Tesla Bears Need To Take A Step Back, Too

May 23, 2019 11:59 AM ETTesla, Inc. (TSLA)543 Comments
Vince Martin profile picture
Vince Martin
7.14K Followers

Summary

  • Tesla bears seem vindicated by the recent plunge in TSLA shares - with some reason.
  • But the bears, particularly the self-described "TSLAQ" community, are making claims that simply are unsupportable.
  • There remains a solid short case for TSLA at current levels - but accusations of fraud, in particular, are unfair.
  • Anyone short any stock should remember what a dangerous and risky trade it can be - and that goes double when sentiment seemingly is moving in your favor.

Up front, I'm short Tesla (NASDAQ:TSLA). It's a hedged short, a bear put spread (200/180, March 2020 expiration, in the interest of full disclosure). But it remains a relatively small part of my portfolio, despite the fact that I've come to see TSLA as one of the higher-conviction short ideas in the entire market.

Truthfully, there's been big one stumbling block in my going big on a TSLA short (either through options or a straight trade): Confirmation bias. Tesla long has been a stock where, from the outsider perspective I kept through late last year, the bears seem to have done more research into the company, and have more understanding of the financials, in particular. But there are reasons that exist that go beyond the relative strength of the two cases - and given the discussion around TSLA on both sides, it's dangerously easy to wind up with tunnel vision on either side of the trade.

In this day and age, where our consumption of information is increasingly defined by pre-existing preferences, confirmation bias lurks everywhere. And at the moment, it's a significant danger to TSLA shorts - myself included. There are a lot of victory laps being taken, and a lot of profits counted. But there's also an increasing sense, at least from my perspective, that bears are losing their perspective - and, perhaps ironically, acting much like the bulls they are so quick to criticize.

Bulls Vs. Bears

The stereotype from TSLA shorts that the bull case comes down to "well, have you driven the car?" isn't entirely fair - but there's some truth to it. Tesla shorts - particularly looking at the so-called "$TSLAQ" community on Twitter - are digging through 10-Qs, running drones over storage lots, and digging through legal filings. Tesla longs are citing the abilities of CEO Elon Musk, calling out long-term projections for EV growth, and assigning value to still-nascent business lines like autonomy and the Tesla solar roof. It certainly appears to an outside observer like TSLA shorts are doing much more work.

Yet it's important to remember that it's not entirely a fair fight. For any growth stock - and even below $200, TSLA unquestionably remains a growth stock - a short always will have to do more work. A long isn't going to find an intriguing detail in footnote 14 of a 10-K - because the details of the long case are in the investor presentation, or spelled out on the conference call.

More broadly, long case for a growth stock almost always, in at least some fashion, comes down to "management is right." And - as is the case with TSLA - it's not necessarily that important exactly how right. If the addressable market grows, and the company takes an increasing share of the market, operating leverage usually does the rest, even in the difficult automotive business.

A long case in a growth stock, then, requires belief. In the case of Tesla, that means belief in Musk, and belief that the company's products (cars initially, then alternative energy options from there) can drive consistent, growing, long-term demand. That belief doesn't justify ignoring the fundamentals altogether or picking random price targets that always somehow end in at least two zeroes. But a TSLA long - no matter how good or educated an investor she is - cannot provide evidence for her case in the way that a TSLA short can. It's simply the nature of a long case vs. a short case in general, and particularly for growth stocks, as anyone who has shorted stocks or (in my case) written up a short argument can tell you.

Add to that the fact that negativity generally seems more prudent. Bearish analysis always appears more sober (I'm sure there's some evolutionary reason for that). As the always-excellent Matt Levine wrote today at Bloomberg (on a completely different subject), "If you identify a bubble and it crashes, you look smart; if you identify a bubble and it keeps going up, everyone forgets; if you cheerlead for an asset and it crashes, you look super dumb."

Even George Costanza figured out that looking annoyed is a good way to get people to believe that you're serious. A short shouting "fraud!" while pointing to p. 87 of the 10-Q likely will seem, on his face, more credible than a long arguing that the electric vehicle market will quintuple by 2025 - particularly to investors not as familiar with the details of the story.

To be sure, there are TSLA bulls out there who haven't done the work. But there are some who did - and continue to do so. The bull case wasn't stupid, or lazy - and there's still a version of a bull case that isn't. The Model 3 was the best-selling electric vehicle in the world last year. Struggles in Europe have been a focus of late, but the Model 3 was the best-selling car of any kind in Switzerland in March. EV adoption likely will only grow. Again, a common growth stock paradigm is growing market share plus expanding addressable market - which fits TSLA perfectly, at least in theory.

