From Stanphyl Capital’s May 2019 letter to investors.
For May 2019 the fund was up approximately 14.4% net of all fees and expenses. By way of comparison, the S&P 500 was down approximately 6.4% while the Russell 2000 was down approximately 7.8%. Year-to-date 2019 the fund is up approximately 32.5% while the S&P 500 is up approximately 10.7% and the Russell 2000 is up approximately 9.3%. Since inception on June 1, 2011 the fund is up approximately 117.9% net while the S&P 500 is up approximately 142.1% and the Russell 2000 is up approximately 93.0%. Since inception the fund has compounded at approximately 10.2% net annually vs 11.7% for the S&P 500 and 8.6% 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 and please note that individual partners’ returns will vary in accordance with their high-water marks.
Yes, Tesla’s stock price finally seems to be collapsing in a manner commensurate with “reality” and we’ll get to that in a moment, but first please indulge my desire to bloviate on the macro…
I continue to believe we’re in a bear market. The U.S. economic slowdown is in its early stages…
…and rail traffic (a terrific real-time economic indicator) is a disaster. Meanwhile global manufacturing and trade are an evolving disaster while U.S. loan demand is at the lowest level since the financial crisis. Although these problems are exacerbated by Trump’s tariffs, they’re not caused by them; rather, the Fed’s balance sheet contraction, lack of European QE and drastic reduction in Japanese QE combined with record levels of debt are allowing the deflation of the economic and asset bubbles those money-printing policies created. And as for the “Fed put” on which many bulls rely, we’re a long way from QE4; in fact the Fed is still removing approximately $50 billion a month from its balance sheet and will continue doing so through September. Meanwhile, real short-term U.S. interest rates are positive for the first time in over a decade and there will be a long time-lag before there’s any economic effect from the possible rate cuts the market anticipates for later this year.
As for U.S. stocks, below are a couple of fascinating charts on corporate stock buybacks, showing how much of the S&P 500’s rise can be attributed to them. Remember that corporations tend to buy back their stock at the highs when everything’s great, then stop buying to “conserve cash” when the economy slows and they go into “cash conservation mode.” So when a recession hits and the largest buyers in recent times disappear, look out below!
Seeking the most overvalued of all stock indices, we thus remain short the Russell 2000 (IWM), which has a trailing twelve-month GAAP PE ratio of around 36 and 35% of its constituents losing money.
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.
Early in May $TSLA did an ugly convertible debt and equity deal to plug a hole in a very leaky bucket, netting approximately $2.3 billion which—on the back of my envelope—means it will still be completely out of cash by year-end, and thus will have raise more money in Q3 with its back against the wall on terms that are even uglier. In fact, fewer than three weeks after the financing, one of Tesla’s lead sell-side analysts held a conference call and generally agreed with me.
Why all this ugliness? Well, 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.
Of course this didn’t stop Tesla’s Q1 earnings press release from blatantly lying about Q2 guidance, claiming it will sell 90-100,000 cars when in fact it’s likely to fall far short of that figure– my current best guess (subject to revision during June) is for around 78,000 deliveries at much lower ASPs than Q1’s. Although this would be more cars than were sold in Q1, that will be due only to massive price slashing and thus will come with no incremental profit; thus, excluding one-time items Q2’s loss will be roughly as bad as Q1’s, with the only wild card being how much deferred Autopilot revenue Tesla recognizes (which could reduce that loss on a non-cash basis).
To put these quarterly delivery numbers in perspective, Tesla is valued similarly to Ford and yet Ford sells approximately 1,500,000 vehicles per quarter. Does anyone really care if in Q2 Ford delivers 1,485,000 cars or 1,515,000? In other words, at this point a 15,000-unit quarterly variance for Tesla should be considered meaningless. The party’s over, folks. With no profitable 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.
