Good Car, Overvalued Stock

I occasionally like to short [1] stocks for fun and profit. One of my recent shorts is Tesla [2], the maker of electric vehicles (“EV”) and energy storage systems. This one gives me particular pleasure because it is a great opportunity to take some money off the politically correct (“PC”) crowd precisely because of their cognitive deficiencies. Let me explain.

Tesla’s model S. A nice car, if a little expensive (we mainly regard it as a plaything for people with too much money, which is not meant to detract from its undoubted “cool” factor). Lately doubts about its reliability have been raised, and in spite of the car being heavily subsidized (see also caption under the Model X picture further below), Tesla still loses $4,000 on every Model S it sells. Last quarter, the company burned $360 million in cash.

I have nothing against the Tesla car. Although I have never owned or even driven one, by nearly all accounts it is a pretty good machine (although clearly with some build-quality issues and probably some long-term reliability ones, too). Tesla has almost single-handedly revived electric automobiles [3] and brought some useful practices to the automotive field from the technology sector, such as over-the-air software updates.

The Tesla car is also the darling of the chattering classes, particularly the West Coast variety. Sleek, fast, expensive and electric, nothing announces “I have arrived…but I am still the same laid-back, eco-friendly [4] and PC guy I used to be” like a Tesla. This has made it a celebrity favourite, as demonstrated by, for example, this six-minute long free commercial on The Late Show with Stephen Colbert which raves about Tesla’s recently downloaded auto-driving features.

These features are common or garden variety for cars in this price category but we can’t apply normal standards to a Tesla. We are talking about a revolution here. Well, you know we all wanna change the world.

Shares in Tesla benefit from the same cult following. I can’t prove this mathematically, but you only have to spend a little time in the Tesla section at e.g. Seeking Alpha, a popular investment website, to realize that the proponents of Tesla are on a PC mission. And like with their politics, these evangelists will not allow logic to distract them.

Cult stock Tesla, weekly, over the past five years. After a huge rally in 2013-2014, it has begun to stall out – click to enlarge.

I have been a businessman for over 25 years. At every point in my career, including when I was working at the all-conquering Goldman Sachs, I have felt the hot breath of competitors on my neck. This is a reality of the “free-ish” markets in which most businesses operate that the PC crowd, most of whom have no direct experience of business, doesn’t understand or acknowledge. And this is the major reason why they are going to take a bath on their Tesla investments.

Competition Is Heating Up

The free market never leaves bags of money lying around and waiting to be picked up. In fact, if you ever find this, it is almost certainly the result of government intervention. Remember the £1 billion that George Soros made betting against the British Pound in 1992? That was a direct transfer from the UK Treasury to Soros. Absent any barriers to entry, these types of extraordinary profit opportunities rapidly draw so much investment that the “arbitrage” disappears. Likewise Tesla’s $30 billion stock valuation.

Tesla’s newest car, Model X, which is a bit reminiscent of the likewise very cool, but ultimately doomed de Lorean. The biggest news with respect to this car is however the amount of government subsidies in the form of tax breaks it will attract. As the LA Times reports, without a hint of irony:

“Take heart, prospective Tesla buyers alarmed by the probable $100,000-plus price tag for the company’s new Model X: You may qualify for a $25,000 tax break. Tesla has confirmed reports that the falcon-winged all-electric SUV, because of its gross vehicular weight, may qualify for a federal tax break designed for heavy equipment. The tax break was originally intended to encourage farmers to invest in their businesses by spending more freely on equipment.”

This particular tax break is only available to businesses (for a detailed account of the situation, see this article by Paulo Santos), but to this assorted “green energy” subsidies have to be added as well as the paper reminds us:

“The $25,000 windfall, available only to buyers who own businesses and are making the automobile purchase as a business investment, would be in addition to other official incentives. Tesla’s Model X, as a non-polluting, zero-emissions, battery-electric vehicle, also qualifies for a $7,500 federal tax deduction and a $2,500 California state rebate. Tesla is particularly adept at using subsidies to market its cars, noting that the tax credits and state rebates help reduce the cost of ownership.”