Obviously, the odds assigned Tesla's ability to match that paradigm have notably weakened in recent weeks, the broad reason why the stock has fallen so sharply. And the reason I put on my trade was that I felt the odds were far, far lower than the market had priced at the time. But that doesn't mean Tesla had, or has, no opportunity to grow, or to drive consistent profits, or to justify its valuation. It doesn't mean that TSLA shareholders (past or present) or bullish analysts were idiots or conspirators. There was a bull case here - and, to be honest, there still is, even if I disagree with it.

After all, honestly, have you driven the car, bro? I truthfully haven't (though I've ridden in a few). But its defenders are legion - well beyond those whose "I love the car, but the bumper detached itself and then hit on my girlfriend" reviews seem to make the rounds on Twitter. Tesla can make really wonderful cars when it's not making mistakes with door gaps or paint jobs. To many consumers not involved in the minutiae of TSLA, Tesla remains an attractive brand. Indeed, despite the negative reviews that swirl around TSLAQ, most of the buyers of the ~600,000 cars Tesla has shipped remain quite happy: The brand still has the highest owner satisfaction as of February 2019.

The narrative that's building around TSLA seems to be that anyone who was bullish, ever, was naive, stupid, ignorant, or some combination of the three. It's wrong - and it's unfair. There was a bull case here - and even if it has narrowed, there still is. These are really good cars. The electric vehicle market is going to grow. The idea that competition is going to "blow Tesla out of the water" strikes me as overly dismissive of just how happy most Tesla customers (and not just "fanboys") remain. The broader plan of integrating automobiles and energy more broadly was intriguing. The market opportunity was, and still is, enormous.

This is not to say that TSLA is a buy. Again, my short position remains and open, I have zero interest in closing it even with a nice profit at the moment. There are no shortage of reasons for concern. Tesla's production ramp appears to have sacrificed quality, as even Consumer Reports noted. That likely has hit the brand, which undercuts the bull case. There are obvious financial concerns in terms of both the balance sheet and the P&L. Musk's management is becoming potentially the biggest risk to the company (more on that later).

But TSLAQ and Tesla shorts more broadly seem to be acting as if there never was a bull case to begin with. There are accusations that Tesla predominantly or solely manufactures cars with unacceptable quality - despite owner reviews to the contrary. Those perceptions are driving a series of increasingly inaccurate and unsupportable claims from Tesla shorts. The irony is that one of the more intriguing arguments from TSLAQ long has been "look who's on the other side of the trade." Of late, I find myself increasingly worried about who is on my side.

Elon and Enron

Shorts increasingly are calling Tesla "a fraud." Comparisons to Enron and even Theranos ("Teslanos") abound. (We'll assume that those references are to the popular narrative of Enron as an intended fraud, to what extent the company actually was a planned con remains somewhat up for debate.)

To be clear, calling Tesla "a fraud" seems quite different from alleging that Musk committed securities fraud during the "funding secured" debacle (in his settlement with the SEC, the CEO neither admitted nor denied those charges). It's an accusation that Tesla's reported numbers are somehow not true.

The points of contention seem to cover areas like understated warranty reserve, gamed depreciation, and other accounting practices. There were claims that the end of 2018 cash balance might have been faked as interest income for Q4 was unusually low. The claims are that not only is Tesla unprofitable at the moment, but those unprofitable numbers - or perhaps just those in the blowout Q3 - cannot be relied upon.

Whether or not Tesla is gaming some of the numbers quite honestly is above my pay grade. Tesla's disclosures aren't exactly fine-grain. As I wrote last year, Musk has emphasized hitting quarterly targets - most notably the much-hyped and instantly-forgotten 5,000/week production target at June 30 - due to an irrational and contradictory belief in the market's "short-termism." It wouldn't surprise me if the company took favorable interpretations of accounting rules from time to time. Nor would it surprise me - or likely most investors - if Tesla wasn't alone among publicly traded companies in doing so.

But to call Tesla "a fraud" goes well beyond even those possibilities. And quite honestly, it makes no sense. For all the hype about "funding secured," I thought the most interesting aspect of Musk's commentary - and the most damaging to the TSLA bull case - was this:

I honestly don't know what was in Musk's head when he sent the infamous "funding secured" tweet. Maybe it was a part of a malicious plan to spike the stock. Maybe he just got frustrated. Perhaps he really thought he had some kind of deal with the Saudis. But it was unquestionably a terrible, poorly thought-out plan - and yet its import, in my opinion, pales in comparison to the tweet above.

That tweet - promising "no forced sales" - shows quite literally zero understanding of public and private markets. It shows nothing but sheer laziness on the part of Musk to even consider the sphere in which his $50 billion-plus company operated. There's some alternate universe where Tesla went private in late 2018 or early 2019 for $420 a share. There was, and is, no universe - no possibility - of a private Tesla with small-bore, retail, non-accredited shareholders. A simple Google search would have proven that: The SEC rules are quite clear.

