Why Elon Musk’s Car Company Is Headed for Disaster
By Whitney Tilson
It was the worst short of my nearly two-decade career running hedge funds…
I shorted Tesla around $35 a share in early 2013 and didn’t throw in the towel until after it had soared to $205 a share a year later. It cost me
$5 million and was the most expensive mistake of my career.
After I covered, I warned all of my friends not to short the stock. It was an open-ended situation, with a visionary, entrepreneurial founder and CEO, Elon Musk. Musk was leading a team of brilliant engineers, developing groundbreaking products in two of the world’s largest markets – autos and energy. Plus, the stock had a cult-like following of investors who didn’t care if Musk behaved erratically and consistently overpromised. These are the ingredients of a dangerous short.
For five years, I stood on the sidelines, closely following the epic battle between Tesla bulls and bears. Then I saw what I believed was the “inflection point” for the stock. In March, I made one of my rare big calls, writing…
I’ve been following [Tesla] closely for years and, after carefully reviewing everything over the weekend (including the transcript of Musk’s [regulation-violating] call last week), today I’m making one of my rare big calls: we will look back on last Friday as the beginning of the end for Tesla’s stock.
I think Musk has no more rabbits to pull out of his hat, and therefore, it’s all downhill from here. I predict that by the end of the year, the stock, today at $295, will be under $100.
I don’t make calls like this very often. The last two were bitcoin the hour it peaked at $20,000 on December 16, 2017… and Tilray (TLRY) the hour it peaked at $300 last September 19…
I only make big calls when three things line up perfectly to create what I call an “inflection point”: the fundamentals, my “scuttlebutt” research, and my read of investor sentiment.
In the case of Tesla, the fundamentals are terrible, the research provided on Twitter and elsewhere by a small army of amateur analysts reveals that demand is weak and inventories are piling up, and I sense that the number of investors who are losing confidence in Musk is finally exceeding those who are drinking his Kool Aid.
Tesla shares were trading at $295 at the time. Six and half weeks later, they closed at $234.54 today, already down more than 20%… And I think they have much further to fall.
The number of investors who are losing confidence in Musk is finally exceeding those who are drinking
his Kool Aid.
To be clear, I am not hoping that Tesla fails. Rather, I am predicting that its shares will collapse.
Musk is an incredible entrepreneur and visionary who has created two companies that are changing the world. Tesla makes great cars. I enjoy driving them, and every one of my friends who owns one loves it. More important, Tesla has almost single-handedly forced every major auto manufacturer in the world to invest billions of dollars into developing electric cars, which is great for humanity. We all owe Musk a debt of gratitude.
But unlike many other investors, apparently, I’m able to separate these “warm and fuzzy” feelings from an unemotional, rigorous analysis of the company and the likely outcome for the stock.
Ironically, I believe that Tesla is about to get crushed by the many competitors it poked into action. While Tesla has an edge in some areas, like driving distance per battery charge, competitors’ cars have many advantages – including better service networks, luxurious interiors, and the “newness” factor. The Audi e-tron, Porsche Taycan, and Jaguar I-PACE represent the biggest threats, followed by highly anticipated offerings from BMW, Mercedes-Benz, and others.
To summarize, Musk has taken his company off a cliff. As more investors wake up to this reality, the stock is going to plummet as the company struggles to sell its cars and starts to run out of cash.
Recent events – concluding with first-quarter earnings, which Tesla released April 24 (discussed below) – have only reinforced my belief.
Lately, it’s almost a full-time job keeping up with all of the major news about Tesla. Here are the recent highlights, with my thoughts…
The SEC vs. Musk
On February 25, the U.S. Securities and Exchange Commission (“SEC”) filed a contempt of court motion against Musk, saying his February 19 tweet about how many cars Tesla would produce this year was a “blatant violation” of the settlement they’d struck with him last year after his infamous “funding secured” tweet.
I attended the hearing in April, where the judge gave both sides a week (later extended another week) to resolve their dispute.
In the end, both sides agreed that Musk must “obtain the preapproval of any experienced securities lawyer” before tweeting or posting to social media… an uncertain outcome in light of Musk’s ego and arrogance. Thus, there’s a chance – albeit small – of a bad outcome for Musk, Tesla, and the stock.
