full list. These people aren’t leaving because things are going great (or even passably) at Tesla; rather, they’re likely leaving because Musk is either an outright crook or the world’s biggest jerk to work for (or both). Could the business (if not the stock price) be saved in its present form if he left? Nope, it’s too late. Even if Musk steps down in favor of someone who knows what he’s doing, emerging competitive factors (outlined in great detail below) and Tesla’s balance sheet make the company too late to “fix” without major financial and operational restructuring.
Finally, the Consumer Reports annual auto reliability survey ranks Tesla 27th out of 28 brands and the number of lawsuits of all types against Tesla continues to escalate-- there are now well over 500!
So here is Tesla’s competition in cars (note: these links are continually updated)…
AUDI E-TRON GT FIRST DRIVE: LOOK OUT, TESLA (available 2020)
Mercedes to launch more than 10 all-electric models by 2022
And in China…
536 HP Nio ES6 Midsize Electric SUV Launches With 317-Mile Range (at 1/2 the price of Tesla X)
Xpeng Motors G3 Electric SUV Launches 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 approximately equals that of Ford and is close to GM’s despite selling approximately 250,000 cars a year while Ford and GM make billions of dollars selling 6 million and 8.4 million vehicles respectively. Thus this cash-burning Musk vanity project is worth vastly less than its roughly $50 billion enterprise value and—thanks to roughly $34 billion in debt, purchase and lease obligations—may eventually be worth “zero.”
Elsewhere among our short 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 4% of its monetary base per year after nearly quadrupling that base since early 2013. In fact, of the world’s three largest central banks (the Fed, ECB and BOJ), the BOJ is now the only one still conducting QE and one result of this insane policy (in 2018 the BOJ bought approximately 67% of JGB issuance and in 2019 anticipates buying 70%!) is there are days when no 10-year JGBs trade in the cash market! The BOJ’s balance sheet is now larger than the entire Japanese economy-- it owns approximately 43% of all government debt…
…and 77% (!) of the country’s ETFs by market value.
Just the interest on Japan’s debt consumes 8.9% of its 2019 budget despite the fact that it 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 nearly 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 that debt, thereby sending the yen into its death spiral.
When we first entered this position USD/JPY was around 79; it’s currently in the 111s 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 0.77% at an average effective maturity of 9.5 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 1.4% annually these are long-term bonds with significantly negative real yields. In mid-December the ECB halted quantitative easing, thereby removing the biggest source of support for those bonds’ bubble prices. Currently the net borrow cost for BNDX provides us with a positive rebate of 2% a year (more than covering the yield we pay out) and as I see around 5% potential downside to this position (vs. our basis, plus the cost of carry) vs. at least 20% (unlevered) upside, I think it’s a terrific place to sit and wait for the inevitable denouement of this insanity:
Also in mid-April we also put on relatively small short positions in Netflix (NFLX) due to its egregious valuation within the context of increasing cash burn and competition (particularly from Disney), Square (SQ) due to its egregious valuation and a stock-dumping CEO who so effusively praises (and enables) Elon Musk that I suspect he’s equally untrustworthy, and Carvana (CVNA) due to a laughable business model with escalating losses and a CEO with a sketchy past who’s dumping stock every two days.
And now for the fund’s long positions…
We continue to own Westell Technologies Inc. (WSTL), a 43% gross margin telecom equipment maker (of primarily small-cell repeaters) in turnaround mode. In February Westell reported a mediocre FY 2019 third quarter, with revenue down 22% year-over-year but up 6% sequentially, and although it burned around $970,000 in free cash flow it ended the quarter with $27.1 million in cash ($1.75/share) and no debt, and on the follow-up conference call management explicitly indicated that it expects to return to break-even or better within a year. (It reports its FY 2019 Q4 in May.) Westell sells at an enterprise value of only around 0.13x (i.e. 13% of) revenue, but in addition to the (hopefully soon-to-reverse) cash burn, the "hair" on this company is the long-term decline in revenue (which now appears to have stabilized and should soon reverse), a cash pile that could potentially be squandered on dumb acquisitions (a risk with all cash-rich companies) and—perhaps most annoyingly—a dual share class, with voting control held by descendants of the founder. However, on the conference call management claimed the controlling family is open to merging the two share classes, and Westell is so cheap on an EV-to-revenue basis that if management can’t start generating meaningful profits it seems primed for a strategic buyer to acquire it. An acquisition price of 1x run-rate revenue (on an EV basis) would be around $4.50/share.
We continue to own Aviat Networks, Inc. (ticker: AVNW), a designer and manufacturer of point-to-point microwave systems for telecom companies, which in February reported a decent Q2 for FY 2019, with revenue up 2% year-over-year (adjusted for a GAAP-mandated change in revenue recognition to ASC 606; unadjusted revenue was up 5.5%). For FY 2019 the company guided to $250-$255 million of revenue and non-GAAP EBITDA of $12.5-$13 million, and because of its approximately $330 million of U.S. NOLs, $10 million of U.S. tax credit carryforwards, $214 million in foreign NOLs and $2 million of foreign tax credit carryforwards, Aviat’s income will be tax-free for many years; thus, GAAP EBITDA less capex essentially equals “earnings.” So if the non-GAAP number will be $12.5 million and we take out $1.7 million in stock comp and $6 million in capex we get $4.8 million in earnings multiplied by, say, 16 = approximately $77 million; if we then add in at least $30 million of expected year-end net cash and divide by 5.4 million shares we get an earning-based valuation of around $20/share. However, the real play here is as a buyout candidate; Aviat’s closest pure-play competitor, Ceragon (CRNT) sells at an EV of approximately 0.8x revenue, which for AVNW (based on the low end of 2019 guidance) would be $200 million. If we value Aviat’s massive NOLs at a modest $10 million (due to change-in-control diminution in their value), the company would be worth $210 million divided by 5.4 million shares = $39/share.
We continue to own the PowerShares DB Agriculture ETF (ticker: DBA), which I first bought in late 2017 because agricultural products were 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. The “DBIQ Diversified Agriculture Index” on which DBA is based is at its lowest level since 2002, and I continue to anticipate a major bounce following a favorable outcome from U.S. – China trade talks. Trump is very conscious of the fact that farm states constitute a significant part of his political base and the China deal implications for U.S. ag products would be huge.
Thanks and regards,