[This is an update to our July 7th post on Tesla.]
Tesla is just one of the many overvalued companies – mistakenly considered "tech" companies and to which normal rules do not apply – that have been in business for a decade or more but have shown no ability to generate and return cash to shareholders. Yet Tesla seems to be closest to the precipice of failure than any of the others, and perhaps it will be the first domino to fall in a series of long overdue revaluations.
Tesla is not profitable and so it has been (and will be) dependent on continually raising capital in order to survive. It sells an expensive product that will sell poorly in a downturn. The Tesla customer base consists to an unusually high degree of engineers at overvalued NASDAQ companies - hence the San Francisco Bay area is the premier market for Tesla vehicles. In this way, Tesla is something of a "derivative of itself." That property seems to be a hallmark of manic entrepreneurship - so you also have Musk's ownership of Tesla augmented by margin loans against his stock, which is a pattern with company managers whose businesses tend toward the unsustainable: Michael Pearson, Aubrey McClendon.
If a bear market, recession, or NASDAQ revaluation occurs, we would expect to see Tesla shares significantly decline in value and therefore the trade makes a nice hedge against long ideas. But it is not clear that Tesla will survive even if the current boom or bubble continues. Since our previous writing about Tesla, the Chairman and CEO Elon Musk announced – on Twitter – that he would be taking Tesla private at $420 per share.
After taking some time to think about it, we decided that we would not be bullied out of our bearish view by his announcement. The normal pattern with a management buyout is that an insider or founder decides that the public market is undervaluing the (normally profitable and cash-generating) company in question, and so essentially swaps the public investors out of the capital structure and replaces them with debt financing. Obviously management wants to get a good price on the purchase, so in addition to the normal considerations of honesty and legal compliance it is intelligent to disclose any problems in the business to the market, so that the market price (which the takeover offer is compared to) will discount them.
Even the biggest Tesla believers would have to admit that with dusty Tesla inventory piling up in lots all over the country, very short wait times after relatively few Model 3s from the big reservation list have been delivered, quality problems, signs of working capital shortages such as mechanic's liens on the factory and unpaid state taxes... the operation is not running as smoothly as a nice gasoline engine.
So why paint a rosy picture and inflate the purchase price for the business? Why complain so bitterly about short sellers driving down the price of something that you want to buy? It looked like the buyout price of $420 that Musk floated was chosen as the highest price that he thought anyone would find plausible, not as an attractive price to actually pay for the business. And it did turn out that the buyout was a hoax, and in the short period of time since we last wrote about Tesla, Musk not only conducted this hoax but was also sued by the Securities and Exchange Commission and then settled the claims against him pertaining to the fake buyout, though not the other investigations which appear to be ongoing. [Worth reading the fake buyout SEC complaints against Musk and Tesla.]
The best way for Musk to "burn the shorts," which seemed to be his purpose in conducting the buyout hoax, would be to demonstrate high demand for his cars combined with an ability to earn a profit. Resorting to fraud to try to burn the shorts suggests to us that good operating results will not be forthcoming, and that Tesla may be closer to collapse than anyone realizes.
You might ask, would not Musk and Tesla disclose any impending financial difficulties or restructuring if things had gotten that dire? There are two episodes from his business career that suggest he would not. According to the Ashlee Vance biography of Musk, Tesla came close to failing in 2013.
Excerpt from Elon Musk: Tesla, SpaceX, and the Quest for a Fantastic FutureSo we know that at least once before when Tesla was close to failing, Musk did not disclose that to investors and in fact lied about shutting down the factory to save cash. Musk gave a speech in 2011 where he commented on the failure of Solyndra, a photovoltaic solar company which had been given loans by Obama's Department of Energy:
By the middle of February 2013, Tesla had fallen into a crisis state. If it could not convert its reservations to purchases quickly, its factory would sit idle, costing the company vast amounts of money. And if anyone caught wind of the factory slowdown, Tesla's shares would likely plummet, prospective owners would become even more cautious, and the short sellers would win. The severity of this problem had been hidden from Musk, but once he learned about it, he acted in his signature all-or-nothing fashion. Musk pulled people from recruiting, the design studio, engineering, finance, and wherever else he could find them and ordered them to get on the phone, call people with reservations, and close deals. "If we don't deliver these cars, we are fucked," Musk told the employees. "So, I don't care what job you were doing. Your new job is delivering cars." He placed Jerome Guillen, a former Daimler executive, in charge of fixing the service issues. Musk fired senior leaders whom he deemed subpar performers and promoted a flood of junior people who had been doing above-average work. He also made an announcement personally guaranteeing the resale price of the Model S. Customers would be able to resell their cars for the average going rate of similar luxury sedans with Musk putting his billions behind this pledge. And then Musk tried to orchestrate the ultimate fail-safe for Tesla just in case his maneuvers did not work.
