Tesla Leverage Manipulating Gross Margin Percentages?

Tesla Leverage Manipulating Gross Margin Percentages?
<a href="https://pixabay.com/users/dominickvietor/">dominickvietor</a> / Pixabay

Whitney Tilson on Tesla Inc. (NASDAQ:TSLA) bulls vs bears, and why some think Elon Musk is manipulating gross margin percentage.

My analyst Kevin DeCamp has NAILED TSLA as a long – and for the right reasons, with good analysis. Read what he published on July 8 (on this email list), when the stock was at $230: Tesla’s Substantial Lead In The Integration Of Hardware And Software. He remains bullish on the not exactly a value stock. It’s been more than a 10-bagger for him – and he thinks it’ll be his first 100-bagger! He writes:

OK, here’s my 5-yr PT, just replace AMZN with TSLA and retailers with Auto OEMs:

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3) NYU Stern School of Business Finance Prof. Aswath Damodaran has also nailed Tesla – he bought it at $180 (and published a blog post about it) in June, the DAY it bottomed, and just sold it at $640. Here’s his latest blog post with his updated thinking: An Ode to Luck: Revisiting my Tesla Valuation. (He’s too humble – he nailed it due to good, clear thinking and analysis.)

Tesla customer service and its gross margin percentage

4) A friend’s comments on a video posted by a Tesla fanboy who has a horrible customer service experience with the company, plus a second example:

In the 7.5 years since the inception of the Tesla Model S, I have watched many hundreds of various types of customer videos, dealing with all sort of problems and other issues, of owning a Tesla car.  1% of that volume and severity alone would have sunk anyone’s spirits.

Today, I have watched a customer account that sets a new record, from a variety of perspectives.  Tesla’s behavior is so nasty, frustrating, evil and painful, that you just want to reach through the screen and scream in anger and frustration.  I can’t imagine myself being in this guy’s shoes and having experienced this nightmare. No wonder he’s on the brink of psychological collapse.

The only Tesla stories that could compete, are those where the solar roof/panels destroyed their houses.  Those would obviously be worse, because of the collateral damage.

Tesla doxxing investigators?

Pay particular attention in this video of how Tesla tried to basically doxx the owner by using private investigator-type techniques to get AAA to reveal if they had ever done business with him, and if so, if they had ever towed his car.  Also, how they searched his hard drive and asked for all the time stamps so that they could pin down his personal life. It is bananas.

There are no words to describe how twisted Tesla’s behavior has been in this story.  If I were a competitor to Tesla, I would play this video in my service department’s waiting room on a constant loop.

Mind you, this guy is one of the country’s foremost Tesla fanboys, including with his YouTube channel.  He is a true believer and enthusiast. He’s in the top 0.00001%. He has been on Tesla’s side at every step of the way, until the absolute madness of this situation caused him to finally break down.  Any other person in this world would have blown a gasket and rebelled far more loudly, way earlier in his Model X ownership saga. I had followed his YouTube channel for months before this culminated in the disaster right around early January, and I kept asking myself “Why is he giving the company such a pass on this horrible situation?” long before he broke down and surrendered.

Tesla gross margin percentage

The story is 28 minutes long, and it takes 7 minutes into it until the situation gets really hot, but it’s all worth any Tesla-watcher’s time.  Here is the video:

PS—On the same subject: Jim Klafehn posted another video today, of his road trip from upstate New York to Austin, TX, which apparently began yesterday:

It is not exactly an advertisement for Tesla.  He has to drive without heat, for else the range of his brand new Model X won’t cut it to the next Supercharger.  It’s like driving 100 years ago!  Yet, despite this inconvenience of driving across the country in an ice box, he has to stop every 150 miles or so, plus or minus.

Customer service

I have read letters from relatives about what it was like driving in the 1920s, in a Ford Model T.  This sounds just like it.

I’m not sure if this is more hilarious than sad.

5) A friend explains how and why Tesla manipulates its financials to increase its reported gross margin:

This is about classifying what should be part of cost of goods sold, to overhead expense (marketing, etc.).  It does not change today’s reported net income — it all cancels out to the bottom line — but it does change the one thing Tesla needs more than anything: Hope among financial analysts and value investors that it can generate higher net income in the future.

Why is this?  If certain expenses are considered “fixed” — or at least not growing anywhere near the rate of revenue, perhaps only by 5% or whatever, per year — and the company can show a positive gross margin percentage, then investors can say “If unit sales eventually becomes large enough, this company can not only make money at all, but also serious money.”

