Tag Archives: Tesla

Tesla: Can You Smell The Blood In The Water?

“The demand for – the demand for Model 3 is insanely high. The inhibitor is affordability. It’s just like people literally don’t have the money to buy the car. It’s got nothing to do with desire. They just don’t have enough money in their bank account.” – Elon Musk on the Q4 earnings conference call

The following commentary/analysis is from the February 3rd issue of the Short Seller’s Journal.

Tesla’s Failed Business Model – The statement above is an actual comment from Elon Musk on the earnings call. I literally had to ask a couple of people who were on the call if I had misread the transcript or if it was a mistake in transcription. I’m not sure if Elon erringly thought he was sharing profound insight into the laws of economics or if the relationship between price and demand eludes his understanding.

It was announced in late January, before Tesla posted earnings, that the Saudi Public Investment Fund had hedged its 4.9% investment in Tesla’s stock (8.33 million shares). It accomplished this via a structured note (OTC derivative) created by JP Morgan. In exchange for downside price protection, the Saudis gave up participation in any gains should Tesla’s shares rise in price. My guess is that the Saudis also paid a hefty transaction fee to JP Morgan on the order of 3-4% on the market value of the shares hedged.

It did not take long for the Saudi fund to abandon its investment in Tesla. The Saudi stake in Tesla was announced shortly after Tesla’s Q3 2018 earnings release. Musk’s infamous “funding secured” tweet was issued right after the Saudi stake was revealed to the public.

My best guess is that the 8.3 million shares where accumulated during July around an average price in the low $300’s. It’s also possible that one of the large U.S. fund holders sold a big block of shares that was crossed into the Saudi fund. Hard to say for sure but I would surmise that JP Morgan and/or Goldman Sachs (Tesla’s primary investment banks) know the truth.

If the hedging derivative was structured during the month before it was announced, the average price of the hedge is likely $320. Let’s assume the Saudis locked in a $20/share profit – $166 million. Netting out all trading and transaction fees (at a 3.5% fee, the derivative hedge would cost $93 million) the Saudi fund maybe netted about $60 million on the trade. But why did the Saudis bail on the investment after less than six months?

For me the demand/price comment exemplifies the Tesla tragicomedy. The Company reported its Q4 on Thursday after the market closed. Until the 10-K is release (40-60 days), I can not layout a detailed dissection of Tesla’s accounting games. But needless to say it appears as if Tesla’s CFO employed all of the same accounting schemes as were used in Q3 in order to manufacture a GAAP “net profit.” Notwithstanding this, the Company “missed” the Wall St consensus estimate and warned that it may or may not generate a profit in Q1 2019.

Speaking of the CFO, it was announced at the end of call – literally before the Company hung up the phone in order to avoid questions on the matter – that the CFO would be leaving the Company sometime in early 2019 though no specific date was set. He is to be replaced by a little-known 34-year old VP in the finance department, Zach Kirkhorn. Kirkhorn prior to Tesla was a “business analyst” McKinsey & Co. This is a fancy term for someone who helps design computerized enterprise applications for McKinsey clients. Prior to McKinsey, Kirkhorn worked at Microsoft.

Kirkhorn was a curious choice becasue he stunningly has little apparent experience in accounting and finance. Typically CFO’s have either worked their way up the accounting/controller side of a company or are hired from a similar role from the outside. This move left everyone scratching their head but reflects the general dysfunctionality that pervades the Company.

Telsa has experienced a stunning drop-off in orders since the end of 2018 that appears to have begun during late December. The $7500 tax credit was cut in half starting January 1st. Data from Europe show that EV sales fall off a cliff when the tax credit disappears. The chart to the right illustrates this by showing Tesla’s Model 3 sales over the last 12 months (from @TeslaCharts).

The jump in December M3 sales is a product of huge incentive programs Tesla implemented to stimulate sales ahead of the cut in the tax credit. As you can see, since July TSLA has averaged 20,000 unit sales per month. The January number is largely the expected cliff dive related to the drop in the tax credit. However, the large drop-off is also likely attributable to potential EV buyers waiting for the spring roll-out of the Audi E-Tron and Porsche Taycan. Porsche announced in January that it was doubling production in response to demand.

Briefly on Tesla’s numbers. Taking $139 million of net income attributable to stockholders at face value – i.e. assuming the accounting is 100% clean – nearly $100 million of that is from Tesla’s sale of greenhouse gas and zero emission vehicle credits. If we assume just $39 million worth of GAAP manipulation used to generate “income” (the real number is multiples of $39 milion) small amount of accounting games were used to generate GAAP “income,” reversing out the GHG/ZEV credits takes Tesla’s actual net income to zero. This means that the ability of Tesla’s business model to generate actual cash income is based solely energy credit sales. This is not a valid sustainable business model.