Musk's attitude toward short sellers is based, too, on a complete inability to understand capital markets. That and his inability to understand basic financial concepts dispel any argument that he is "in charge" of the financials in any way. There is no evidence - zero, zilch - that Musk has the knowledge to aggressively inflate, alter, or falsify Tesla's operating results. In fact, what evidence we have suggests over and over again that he does not even understand how capital markets work. As more than a few people of late pointed out, the buyers of the recent convertible debt raise hedged their bond purchases by selling TSLA stock short - meaning Musk is happily raising capital from the same market participants he has regularly demonized.

Musk may not even be a hypocrite. His commentary suggests it's more likely he doesn't even understand the contradiction. Musk isn't even an engineer. Nor he is actually the founder of Tesla. But he's so versed in accounting minutiae that he is cooking the books at Tesla? Come on. He doesn't appear to have the financial understanding to be CEO of a public company; that actually is a significant aspect of the bear case (my bear case, anyway).

If Musk isn't directing Tesla's finance department in specific terms of how to, shall we say, "manage" the results, who is? To stretch the Enron metaphor, who is the Andy Fastow to Musk's Skilling? The only possible answer would be Deepak Ahuja, the company's CFO from 2008 to 2015 and then again from 2017 to February of this year. At the very least, were Tesla gaming its financials, Ahuja would have to know at least something about it.

So, to call Tesla "a fraud," or to allege significant accounting improprieties, an investor has to believe that Ahuja most likely planned those improprieties, or at the absolute least was aware of them. He goosed the Q3 numbers...and then retired on Feb. 1, handing over the reins to a 34-year-old with no real experience outside the company.

Is that what those in charge of a multi-billion-dollar fraud do? Retire? Twice? And then leave their handiwork in the hands of someone with zero CFO experience? Meanwhile, if Ahuja (or Musk, for that matter) was such a financial savant, and was expertly doctoring the financial statements to hide a collapsing company, why didn't he lead a capital raise last year at $350-plus? In this scenario, the CFO must have known the financials were faked to some extent, and thus that the fraud could potentially unravel at any moment. Why did the raise only come this month, at $243, three-plus months after he left for the second time?

The "fraud" allegations look like conspiracy theory nonsense, simply put. They rely on the same faulty premise as so many conspiracy theories do: That the guilty parties are so brilliant as to masterfully execute complicated, multi-year, multi-faceted plans, yet so stupid as to leave evidence out in plain sight. Those alleging fraud are attributing to malice what is more than adequately explained by incompetence - particularly given how often this company has shown that incompetence, especially in recent months.

#CRCL, Or Why Tesla Is Going Bankrupt In Six Months, And This Time We Mean It, Seriously

For those unfortunate readers who don't spend hours a week reading snarky comments about a single stock, #CRCL was - and still is - a hashtag used by bears on Twitter. It stands for "Can't Raise, Can't Leave," shorthand for the theory that an undisclosed SEC investigation was preventing Tesla from raising capital.

#CRCL often combined with allegations of some type of fraudulent activity, which presumably was the subject of the hypothetical investigation. And - in some tellings - since Tesla didn't have the cash it claimed, and inevitably would burn what was left, bankruptcy would inevitably follow within weeks or months.

Then, of course, Tesla went and raised $2.7 billion. And while a few admitted the theory had been off, the response for the most part was - and still is - rationalization. The raise wasn't big enough. It was another misstep, given that Tesla could have raised last year (including a direct sale, assuming reports were true, to the Saudis who eventually purchased shares on the open market). Tesla only delayed the inevitable.

Those facts may all be true. But the fact remains that a good number of bears argued for several quarters that Tesla was under an investigation so serious that it couldn't file a registration statement under which it could raise capital. Those arguments were wrong, full stop. And that's a reasonably large aspect of a short case on which to be wrong.

Indeed, the "Tesla is going bankrupt" argument has been relatively widespread going back to predictions that began last year that the company wouldn't be able to raise the $920 million needed to pay off its convertible debt in March. At a certain point, the breathless proclamations that bankruptcy is just around the corner need to stop. There's no substantial evidence that Tesla truly is "a fraud," or anything like Enron or Theranos.

And does anyone doubt that if push came to shove, Tesla couldn't raise more capital? Or possibly find some buyer to assume its current ~$12 billion in debt plus some value for the equity? I'm not saying a takeover is likely - or that Apple (AAPL) is on the way - but it's not a possibility that can be ruled out, particularly with a man like Larry Ellison still apparently in Elon's corner.

Obviously, TSLA shares fall precipitously in either scenario. But the case that the TSLA stock price is going to zero generally seems to start from the apparently incorrect assumption that there's extensive fraud in the numbers, and for the last few quarters has added on the obviously incorrect belief that Tesla could not raise capital. It's not a strong case.

