You would think that investors would learn from their mistakes. For example, a lot of Wall Street analysts – two dozen of them in fact – have egg on their faces after missing the disaster at Valeant Pharmaceuticals, a stock that I warned about last October when it was trading at $170 per share. Today, with VRX stock down under $30 per share, the financial media and Wall Street has finally figured out what Sure Money readers knew before the rest of the crowd – that the pharmaceutical company was a house of cards built on a foundation of debt and a toxic business model.
Right now, my readers are about to get in ahead of the curve once again.
There is another stock market darling that has many similarities to Valeant – phony financial statements, a CEO spending overtime pimping investors and hedge funds into the stock, a mesmerized financial media, and a grossly overvalued stock – Tesla Motors, Inc. (TSLA).
In its defense, it must be said that unlike Valeant, which takes advantage of the sick by overcharging them for drugs, Tesla is trying to do something noble by building electric vehicles. But these vehicles are primarily toys for rich people and subsidized by U.S. taxpayers, so the company’s nobility goes only so far.
And on a financial basis, TSLA is a ticking time bomb.
Here’s why you should get out of TSLA right now – and here’s how to profit.
Tesla Has All the Hallmarks of a Cult Stock
While the financial media and Wall Street analysts suck up to Tesla’s founder, Elon Musk, they ignore the fact that the company is running through billions of dollars of cash while running a massive Ponzi game on consumers. In the last quarter, the company lost $19,059 for every car it sold (despite a starting selling price of over $70,000). Its negative net margin was -24.6% compared to -16.4% a year ago. It promised to produce 200,000 cars in 2017, 500,000 cars in 2018 and 1,000,000 in 2010 but only expects to manufacture 17,000 in the second quarter of this year. The odds of the company meeting these projections are about as high as the odds of Hillary Clinton starting to tell the truth. In the first quarter of 2016, Tesla burned $249.6 million in cash in operations, almost twice as much as a year earlier ($131.8 million). It also spent $233.8 million in capex, which it considered a victory since it was less than the the $432.3 million it spenta year earlier. It raised $715.4 million to pay for this, up from $186.2 million a year earlier. But it’s going to have to spend a heck of a lot more to come close to reaching its absurd projection targets.
Not to mention the fact that the cars themselves are literally at the bottom of the reliability list:
At this rate, Elon Musk is going to give carnival barkers a bad name.
In order to plug the hole in its finances, the company just sold $1.4 billion in stock (and Musk sold another $600 million to pay taxes on egregious stock option grants). At the rate the company is running through cash, this new monty will last only for little more than a year. The company should have taken the opportunity to sell $5 billion of stock. Its cult members – excuse me, I mean its investors – would have happily paid more than $200 per share for that many shares. It is going to be much more difficult to raise capital when the company really needs it – after the bottom falls out.
Tesla has all of the hallmarks of a cult stock. Like Valeant Pharmaceuticals, which pimped every hedge fund and Wall Street analyst into buying it until the stock reached a ridiculous $263 per share while ignoring a rotting balance sheet filled with tens of billions of dollars of debt and goodwill on top of a corrupt business model that preyed on sick people and the American taxpayers that pay their bills, Tesla has enlisted Wall Street to suck in gullible investors and consumers.
Not that Wall Street needed much convincing.
On May 19, 2016, Goldman Sachs published a research report ludicrously comparing Elon Musk to Henry Ford and Steve Jobs while ignoring obvious flaws in how the company does business. Even worse, Goldman used these bogus comparisons to paste a $250 per share price target on the stock one day before the company disclosed that it had hired – surprise! – Goldman to lead the stock sale described above.
If you think that Goldman didn’t have the order to sell the stock in its pocket at the time it issued its giddily bullish report, you don’t know how Wall Street works. And if you believe that the so-called Chinese wall between the research department and investment banking kept its analyst in the dark about the upcoming stock offering, you are a fool. This is crony capitalism and Wall Street corruption at its worst. While regulators are nitpicking every wealth manager and banker in the world over trivial compliance nonsense, Goldman Sachs flouted obvious conflict-of-interest rules and made the SEC look like a bunch of fools.
Goldman’s report argued that Tesla’s already absurdly overvalued stock was too cheap: “Following a 23% decline in the share price post the Model 3 unveil, we do not believe Tesla shares are fully capturing the company’s disruptive potential.” “Disruptive potential” is one of those meaningless terms that analysts use that allow them to put any price on a stock that they want. Goldman downplays the fact that a dozen other companies already manufacture or are moving forward on plans for electric or hydrogen vehicles to compete with Tesla. The only company about to get disrupted is Tesla.