In the short term, the next big event is the maturity of the $920 million convertible bond due in March. It looks like Tesla’s stock price will be below the price at which bondholders will want to convert. Additionally, the deadline to reset the conversion price lower has passed. This suggests that Tesla will use cash to pay off the converts.

But here’s the problem:  At quarter end, Tesla’s balance sheet showed a working capital deficit (current assets minus current liabilities) of $1.7 billion.  Of the $8.3 billion in current assets, $3.6 billion is cash. However, of the $9.99 billion in current liabilities, $3.4 billion is accounts payable. It would appear that Tesla will be stiffing its suppliers, vendors and service providers if it uses the cash, as reported, to pay the converts.

I don’t know how Tesla will resolve this issue but I suspect the maturing bond will paid. Otherwise the Company will be forced to file for bankruptcy of some flavor. I don’t see this event happening until at least the end of 2019. This is why I moved my long-dated Tesla OTM puts out to June 2020.

Regardless of this immediate issue, I expect to see continued deterioration in Tesla sales across all three of its models. Snapshots from around the country from major metropolitan areas show lots full of unsold Teslas – all three models – with the inventory stored in these lots growing by the week.

Since I wrote the above analysis for the Short Seller’s Journal issue released this past Sunday, it was reported that Tesla has not received EU approval to sell Model 3’s with autopilot installed. Most of the Model 3’s pre-ordered in Europe were for the Model 3 with autopilot. This little factoid was in direct contradiction to the Company’s announcement, reiterated by Musk in the earnings letter to shareholders, that the Model 3 was fully approved in Europe.

There’s clearly something amiss with Tesla’s liquidity. It’s been reported by customers in Germany that Tesla is demanding full payment for Model 3’s ordered before the Company will deliver the vehicle. Perhaps a tempest in a teapot? A Model S owner who had canceled his Model 3 order and requested a refund of the $1000 deposit posted a copy of the refund check on Twitter – only Tesla had placed a “stop payment” on the check:  LINK

Meanwhile the Company has been laying of workers and cutting prices on feverishly on the Model 3. This is in response to a cliff-dive in demand since January 1st, especially in China. Based on this new evidence, I don’t know if Tesla will be able to make the $920 million convertible bond payment. I would seem possible, given the anecdotal evidence, that Tesla has misrepresented the cash balance on its year-end financials (unaudited as of December 31st). No one knows the answer to that question right now except the banks holding the alleged cash as shown on Tesla’s year-end balance sheet.

Whether or not Tesla can complete a financial hail Mary and address the convertible bond repayment, this company is circling the drain. As far superior competitive models hit the market, demand for Teslas could possibly disappear completely. The stock will drop to zero and the creditors will be left to fight for standing and priority in bankruptcy. I can smell that blood in the water.

In the Short Seller’s Journal I cover economic analysis combined with ideas for shorting the stock market, including market timing, capital management and the use of options.  In the latest issue I presented ideas for using puts to short Tesla, including full disclosure of my trades in the name.  You can learn more about this newsletter here:  Short Seller’s Journal.

The Trade War Is Not The Problem With The Global Economy

I chuckle when the hedge fund algos grab onto “positive” trade war headlines and trigger a sharp spike in stock futures.  Settlement of the trade war between the Trump Government and China will do nothing to prevent a global economic recession – a recession which will likely deteriorate into a painful depression.  The Central Bank “QE” maneuver was successful in camouflaging and deferring the symptoms of economic collapse.  Ironically, treatment of the symptoms made everyone feel better for a while but the money printing ultimately served only to exacerbate the underlying financial, fiscal, economic and social problems that blossomed after the internet/tech bubble popped.

Trade war “hope” headlines coughed up by Larry Kudlow last Friday morning were designed to offset the disappointing job report and sent the Dow up 156 points in the first 12 minutes of trading. But alas, the gravity of deteriorating systemic fundamentals took over and the Dow ended up down 558 points:

All three major indices closed below their key moving averages (21, 50, 200 dma). I wanted to show the chart of the Nasdaq because, as you can see, the 50 dma (yellow line) crossed below the 200 dma (red line) last week. This started to occur for the SPX on Thursday. The Dow’s 50 dma remains above its 200 dma, but that will likely change over the next few weeks.

The point here is that investors, at least large sophisticated investors, continue to use rallies to unload positions. The stock market has a long a way to fall before the huge disparity between valuations and fundamentals re-converges. This reality will not be altered even if Trump and China manage to reach some type of trade agreement. Nothing but a painful “reset” can correct the massive overload of fiat currency and debt that has flooded the global financial system over the last ten years.