During the first week of April, Musk reached out to his friend Larry Page at Google. According to people familiar with their discussion, Musk voiced his concerns about Tesla's ability to survive the next few weeks. Not only were customers failing to convert their reservations to orders at the rate Musk hoped, but existing customers had also started to defer their orders as they heard about upcoming features and new color choices. The situation got so bad that Tesla had to shut down its factory. Publicly, Tesla said it needed to conduct maintenance on the factory, which was technically true, although the company would have soldiered on had the orders been closing as expected. Musk explained all of this to Page and then struck a handshake deal for Google to acquire Tesla.
While Musk did not want to sell, the deal seemed like the only viable course for Tesla's future. Musk's biggest fear about an acquisition was that the new owner would not see Tesla's goals through to their conclusion. He wanted to make sure that the company would end up producing a mass-market electric vehicle. Musk proposed terms under which he would remain in control of Tesla for eight years or until it started pumping out a mass-market car. Musk also asked for access to $5 billion in capital for factory expansions. Some of Google's lawyers were put off by these demands, but Musk and Page continued to talk about the deal. Given Tesla's value at the time, it was thought that Google would need to pay about $6 billion for the company.
As Musk, Page, and Google's lawyers debated the parameters of an acquisition, a miracle happened. The five hundred or so people whom Musk had turned into car salesmen quickly sold a huge volume of cars. Tesla, which only had a couple weeks of cash left in the bank, moved enough cars in the span of about fourteen days to end up with a blowout first fiscal quarter. Tesla stunned Wall Street on May 8, 2013, by posting its first-ever profit as a public company—$11 million—on $562 million in sales. It delivered 4,900 Model S sedans during the period. This announcement sent Tesla's shares soaring from about $30 a share to $130 per share in July. Just a couple of weeks after revealing the first-quarter results, Tesla paid off its $465 million loan from the government early and with interest. Tesla suddenly appeared to have vast cash reserves at its disposal, and the short sellers were forced to take massive losses. The solid performance of the stock increased consumers' confidence, creating a virtuous circle for Tesla. With cars selling and Tesla's value rising, the deal with Google was no longer necessary, and Tesla had become too expensive to buy. The talks with Google ended.
"[T]here is a difference between knowing that any product-in-development may run into a few snags, and knowing that a particular product has already developed problems so significant as to require months of delay." In re Apple Computer Sec. Litig., 886 F.2d 1109, 1115 (9th Cir. 1989). As 2017 started Tesla faced an existential crisis. It had burned through more than a billion dollars in 2016 developing the Model 3, diverting profits from its existing luxury cars to satisfy the cash demand for the Model 3. By the beginning of the Class Period, Defendants disclosed that they would mass produce the Model 3 by the end of 2017 despite contemporaneous facts and warnings from executives, suppliers, and vendors that Tesla's timeline was impossible to meet. Tesla had to build and operate automated production lines for the Model 3 body in its Fremont, California facility, and mass produce 5,000 batteries per week in its "Gigafactory" in Reno, Nevada.So we must look to our own clues about how the company is doing, like the inventory piling up in lots across the country, and the staggering number of high level executive departures from Tesla. Our favorite one recently was David Morton, who joined as a new Chief Accounting Officer on August 6th, only to quit a month later. He had worked at his previous employer Seagate Technologies for 23 years. The previous Chief Accounting Officer Eric Branderiz had resigned this March after being in that job for a year and a half. But those are just a start. This year, the company also lost its President of Global Sales and Service, Treasurer and Vice President of Finance, Vice President of Autopilot, Chief People Officer, Senior Vice President of Engineering (Doug Field), and numerous others. The latest Chief Accounting Officer to resign walked away from a $10 million stock grant that would have vested after four years.
First, the Complaint adequately pleads material falsity. In May and August, 2017, in SEC filings and in earnings calls with analysts, Defendants reported on their progress in first building, and then operating, automated production lines in Fremont and at the Gigafactory. Defendants leveraged these statements of present progress, claiming to be on track to meet Tesla's mass production goal by late 2017. These statements of present progress were materially false. Tesla was building small numbers of Model 3s by hand in its beta shop, where prototypes were constructed. In May, 2017, the automated line, itself, was in the very early stages of construction. Tesla continued to build Model 3s by hand as neither the automated production line, nor the body in white line, would produce a single Model 3 in Fremont until at least October, 2017. As with the Fremont facility, it was only in October, 2017 that the first car-ready battery came off an automated line at the Gigafactory. Similarly, supply issues abounded, and workers constructing the automated production line were regularly idle, lacking parts and instructions.