Not to be outdone, however, the analyst at Goldman’s co-manager on the deal, Morgan Stanley, has an even more ridiculous $465 per share price target based on claims that Tesla will not only revolutionize the auto business but the battery business as well. You can see how 24 analysts had “buy” recommendations on Valeant until the stock finally collapsed under $50 per share.
Behind The Glittering Façade, Tesla Is Bleeding – Badly
Speaking of Valeant, Tesla has concocted a scheme that puts Valeant’s worst abuses to shame. Naturally the financial press and Wall Street are cheering on Tesla in this masterful example of a Ponzi scheme and a better example of why financial journalism and analysis deserves the moniker “dumb and dumber.”
In the company’s recent earnings release, it announced that it collected $1,000 refundable deposits from 373,000 customers for its new Model 3 that won’t launch until late 2017 (assuming it launches at all). It noted, “We have obtained this level of reservations…with only a few social media posts” as though it didn’t have half the financial media broadcasting what it was doing. But even that omission doesn’t properly capture the sheer idiocy of the company’s comment. Elon Musk likes to drop tweets about the company like giant turds out of the sky promising new product launches and all kinds of surprises that investors slop up like fools, but behind the PT Barnum act the company is bleeding while making promises that it is not going to be able to keep.
Alarmingly (at least to anyone who actually thinks about things these days), Tesla didn’t stick this money in an escrow account; instead, these funds are sitting in its general account and will be rapidly consumed in operations. Does the SEC even read the papers anymore? And CNBC and the rest of the media sycophants cheered on the company’s reckless financial practices. Welcome to finance in the Age of Obama.
Leave aside for the moment the fact that Tesla produces very expensive cars for very wealthy people. Or that these wealthy people who buy is cars are subsidized to the tune of $7500 per vehicle by the U.S. government (the $7500 federal tax credit begins phasing out after the company sells 200,000 vehicles, a number the company isn’t close to reaching). A deeper look at Tesla’s financial statements – an exercise in which Wall Street analysts no longer engage (how do we know that? – look at what happened at Valeant Pharmaceuticals) – reveals a company running on fumes.
Tesla is a study in the use of non-GAAP earnings adjustments to create a false picture of financial health. Tesla uses a variety of non-GAAP adjustments from the common to the ridiculous. The common include phony stock option accounting adjustments that understate executive compensation expenses, something widely used by corporations and especially tech companies. But then there are more arcane adjustments. For example, Tesla pumps up its earnings for early extinguishment of loans it receives from the U.S. government – remember, Tesla’s business is heavily subsidized by the government due to its production of electric cars. The company has earned a lot of money from government subsidies in its early year of existence.
And then there is an adjustment that is little more than fiction – Tesla pumps up its earnings by an entry called “Model S gross profit deferred due to lease accounting” – and if that sounds confusing it is. First, while the company uses the term “lease accounting,” this line item relates to cars that the company sells, not to cars it leases. Tesla guarantees to buy back all Model S vehicles it sells after between 36 and 39 months old for 50 percent of their value. It expects to make money by reselling these cars and reports that expected profit (whether realized or not) as gross profit that it uses to adjust upward its earnings – hence the line item “Model gross profit deferred due to lease accounting.” But this is just a management estimate and not an actual number. Tesla defers the residual value it is obligated to pay to repurchase these vehicles until the 36-39 month period expires and carries that value on its balance sheet as an asset where it is depreciated. As of March 31, 2016, the company had $2.24 billion of “Operating lease vehicles” on its balance sheet, up from $1.8 billion three months earlier at December 31, 2015. As of March 31, 2016, it had $192.4 million of guarantees that were exercisable by customers over the next 12 months, up from $136.8 million three months earlier at December 31, 2015. This is a huge and growing cash liability for a company that already has massive capital expenditure needs to meet in order to increase its ambitious – and likely unachievable – production schedule.
How to Play the Tesla Disaster
There are some simple rules of thumb in investing. One of the most important is “keep it simple.” Tesla, like Valeant, violates that principle at every turn. While I don’t hesitate to recommend that investors avoid the stock at all costs and even short it through long-dated puts, there is one risk to doing so that must be acknowledged – the possibility that the company could be acquired by a cash-rich company like Apple, Inc. (AAPL) or Alphabet, Inc. (GOOG). For that reason, I would limit any short sale to buying put options. But the one thing I would not do is touch this company with a ten-foot pole. Without being acquired, this stock should trade in the low double digits.
If you are interested in buying puts on TSLA, I recommend the TSLA January 2017 $100 puts (TSLA170120P00100000). At this writing, they’re trading at about $1.35; pay no more than $1.50.