I also believe that a massive credit market liquidity problem is slowly engulfing the system. This is a contributing factor in the yield curve inversion, which moved from the 3yr/5yr interval to the 2yr/5yr interval last week, thereby reflecting the market’s growing awareness of the percolating systemic problems. In 2008 the liquidity problem began with widespread sub-prime bond defaults and was compounded by derivatives connected to the sub-prime credit structures. This time, it appears as if the credit market problem is starting in the investment grade bond and leveraged bank/senior loan markets.

It was reported last week that $4 billion was removed from leveraged loan funds over the last three weeks. Although the loans are leveraged, these are typically senior secured “bank debt equivalent” loans. Money is leaving this segment of the loan market because of a growing perception that the leveraged senior loan market is becoming risky. Loan and bond investors are more risk-averse than stock investors. They thus tend to be more vigilant on the ability of debt borrowers to make loan payments.

Currently there’s a record high amount of triple-B rated corporate debt outstanding. This amount outstanding is higher than any other rating category. At some point, as the economy continues to weaken, a large percentage of this triple-B rated will be downgraded. Assuming cash continues to flee the loan market, and as a lot of low investment grade paper is moved into junk-rated territory, it will exert huge pressure on bond yields. It will also make it much harder for marginal credits to raise capital to stay alive.

General Electric losing access to the commercial paper market is an example of the market cutting off a source of liquidity to companies that need it. It’s also a great example of a company with a large amount of outstanding debt that is headed toward the junk bond pile (GE is one notch away from a junk rating – at one time it was a triple-A rated company). Ford is headed in the same direction – the stock of both companies trades below $10. If this is happening to a companies like GE and Ford, it will soon happen to smaller companies en masse.

The commentary above is an excerpt from the latest issue of the Short  Seller’s Journal.  Also included is an updated analysis on Tesla and why I am increasing my short exposure in the stock plus follow-up on my Vail Resorts (MTN) short presented a week earlier. You can learn more about this newsletter here:  Short Seller’s Journal information.

 

Tesla’s Q3 GAAP “Net Income:” Manipulation If Not Outright Fraud

I perused Tesla’s Q3 10-Q and scrutinized the footnotes to figure out, to the extent possible, where Tesla manipulated GAAP accounting standards and outright “cooked” its numbers. Before I had a chance to analyze the 10-Q, others had already posted their findings on Twitter or in Seeking Alpha articles. In the analysis below, I’ve double-checked and confirmed the findings presented by others. In addition, where appropriate, I’ve added my findings to the previous work of others and explained how and why Tesla’s numbers are highly misleading, if not outright fraudulent.

Net income – Tesla reported GAAP income of $311.5 million. But what it did not disclose when it released its earnings report was that $189 million of that income was generated from selling regulatory credits – Greenhouse Gas (GHG) credits and ZEV (Zero Emission Vehicle) credits. Automakers in 10 States are required to sell a specified number of electric or hybrid vehicles within the State. Credits are earned for the number of emission-friendly vehicles sold. Automakers are required to maintain a level of credits based on each automaker’s overall vehicle sales volume within the State. GHG credits function in a similar way at the Federal level.

Some companies, like Tesla, generate more GHG and ZEV credits than required to be in compliance with the law. Companies with excess credits are allowed to sell their excess credits to car manufactures and other companies that manufacture carbon-emission equipment and do not generate enough credits to be in compliance with the regulation. Selling excess credits over the past few years has been a significant source of cash flow generation for Tesla. The money raised by selling these credits is accounted for as income under GAAP.

The problem is that, in its presentation of its Q3 earnings, Elon Musk and the CFO did not disclose that nearly 61% of its GAAP net income was derived from selling these credits. While Tesla referenced that $52 million was generated from ZEV credit sales in Q3, they did not disclose the $137 million GHG credit sales in the earnings press release or the analyst conference call. Rather, they postured as if the net income was generated thru cost-efficiencies and sales volume. The $137 million in GHG credit sales was buried in the 10-Q.

In the chart above, you can see that TSLA’s use of GHG credit sales has been inconsistent over time. In all probability, Musk chooses the timing and quantity of the credit sales based on when he needs to generate cash. It’s pretty obvious that he decided to unload a massive quantity in Q3 in order to help generate the GAAP net income and positive cash flow he had been promising for months.

Technically, the manner in which Musk utilized,and disclosed the use of, ZEV/GHG credits to manufacture income, is highly deceptive. Selling regulatory-derived environmental credits is a low-quality, unreliable source of income. As Tesla’s competition ramps up production and sales of EV’s, the supply of credits will escalate rapidly. This will drive down the resale value of these credits toward zero. And there’s always the possibility that regulatory requirements will be rolled back. Over time, this source of income and cash will disappear.