Defendants' statements that they were "on track" to meet mass production goals are actionable representations of present or historical fact. See Mulligan v. Impax Labs., Inc., 36 F. Supp. 3d 942, 946, 964 (N.D. Cal. 2014); Westley v. Oclaro, Inc., 897 F. Supp. 2d 902, 918–19 (N.D. Cal. 2012); In In re MGM Mirage Sec. Litig. , No. 2:09-CV-01558-GMN, 2013 WL 5435832, at *8 (D. Nev. Sept. 26, 2013). Further, Defendants are liable for expressions of opinion when they know facts undermining the positive statements. See In re Atossa Genetics Inc Sec. Litig., 868 F.3d 784, 802–03 (9th Cir. 2017) dismissal of opinion because it did not fairly align with facts in possession at the time).
By August, 2017, Tesla was, by its own timeline, supposed to have been in the second month of automated production at both facilities. Again, Tesla told investors about progress they claimed had already occurred in Fremont and at the Gigafactory that supported its readiness to mass produce the Model 3 in 2017. And, again, Tesla repeatedly lied. About automated production, Tesla told investors that a "gigantic machine" meant to produce 5,000 vehicles weekly was—at that time—"producing a few hundred vehicles a week." Directly contrary to that statement, not a single complete Model 3 had been produced on the still-incomplete production line in Fremont, necessary robots were not even on site, and all Model 3s continued to be built by hand. Similarly, at the Gigafactory, no automated production occurred until September, 2017, and as late as October, 2017, only two batteries per day were completed. There had been no "great progress." Defendants' warnings of risk to their mass production goals were meaningless in the context of the facts they knew to be true no later than May 3, 2017. Their statements were provably false, and therefore, not forward-looking. Oclaro, 897 F. Supp.2d at 918-19 ("a statement about a past or present fact can demonstrably be proven false" and is not forward-looking). Warnings about possible problems is insufficient to rebut falsity allegations when the risks are no longer theoretical, but have materialized. Nor do Defendants' remaining arguments undermine the falsity allegations. The cases they cite in support of their claim that Plaintiffs must produce Tesla's specific timelines for specific tasks offer no support for this assertion. The "on track" cases they cite are distinguishable; almost all concern financial projections, and not statements of existing fact, on the ground.
A key premise for the next decade: it's easier for software to enter other industries than for other industries to hire software people— Benedict Evans (@BenedictEvans) September 3, 2016
A decision to take an electric battery innovation and go into automotive production would make even less sense when you look at the base rate of success in that industry. Check out the Wikipedia page “list of defunct automobile manufacturers of the United States,” there have been hundreds of failures; not to mention the equity-extinguishing bankruptcies of some of the brands that have survived. The licensing model would make much more sense – again, if you had something to license.You can see this very clearly in the car industry: if tech companies build cars and car companies hire developers, the former will win— Benedict Evans (@BenedictEvans) September 3, 2016
Automakers like Ford are rightly frustrated by the public and market's readiness to believe Tesla's narrative about disrupting automotive manufacturing, but there's reason to believe that the wildly different standards to which Tesla and other automakers are held actually hurts the would-be upstart. After all, one of the main reasons that KTP [Kentucky Truck Plant] operates so efficiently and with such high quality is that it has no choice. Whereas Tesla has been able to count on investors and analysts to forgive its "production hell" fiascoes, KTP is the beating heart of Ford's business, building some of the most high-margin and in-demand vehicles Ford has ever made.The indulgence of investors towards Tesla has created a hothouse flower that simply cannot compete over the long term in the competitive, for-profit automotive market. Also, amusingly, the "kanban" in Daily Kanban refers to Toyota's scheduling system for lean manufacturing and just-in-time manufacturing, but according to the recent article on Musk by Lora Kolodny, the kanban system is verboten at Tesla:
With the new Expedition and Navigator flying off lots, the vehicles made at KTP are absolutely critical to the financial performance that markets demand. Since every minute of downtime means that at least one margin-padding truck or SUV won't be delivered on time, the people of KTP know that the company's financial performance depends on their perfect execution and attention to detail. Were Ford able to raise capital from the markets whenever its financial performance fell short, it's easy to imagine a plant like KTP cutting corners or making excuses about "production hell." But because Ford isn't coddled like the self-described "disruptors," workers here at KTP know that downtime and poor quality simply aren't an option.