Tesla leverage

In other words, leverage.

It is of course the lesson learned from companies such as Facebook and Alphabet, where the expenses are relatively “fixed” — emphasis on relatively — but where variable revenue has high gross margin.  As those companies grow into profitability, the leverage from there is huge — profits grow much faster than revenue, at that point.

The biggest trick Tesla has used in this regard, which makes for an unfair comparison with other automakers, is the sales/distribution situation.  Unlike other automakers, Tesla owns its own “dealerships.”

In accounting for those vertically integrated stores, Tesla makes it a “fixed” expense.  In other words, the cost of the stores aren’t added to cost of goods sold — thereby reducing gross margin — but rather added to overhead expense (“sales and marketing”) instead.

Considering that other automakers allocate 10% of revenue to its independent dealership expense, and this comes straight out of the COGS line, that means that in a comparison with other automakers, Tesla’s gross margin is 10% overstated automatically, right there.  When Tesla says its gross margin is 20%, based on its vertically integrated stores, that line item alone makes it equivalent to a 10% gross margin number posted by every other automaker.

Tesla and gross margin percentage

A similar thing goes on with R&D.  Tesla allocates 100% of its R&D cost into… the R&D line, which is overhead expense.  Most other automakers don’t do that. For example, at least until very recently, Porsche allocated 50% of its R&D into COGS and the other 50% into overhead.  That has a huge impact on the gross margin line, compared to Tesla.

And if I recall correctly, General Motors allocates a whopping 100% of its R&D into COGS.  That’s why GM’s almost laughable gross margin percentage still results in very solid profitability (adjusted for any special items, of course) almost every single quarter for the last decade.  The difference between GM’s gross margin percentage, and its net margin percentage, is tiny. In Tesla’s case, that difference between gross margin and net margin is huge!

If investors saw these expenses at Tesla as ongoing/recurring and proportional to revenue, as opposed to some sort of one-time overhead blip, the valuation of the company would look dramatically different.  That’s why this accounting gimmick is worth so much to Tesla.

I am not the one to judge whether this extreme accounting treatment is illegal or just immoral.  Obviously the auditors have signed off on it every quarter for about a decade now, so the presumption at least on one level, is that it’s perfectly legal.  One would think that, at a minimum, the sell-side analysts would not allow themselves to be bamboozled by this misleading shift of expenses from COGS to overhead, but evidently they are as gullible as the analysts were who covered Worldcom, Enron and Adelphia back in the 1999-2001 timeframe.

Trump helping Elon fake gross margin percentage?

In that comparison, Tesla has a Trump card — literally — that Bernie Ebbers, Ken Lay and The Rigas family didn’t have: A President who goes on TV (CNBC last week in Davos) and says that the company’s CEO is an “asset” (or was it “genius”?) who needs to be “protected.”  Which FBI agent, SEC official or accounting executive, would dare to pop this bubble now? The US President, who has a justice department which can conduct pre-dawn no-knock raids, says that this is an entity that needs to be “protected.”

Automotive News, the auto industry’s bible, made that point just the other day:

Bernie Ebbers must think this is unfair.  If he only had better friends at the highest levels in Washington DC, he too could have gotten away with this accounting treatment, instead of rotting away his last couple of decades in prison.

Who was it who said “Kill one man and you’re a murderer, but kill a million and you’re a conqueror”?

Bernie Ebbers just didn’t aim high enough.  But another CEO is flying high as a kite, clearly without any inhibitions about how high he aims.  Tesla’s biggest innovation has been its ability to get away with its uniquely aggressive accounting — and it’s all there in the open for anyone to see.

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Jacob Wolinsky is the founder of ValueWalk.com, a popular value investing and hedge fund focused investment website. Jacob worked as an equity analyst first at a micro-cap focused private equity firm, followed by a stint at a smid cap focused research shop. Jacob lives with his wife and four kids in Passaic NJ. - Email: jacob(at)valuewalk.com - Twitter username: JacobWolinsky - Full Disclosure: I do not purchase any equities anymore to avoid even the appearance of a conflict of interest and because at times I may receive grey areas of insider information. I have a few existing holdings from years ago, but I have sold off most of the equities and now only purchase mutual funds and some ETFs. I also own a few grams of Gold and Silver

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