As more investors wake up to this reality, the stock is going to plummet as the company struggles.
Regardless of what happens, Musk’s behavior underscores his negligent and impulsive nature – exactly the opposite of what is needed during this time of extreme stress for the company.
Cars Catching Fire
A video of a Tesla Model S in a garage in Shanghai suddenly bursting into flames last month has gone viral. One report indicates it was caused by a short-circuit. Tesla is investigating.
This comes on the heels of a widely reported crash in Florida in which a 2016 Model S hit some trees. The driver survived but was burned to death when the battery caught fire and emergency responders couldn’t open the doors because Tesla’s famous recessed handles failed to deploy after the accident.
It’s hard to know if anecdotes like these are indicative of bigger problems or whether they will affect Tesla’s brand and reputation – but they sure don’t help.
Massive High-Level Turnover
I’ve never seen executive departures like this… More than 88 executives at Tesla have left the company since January 2018. And overall, the departures are heavily skewed in the legal and accounting areas of the company – exactly what one would expect to see if fraud is occurring. Even if it’s not, it’s hard to imagine that Tesla is well-positioned to navigate its current troubles (financial or otherwise) with an inexperienced, 34-year-old CFO.
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Last Friday, Tesla disclosed that four members of its board of directors would depart, which will shrink the board from 11 to seven members. While bulls note that they will serve until the end of their terms and argue that a smaller board will improve governance, my gut tells me they’re fleeing what they believe to be a sinking ship…
Unexpected, en masse board resignations are one of the most classic and time-tested warning flags that experienced investors look out for. Worse yet, these board members are selling all the shares they can, as fast as they can. If they thought the company and its stock had bright prospects, it’s hard to imagine they’d be leaving the board and dumping shares.
A final clue that this is bad news is how Tesla disclosed it… via an SEC filing, not a press release, and after the close on Good Friday – the perfect time for an announcement you hope no one will notice.
Terrible First-Quarter Earnings
The company reported a $702 million loss in the first quarter of 2019 – double consensus expectations – and guided for another loss in the second quarter.
It was so bad that Wedbush analyst Daniel Ives, who was once bullish on the stock, wrote…
To this point, in our 20 years of covering tech stocks on the Street we view this quarter as one of top debacles we have ever seen, while Musk & Co., in an episode out of the Twilight Zone, act as if demand and profitability will magically return to the Tesla story.
Ives said he was “throwing in the white towel” and downgraded the stock.
The cash flow statement was equally bad, as the company had negative $640 million in cash flow from operations. It spent an additional $280 million in capital expenditures, for a total cash burn of $920 million.
That’s a huge reversal from the previous quarter, when Tesla reported $210 million in profit and generated positive $1.24 billion in operating cash flow. That led Musk to say on the conference call in January that he was “optimistic about being profitable in Q1 and all quarters going forward.”
Oops.
Believe it or not, the quarter could have been much worse. On that same call, Musk admitted…
Over half of our global deliveries [are] occurring in the final 10 days of Q1. This was the most difficult logistics problem I have ever seen and I have seen some tough ones. So I will say it again… We literally delivered half of the entire quarter’s deliveries were [sic] in the final 10 days of Q1. That’s insane.
For once, I think Musk is telling the truth. I agree with him: It is insane to deliver more than half of a quarter’s deliveries – worth roughly $2 billion – in the last 10 days.
Weak Demand
I’d be willing to overlook Musk’s erratic behavior, the operational chaos, executive departures, etc. if Tesla’s cars were still selling like hotcakes.
But all of the evidence I can find shows that, now that Tesla has fulfilled the backlog for the Model 3, demand has fallen off a cliff.
Musk has promised that deliveries will rebound strongly from the first quarter’s dismal number of only 63,019 cars to between 90,000 and 100,000. But I think the company will be lucky to match that number of deliveries in the second quarter.
As you can see, the first quarter was weak…
Deposits Plummet
In past years, Musk was able to attract hundreds of millions of dollars in deposits – which are effectively free unsecured loans to the company – by announcing a new car. Yet when he tried that last month with the Model Y reveal, it was a total bust.