Behind his back, employees turned to a method pioneered by Toyota, known as "kanban," to solve their problems. In its simplest form, workers using "kanbans" put up workflow charts, schedules and cards around a production line to help keep track of items they have and items they need.The bullish theses for Tesla (at the current $50-$75 billion price range) involve the company growing to a $500-$1000B titan like Google, Amazon, Facebook, or Apple. That is actually one of the main expected value calculations that keeps the tech mutual funds invested. They know that Musk is a loose cannon and they could not justify holding without the possibility of 10x upside. But what trillion dollar company ever spent its first fifteen years insulated from concern about profitability?
In this case, workers took all the parts out of the boxes around the Model X line, arranged the parts with a clear sequence and labels, and put the parts back into the boxes. If one part was out of sequence or damaged, they'd remove a card and leave it in a box or bag to let the supply team know what needed to be replenished.
The cards helped the teams reduce the clutter, keep a small stock of spares nearby, and find the right parts quickly.
But because kanbans were pioneered by Toyota, workers thought they had to hide their kanban cards from Musk during his visits to the factory. Half a dozen current and former Tesla workers say that supervisors in Fremont warned them that if Musk discovered kanban cards posted around their work areas, they were in danger of being fired.
I want to review the last three months (as of 11/1/18) and see if “The Story” we are presently being told ($TSLA turned a corner in Q3 and is now a highly efficient, well-run, profitable car manufacturer) makes sense given what was happening at the time.It is especially strange how little explanation the Q3 results and business trends got in the Q3 summary release and conference call. And now the 10Q is not materializing. It seems as though the reason the summary results were released in the first place was to get in front of the WSJ article that came out on Friday, "Tesla Faces Deepening Criminal Probe Over Whether It Misstated Production Figures":
August 7: Elon tweets that he is thinking about taking Tesla private. He follows this up with a blog post explaining his thinking, citing short sellers and avoiding quarterly reporting as reasons. This is a month into Tesla's greatest quarter to date.
August 16: A NY Times article about Elon and his fateful tweets quotes Mr. Musk as saying, "But from a personal pain standpoint, the worst is yet to come." This is halfway through the greatest quarter Tesla has ever had.
September 4: CAO Dave Morton resigns, effective immediately, after less than a month on the job. At this point, Tesla is two months in to a great Q3 in spite of high numbers of employee turnover and executive departures.
September 27: Elon calls off a settlement that had been agreed upon with the SEC, and he tells the BOD that he'll quit on the spot if they don't publicly support him and "extol his integrity". The best Q3 he could have hoped for is wrapping up in 4 days.
September 30: Musk emails his employees and states, "We are very close to achieving profitability, but to be certain, we need to execute tomorrow." This is the last day of a quarter in which Tesla reported net income of $311 million dollars.
October 24: Tesla releases their Q3 numbers; they're great. They've gone from a cash-burning enterprise to one of the most efficient car manufacturers on the planet. On the earnings call, they have no prepared statements about operational adjustments and instead talk about safety.
October 26: Mr. Musk uses twitter to question the FBI's investigation into Tesla, as well as claiming that the tweet that cost both him and $TSLA $20M was "worth it". At this point, Elon is antagonizing regulators even though his company is finally performing at a high level.
October 30: Elon Musk tweets that he has relinquished the roll of Tesla CEO "just to see what would happen". $TSLA is now a profitable and growing enterprise that had the CEO remove his title and confuse the corporate governance structure for kicks.
This is obviously not an all-inclusive list and you could explain away any one of these examples. (Miscommunication, personal reasons, etc) But all of them combined paint a pretty vivid picture. (At least, to me they do) And that picture doesn't match "The Story" we're being told.
Why try to go private? Why pick fights with regulators or threaten to quit when your company is finally executing? Why are so many executives leaving the company during one of the greatest turnarounds in automotive history? Why remove your title of CEO "just to see what happens"?
Why wouldn't Elon, who promised "the short burn of the century" and called the boss of a Tesla critic in an effort to shut him up, spike the ball during the Q3 conference call? Why wasn't he bragging about the operational improvements he made that ruined the short thesis?
In recent weeks, FBI agents have contacted former Tesla employees asking them for testimony in the criminal case. The former employees received subpoenas earlier in the probe, and FBI agents recently have sought to interview a number of them, the people said.For whatever reasons, the bulls are just not bothered by this. Maybe it is because the civil penalty for his buyout hoax was so low in relation to the damage it caused - $40 million vs billions in damages is a penny on the dollar. It is probably also relevant that Silicon Valley "disruptors" have been allowed, this cycle, to break the law with impunity.