Here’s a “Twitter nutshell” of how desperate Tesla now is to generate money-losing revenue: its offer today of “unlimited free Supercharging” vs. Musk’s tweet last September when the program was “ended forever”:
And for those of you looking for a resumption of growth from Tesla’s (supposedly) upcoming Model Y, by the time it’s available in late 2020/early2021 (if Tesla is still in business), 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 (and semi-departures!) I’ve ever seen from any company, a dubious achievement that continues in full-force– 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.
In May Consumer Reports completely eviscerated the safety of Tesla’s so-called “Autopilot” system while its annual auto reliability survey ranks Tesla 27th out of 28 brands. Meanwhile the number of lawsuits of all types against Tesla continues to escalate– there are now over 600!
So here is Tesla’s competition in cars (note: these links are regularly 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 nearly equals that of Ford and is around 70% of GM’s despite selling fewer than 300,000 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 nearly $45 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 (despite having substantially tapered its QE) continues to print over 3% of its monetary base per year after nearly quadrupling that base since early 2013. In 2018 the BOJ bought approximately 67% of JGB issuance and in 2019 it anticipates buying 70%! The BOJ’s balance sheet is now larger than the entire Japanese economy— it owns approximately 43% of all government debt…
…and nearly 78% (!) 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 108s 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 1.7% 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 nearly 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:
We also have 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, Carvana (CVNA) due to a laughable business model with escalating losses and a founder with a sketchy past who’s dumping stock every two days and Wayfair, an egregiously bad on-line furniture business with yet another stock-dumping CEO.
And now for the fund’s long positions…
We continue to own Aviat Networks, Inc. (ticker: AVNW), a designer and manufacturer of point-to-point microwave systems for telecom companies, which in May reported a lousy Q3 for FY 2019 (with revenue down 13% year-over-year), but guided to a very strong Q4 (ending June 30th) with revenue and income up substantially year-over-year. For all of FY 2019 the company cut guidance to $246-$251 million of revenue (a $4 million reduction from previous guidance) and non-GAAP EBITDA of $11-$12 million (a $1 million reduction), 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 $11.5 million and we take out $1.7 million in stock comp and $6 million in capex we get $3.8 million in earnings multiplied by, say, 14 = approximately $53 million; if we then add in approximately $29 million of expected year-end net cash and divide by 5.4 million shares we get an earning-based valuation of around $15/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 0.6x revenue, which for AVNW (based on the low end of 2019 guidance) would be 0.6 x $246 million =$148 million + $29 million net cash = $177 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 $187 million divided by 5.4 million shares = just under $35/share.
I added a bit in May to our position in Westell Technologies Inc. (WSTL), which this month reported a terrible FY 2019 Q4, with revenue down 12.5% year-over-year and a drop in gross margin from 45.5% to 37.6% and negative free cash flow of around $1.4 million. About the only good news here is that the company ended the quarter with $25.5 million in cash and no debt, and (as gleaned from the conference call) normalized FCF burn at Q4’s revenue level is “only” around $900,000. Westell now sells at an enterprise value of only around 0.06x (i.e., 6% of) revenue, so on that metric it’s clearly dirt cheap but the business needs to stabilize and grow. On the conference call management was confident that later this year there should be enough revenue growth to cut quarterly burn to around $500,000 but “break-even” now sounds like more of a “next year” possibility. Westell also suffers from a dual share class with voting control held by descendants of the founder; however, management has often stated that the controlling family is open to merging the two share classes, and the company 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 just 0.8x run-rate revenue (on an EV basis) would be around $3.70/share.
We continue to own the PowerShares DB Agriculture ETF (ticker: DBA), although I halved the position in early May when trade deal talks stalled and new tariffs on China went into effect, as part of my rationale for owning this was an imminent trade deal. The other reason we own it though hasn’t changed, and in fact has strengthened as prices continue to decline: agricultural products remain the most beaten-down sector I can find that isn’t a “buggy whip” (something on the way to obsolescence) or cyclical from a demand standpoint. If a trade deal with China is made the implications for U.S. ag products would be huge, and meanwhile the position recovered a bit in late May due to disastrous weather in the farm belt.
Thanks and regards,