This “reduces the cost of ownership” for Tesla buyers, but someone still has to pay – ultimately, all other taxpayers are providing an indirect contribution to every sale the company makes (of course the same applies to EVs made by other manufacturers). PT

The incumbent automobile manufacturers are now entering the EV market in force. VW/Audi. Mercedes Benz. BMW. Nissan. Honda. KIA. Porsche. Like turkeys welcoming Thanksgiving, the Tesla supporters applaud this, saying that it is an “endorsement” of the Tesla approach that can only help the company. One proponent recently entitled an article “The Auto Industry Just Admitted That Tesla is Right.” I am sure that this will be a great comfort when these competitors start eating into the growth and profitability that is the basis of Tesla’s extraordinary stock valuation.

The massive entry of the incumbents proves two things. The first is that there are no barriers to entry – no “economic moat,” to use the popular phrase – that will give Tesla the competition-lite growth and profitability needed to justify its stock price. And the second is that the free run that Tesla has enjoyed so far is purely because the incumbents have been happy for Tesla to pioneer this market, knowing that the pioneers are often the ones with the arrows in their backs. Now that Tesla has been proven to be “right,” they can use their myriad scale and other advantages to eat Tesla’s lunch.

The PC crowd will never get this. Implicitly or explicitly, they assume that all businessmen are short-sighted, greedy dolts sitting around and waiting to be disrupted by some Silicon Valley type who says “cool” a lot, never wears a tie and votes solidly Democratic. They don’t realize that, for example, the automobile industry is one of the most internationalized, dynamic and competitive industries in the world. And it is also one of the most high tech, both in its products and the way it makes them.

Little known fact: automotive giants Volkswagen and Toyota are in the top-10 companies in the world in terms of R&D expenditures, with VW leading the pack at $13.5 billion per year. Much of this is spent exploring alternative drive train technologies, such as EV, cleaner and more efficient internal combustion engines (“ICE”), hybrids, fuel cells, etc. If the PC crowd backing Tesla thinks that the incumbents are sitting around waiting to be disrupted, then they should think again.

Of course, all of this has been pointed out to the Tesla proponents. But this is where their second cognitive failure comes in. Like with their politics, they are unable to imagine anyone could disagree with their messianic vision except due to evil or base motives. So, wade into the comments section of Seeking Alpha and dare to question the investment logic of Tesla. You will be met with a torrent of ad hominem abuse and attacks on your motives, intelligence and maternal parenting. But the one thing that you will not be met with is a reasoned retort. You are so obviously unenlightened that this is not deserved.

At the current stock price, I am slightly in the money on my Tesla short. But I am maintaining the position until I make enough from shorting Tesla stock to buy a Tesla car. Or, more likely, to buy one of the better, cheaper and more reliable EVs that Tesla’s incumbent competitors will shortly be producing.

Footnotes:

[1] “Shorting” a stock is a way of betting that its price will fall. To be precise, you short a stock by borrowing it from someone, promising to return it at a later date with interest; in this respect, it is just like any loan, except in this case the “principal” is the number of shares that you have borrowed and which you have to return. After you borrow the shares, you sell them at the current market price for cash. When it comes time to return the shares, you have to buy them back. You profit if the price of the stock has fallen in the interim and you can buy back the shares for less than you received when you sold them. Short sellers are often derided as a type of financial parasite living off the misery of others. In fact, they should be strongly encouraged. Imagine, for example, what would have happened if investors had more vigorously shorted sub-prime mortgages in the lead up to the financial crisis. With much more shorting, the price of these loans would have fallen and it would have become unprofitable to create them. A huge amount of bad investment and financial chaos could have been avoided. [2] As always, this is not any kind of financial advice. [3] I say “revived” because, in fact, EV is a very old technology. Before being eclipsed by internal combustion engines (“ICE”) in the early 19th century, EV and ICE were neck and neck. [4] Of course, we must never ask where the electricity comes from. Or question the environmental impact of making the batteries.

Chart by: StockCharts

Image captions by PT