When an analyst on the call asked why customer deposits were down, Musk dodged the question, answering, “I think we don’t want to comment on the granularity of deposits. Again, people read too much into this. We’re not playing off the Model Y because we’re just not in production so you can’t really read anything into Model Y orders at this point.”
What nonsense! When Tesla was deluged by customer deposits for the Model 3 (which can be seen in the chart below, Musk was tweeting about it constantly. His silence now speaks volumes.
Slumping Demand in Netherlands and Norway
In most countries, there’s usually at least a month lag time to see public data on car sales. That’s not the case in Norway and the Netherlands, because both countries report each day’s sales the next day on a public website. Norway in particular is important because it’s by far the largest market for electric cars in Europe. Thanks to huge government subsidies, electric vehicles were 58% of total car sales in March.
Tesla had a strong first quarter in both Norway and the Netherlands, as ships full of the first Model 3s arrived to meet the backlog of demand, making it the best-selling electric car in both markets.
Since then, sales have fallen off a cliff. As my friend Anton Wahlman reported last month…
April is off to a horrible start for Tesla in the countries in Europe where we get daily sales (registration) data: Norway and The Netherlands. Compared to March, the daily sales rate in Norway in April thus far is down 82%, and in the Netherlands it’s down 76%.
For the more expensive and higher-margin Model S and X, Tesla is losing market share to Audi and Jaguar’s electric cars in the most dramatic of ways. Audi e-tron and Jaguar I-PACE are outselling Tesla Model X and S combined by a factor of 5.7 to 1 in Norway, and 9.7 to 1 in the Netherlands.
Tesla usually makes up for an April shortfall in the last month of the quarter, but this is a very deep hole from which Tesla now has to dig.
A few days later, he e-mailed me, “Fun fact from Norway today: Tesla registered 1 (one!) Model 3 car. Volkswagen registered 148 electric Golfs. Tesla’s market share is dropping like landlines versus cell phones among 22-year-olds.”
Why Aren’t Tesla Shares Down More?
In light of the terrible quarter and increasing evidence of lagging demand, why isn’t the stock down even more? Here are a few reasons…
Not Enough Capital
It’s clear to everyone – even the bulls – that Tesla desperately needs to raise capital. Musk stubbornly resisted… until April’s call, when he finally acknowledged, “I think there’s merit to the idea of raising capital at this point.”
Whether a capital raise helps or hurts the stock will depend on the details… the amount, price, etc. One of my friends noted…
I think the only reason the stock held up at all today is because Musk did a 180 on the desire for a capital raise. If he can execute a clean raise with either of his two lead banks – Morgan Stanley and/or Goldman Sachs – as underwriters, and do it at the market price at the time of the offering, I think it has the potential to have the opposite effect it would have in almost any other company. In any other company, the stock would go down. In Tesla’s case, I think it’s better than a 50/50 that the stock would actually go up – all other things equal.
I agree that the stock could jump if Tesla announces that it has issued stock to raise cash, though it’s unclear whether Tesla can do so via traditional means (which typically requires SEC approval).*
* Editor’s note: Whitney and his friend were right. Earlier this month, Tesla skirted the SEC with a dubious but legal convertible bond offer. In the end, the company raised $2.4 billion, but paid a steep price to do it. The details are a bit complicated for the pages of American Consequences, but Whitney does a great job explaining things here.]
Normally, this would be routine for a company that still has a $41 billion market cap today, but given the SEC’s contempt of court motion against him – and that Musk has repeatedly stuck his finger in the SEC’s eye – it’s hard to imagine it approving anything Tesla-related right now. For proof, consider the repeated delays in Tesla’s $218 million acquisition of battery supplier Maxwell Technologies.
A ‘Kitchen Sink’ Quarter
It’s clear to me that Tesla had a “kitchen sink” first quarter. Ironically, that could be good news for the stock.
A “kitchen sink” quarter is a classic ploy whereby companies that know they’re going to have a bad quarter throw in the towel and take every charge and write-down they possibly can. This has two benefits. One, it makes the year-over-year comparison easy the following year. It also provides a “cookie jar” from which to draw revenues and earnings that can be leaked back into future quarters (when the fundamentals have presumably improved a bit to make them look better).