There still is value in the Tesla brand (for now) and there's still $22 billion in revenue. Tesla's cost of capital for the new convertibles was roughly 8% (including the hedges). The existing 2025s are trading at a YTM of 9%. Credit default spreads are rising Anyone arguing that Tesla is going bankrupt in the next 12 months is an outlier, and is betting not just against Tesla bulls, but a bond market to which shorts, in particular, often point to as a barometer of default risk. And anyone making that case for bankruptcy needs to make a much better case than I've seen so far. At the least, that case should include some acknowledgment that many similarly dire predictions haven't come close to panning out.

The "Real" Bear Case for TSLA

To be clear, none of this is to say that Tesla bears or TSLAQ are lying, or funded by Big Oil, trying to stop green energy, or any of the other ridiculous accusations tossed our way. In fact, as a Tweet this week noted, there's an impressive and wide-ranging amount of expertise and experience within that community. And TSLAQ surfaced, well ahead of time, many of the key questions now making their way into sellside and buyside analyst reports. Why is Tesla's capex plummeting? Has demand for the Models S and X collapsed? Why have so many executives departed - and who, exactly, remains beyond Musk?

These are all valid questions, and the community has expanded my knowledge of the stock and provided the bedrock for much of my own thesis. But that thesis, at the risk of sounding arrogant, is quite a bit more simple - and at least in my eyes, more reasonable. I'd note that Tesla still has a market cap, as of this writing, of roughly $37 billion, and an enterprise value near $50 billion.

By any valuation metric, TSLA still trades at a massive premium to other automobile manufacturers. As such, to support anything close to those valuations, Tesla has to be the best automotive manufacturer in history. It has to drive more profitability per car (one reason why gross margin debates are so important to the case here) than its rivals and show growth that dramatically outpaces every other carmaker on Earth. Even the ancillary efforts in solar depend on the success of the automotive business, as Musk himself wrote almost three years ago.

Nothing that Musk has done in recent years suggests that a company he runs can meet that goal. (You might call it a version of the "founder's dilemma," were Musk actually the founder.) Everything in the past few quarters - funding secured, the closing/not closing of the service centers, the disappointing and haphazard Model Y rollout, the plunging capex, the decision not to raise capital last year, the ridiculous claims that a Tesla car will be worth $250,000 in three years - only strengthen that skepticism. This company, quite frankly, is being run into the ground. And it's still worth ~$50 billion or so at the moment. I don't believe that combination will hold.

That doesn't mean, however, that Tesla is a fraud. It doesn't mean that Tesla is doomed to hit zero. The biggest risk to the short thesis, in my opinion, is the company getting some sort of grown-up management, whether through a new hire (good Lord, this company needs a COO) or through a takeover. Bulls would argue that Musk's ego would never allow such a thing - and/or would prevent any seasoned auto executive from taking that type of position - and that's probably true, one reason I'm still short. But this is not a company that is doomed, or honestly even close to doomed - at least not yet.

TSLAQ in many ways highlights the promise of the Internet and social media: The grouping of disparate individuals with a common interest, all of whom benefit from the exchange of ideas. But, particularly of late, it's highlighting the dangers of online discourse as well. Outside ideas are ignored or discarded. And there's been some notable one-upmanship in terms of how dire Tesla's situation is and how soon TSLA is going to zero. Conspiracy theories are spreading about Musk's efforts to bait the SEC into a "suicide by cop" situation or that same regulatory agency allowing Tesla to exist for a few more quarters solely to execute a pre-packaged bankruptcy.

The discussion, ironically, looks like the mirror image of bulls. Tesla longs have their own conspiracy theories about Big Oil and the media paying off Twitter users, journalists, and, presumably, people like myself to "take down" TSLA stock. And only last year, in a different market for TSLA, they, too, were excitedly creating ever-higher round-number price targets and unquestionably accepting any information that seemed to support their case.

That's a dangerous way to invest. Investors can't become emotionally attached to a position - and that goes double for a short position. And anyone who has shorted should know or should remember, that it's usually a contrarian trade. When the narrative turns in your favor can be precisely the most dangerous point. The narrative quite clearly has turned.

In a matter of months, in the eyes of many, Tesla seems to have moved from being a company poised to revolutionize the world energy business to a company doomed to failure because no one will ever again buy any product it makes. The truth is likely somewhere in between, as it usually is. That, in turn, means the path forward for Tesla shorts may not be as smooth as it has been, or that they believe it will be.

This article was written by

Vince Martin profile picture
7.14K Followers
Overlooked Alpha launched April 2022 - subscribe at overlookedalpha.com. Some OA articles are also available here at Seeking Alpha.I've been contributing to Seeking Alpha and other investment websites since 2011, with a general (though far from rigid) focus on value over growth. I got my Series 7 and 63 back in 1999, and watched the dot-com bubble peak and then burst in real time at a small, tech-focused retail brokerage in NYC.

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.

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