Tesla's non-GAAP hand is filled with aces, even where previously SolarCity reported deuces.
This is a story about how non-GAAP metrics, flexible as they are, can be changed in real time to provide a better-looking picture for the same reality. This is extremely rare, of course, because it's so obvious.
However, as we will see, it just happened with Tesla (NASDAQ:TSLA), and there's no doubt the reality the non-GAAP measure represents is, indeed, the same reality. Meanwhile, regulators somewhere seem to be looking the wrong way. Here we go.
A Bit Of Background
Up until recently, SolarCity was an independent company. It had its business, and reported on it. It reported not just in GAAP terms but also non-GAAP.
Then came Tesla and bought it in a controversial acquisition. SolarCity's business was incorporated into Tesla's, and Q4 2016 was the first time Tesla reported accounts including SolarCity's business.
Night Turns To Day
Here's the thing. When SolarCity reported on its earnings, it did some non-GAAP adjustments. Here's a typical report:
Source: Q2 2016 SCTY Earnings Report
The largest component among those adjustments was a large loss attributed to non-controlling interests. Those non-controlling interests are third-party investors in SCTY's "tax equity" VIEs.
Accounting-wise, when new assets are sold into those VIEs, they're then re-valued lower as if liquidated right away for accounting purposes. This produces an accounting loss for third parties, which was removed from SCTY's own results, providing for much more positive GAAP results.
SolarCity, though, thought it well to remove these accounting effects from its actual non-GAAP earnings - thus making them actually look worse than its GAAP earnings.
Obviously, when SolarCity was incorporated into Tesla, these same effects continued to exist. Indeed, you can see in Tesla's Q4 2016 earnings report that they're there:
Source: Q4 2016 TSLA Shareholder Letter
Notice how net income was minus $219.5 million before minority interests, and then becomes less negative, minus $121.3 million, afterwards. Typically, if the same approach SolarCity used was applied, this positive effect would then have been removed when reporting non-GAAP earnings.
So how did Tesla calculate its non-GAAP earnings? Let's see:
Source: Q4 2016 TSLA Shareholder Letter
As we can see:
- Tesla starts from the "improved" net income figure.
- It excludes several positive and negative effects (SBC, acquisition costs and a one-off SolarCity accounting gain).
- But it never excludes the effect from minorities.
What's the result here? Several things take place:
- Just by changing the way it represents non-GAAP earnings, Tesla improved non-GAAP earnings by a full $98.1 million in Q4 2016. On 155 million shares, this added $0.63 to its non-GAAP EPS.
- Moreover, the SolarCity acquisition only closed on November 21. This effect would probably have been much larger if the acquisition was accounted for throughout the entire quarter.
- Finally, if Tesla did this in Q4 2016, it's now going to do it on all quarters. This is an effect which can easily add up to $200 million in a single quarter, or as much as $1.23 per share. It's a massive effect. It's what can ultimately make Tesla report positive non-GAAP earnings, and maybe even as soon as Q1 2017.
This is yet another clear example of deception. Tesla has clearly and un-ambiguously changed how non-GAAP measures are calculated for SolarCity's business. The same reality now leads to incredibly better non-GAAP earnings.
This will allow Tesla to report massively improved non-GAAP and GAAP EPS numbers (GAAP is already improved by the minorities accounting). The effect is so large that it should represent the difference between reporting negative and positive non-GAAP EPS.
In many (but not all*) instances, non-GAAP adjustments can be used to obfuscate. This usually comes from what costs are excluded under non-GAAP reporting, with a common problem being the exclusion of stock-based compensation even when paid in stock and not options. What happened here, though, goes well beyond that debate. It represents the full-out changing of how the very same reality is represented under non-GAAP. To the very opposite of how it was previously reported, no less.
The regulators? Still watching those videos. The analysts? Silent as they are.
* On the "but not all" I'd even include Tesla at times. For instance, most measures trying to establish days payable outstanding, days of inventory, etc., would require Tesla's non-GAAP revenue and non-GAAP COGS measures to be calculated properly.
Disclosure: I am/we are short TSLA.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.