While this is no doubt misleading to investors, it’s not necessarily accounting fraud if it’s done cleverly. Generally accepted accounting principles (“GAAP”) give management wide discretion to make dozens of assumptions that affect reported financials. As Warren Buffett noted in his 2010 annual letter, “Regardless of how our businesses might be doing, Charlie [Munger] and I could – quite legally – cause net income in any given period to be almost any number we would like.”
When management abuses this discretion, its goal is usually to report higher earnings. That’s why you almost never see a company miss earnings estimates by a penny. Management can always tweak some assumption to slightly boost earnings.
But sometimes, the incentives are reversed. For example, when a new CEO takes over a beaten-down company, he has a double incentive to report bad earnings… It might further depress the stock so the CEO’s options strike at a lower price, and it puts the blame on the former CEO, while the new CEO will benefit from the easy comparisons and “cookie jar” going forward.
Alternatively, as was the case with Tesla last quarter, it’s just one lost quarter. Why not take all of the medicine at once?
Nathan Weiss of investment manager Weiss, Harrington and Associates beautifully explained what Tesla did – and why it could be good for the stock later this year…
Virtually all of the accounting “maneuvers” made during the first quarter were classic earnings manipulation tactics taught in business schools (which Tesla’s CFO just finished attending): Deferred earnings recognition, inventory write-downs, provisions for future losses and one-time restructuring charges which likely incorporate costs to be recognized in subsequent quarters. Accounting textbooks and MBA case studies will surely cite Tesla’s Q1 2019 results for years to come.
That said, with a bank of future earnings (and “operating cash flows”) and improving deliveries, Tesla has set the stage to potentially report (slightly) positive non-GAAP earnings in one or more quarters before year end. While Tesla’s scheme has likely backfired in the short-term (analysts “throwing in the towel” and the media reporting an “epic negative surprise” will pressure shares), the stage may be set for us to opportunistically (and temporarily) switch our “Sell” rating to “Buy for Now” in the coming quarter or two…
Why Didn’t Tesla Cut Guidance?
As noted above, in its first-quarter earnings release, Tesla estimated second-quarter deliveries between 90,000 and 100,000 vehicles and reaffirmed that it expects to deliver between 360,000 and 400,000 vehicles this year.
It makes no sense that Tesla would miss first-quarter deliveries by a mile, yet reaffirm annual guidance. Mathematically, this means that Tesla increased its guidance for the rest of the year, which flies in the face of all available evidence.
Naturally, this was the first question a Wall Street analyst asked on the conference call.
Musk surely knew the question was coming, but he whiffed, giving a vague, rambling answer…
Yes. We do see strong demand for vehicles, both S, X, and 3. The standard range plus Model 3 with autopilot included at $39,500 is just an incredibly compelling vehicle and affordable to probably something on the order like the top 40% income earners in the U.S. and Europe. So, it’s – I think we will see a lot of interest and demand in that. We are.
And then with the upgraded S and X, I think a lot of people were kind of anticipating that there would be an S, X upgrade and this really is kind of a game-changer of an upgrade.
So, I think we are seeing an uptick in demand and we expect to see that to be quite significant. And we are also out of the seasonality of Q1 with few people just generally don’t like buying cars in winter and we are getting past the overhang of that tax credit cliff, which for us ended in the U.S. on December 31.
So, these were all very positive factors. We also have just a lot of markets where there is program or tapped into demand, especially for Model 3. So we will be really saying the right-hand drive Model 3 and expect to see significant demand in right-hand drive countries. Overall, I feel really good about the way things are headed.
In light of this answer and the various data points noted above, why anyone believes his rosy forecast is beyond me.
I don’t think even Musk himself believes it…
Which raises that question: Given that Tesla was doing a kitchen sink quarter anyway, why didn’t the company reduce guidance to a level it could meet or exceed?
It couldn’t… at least, not without risking bankruptcy. And it’s possible that Tesla will never report another profitable quarter – ever.
Whitney Tilson is the founder of Empire Financial Research and edits its flagship newsletter, the Empire Investment Report. Prior to that, he worked at the Boston Consulting Group and later founded and ran the Kase Capital Management hedge fund, which he grew from $1 million to nearly $200 million.