Warranty Provision – Every quarter companies that issue warranties have to take a warranty expense provision, which is an estimate of the quarterly expense that will be incurred under warranties on products sold by the company. The warranty provision hits the income statement as an expense. The idea is to match estimated quarterly warranty costs that will be incurred from selling products covered by the warranty each quarter. Warranty expense is part of the cost of goods sold. The information on warranty expenses is found in the footnotes (this is standard).

In Q3 this year, Tesla expensed $187.8 million, or $2,249 per car delivered, vs $118.6 million, or $2,913 per car delivered in Q3 2017. If Tesla had kept the cost per vehicle delivered constant, the provision for warranty expense in Q3 would have been $243.2 million, or $55.4 million higher than was expensed in Q3. In this case, Tesla’s cost of goods sold would have been $55.4 million higher and the gross profit would have been $55.4 million lower. This is part of the reason Tesla’s gross profit margin was much higher than anyone expected. It also translates into a $55.4 million net income benefit.

In Q3 2108, Tesla sold a little more than double the number of vehicles sold in Q3 2017. At the very least, and to be prudent, in Q3 this year Tesla should have at used at least double the warranty provision it used in Q3 2017. This is especially true since the Model 3 is in its debut model year and will likely require higher than expected warranty-based repairs. The probability of greater than expected warranty repairs for cars sold during Q3 is even higher when taking into account the high number of production difficulties the Company encountered – and about which Musk whined publicly.

Using a warranty expense estimation method simply based on doubling the warranty provision taken in Q3 2017 – given that Tesla sold more than double number vehicles, Tesla’s warranty provision expense would have been $237.2 million in Q3 rather than the $187.8 million recorded, which would have reduced net income by $49.4 million.

To be sure, the warranty expense provision can be adjusted based on using the actual amount of warranty costs incurred over time. But given the limited history of Tesla, and given that the Model 3 is a 1st-year production automobile with noted production and quality control issues, Tesla probably should have used a warranty provision that was higher on a per car delivered basis than the number used in Q3 2017. But, then again, Musk and his CFO were goal-seeking positive net income and thus likely decided to reduce the provision per vehicle delivered by nearly 23% and pray that they figure out a way to bury an increase in the actual amount spent on warranty repairs in future quarters.

Inventory Write-Down – An inventory write-down is recorded as an expense in the quarter in which it is taken. For a company like TSLA, an inventory write-down occurs for excess or obsolete inventories (unsalable cars, worthless parts and supplies) or when the carrying value of certain cars held in inventory is greater than the realizable value. The latter would primarily apply to cars taken back by Tesla under lease guarantees (keep this tidbit in mind for reference below) or cars held in inventory deemed unsalable because the cost of fixing manufacturing defects is greater than the gross margin generated from selling the car.

Over the last six quarters, Tesla’s inventory write-down as a percentage of total inventory has averaged 1.4%. In Q3 2017, the write-down was 1.1% of inventory; in Q2 2018 it was 0.9%). However, in Q3 Tesla’s inventory write-down was 0.4% of inventory. In terms of numbers, Tesla’s inventory expense in Q3 was $12.4 million vs $26.2 million in Q3 2017 and $24.6 million in Q2 2018. This chart shows the degree to which it appears as if Tesla purposely minimized the inventory write-down expense in Q3 2018:

(Kudos to @TeslaCharts for the charts he created illustrating the extreme inconsistencies in Tesla’s Q3 financial statements)

The effect of taking an inventory write-down that is far lower than the historical average reduces the cost of sales and thereby increases the gross, operating and net profits. If TSLA had used the historical average of 1.4%, the expense taken for the Q3 inventory write-down would have been $46.2 million, or $33.8 million more than the $12.4 million used. The reduced write-down had the effect of reducing cost of sales by $33.8 million and increasing gross profit and net income by $33.8. This also contributed to the large increase in the gross profit margin in Q3 vs historical quarters.

The inventory write-down charge was clearly an extreme outlier in relation to the historical application of this write-down over the previous six quarters. Make no mistake, the minimization of the inventory write-down expense in Q3 was a blatant effort to exploit accounting standards for the purpose of reducing GAAP expenses and thereby increasing GAAP income. The discrepancy between the Q3 charge vs historicals predictably was not addressed by the CFO or by analysts in the Q3 earnings conference call.

Tesla’s Actual Net Income? Telsa reported $311 million of GAAP net income. Of this, $83.2 million represents the highly questionable reduction in costs attributable to lower than usual warranty and inventory write-down expenses. Tesla also sold an unusually high amount of GHG/ZEV credits, which boosted net income by $189 million. While this is a source of actual cash income, it’s not a long-term sustainable source of income. Combined, these items accounted for $272 million – or 87.5% – Tesla’s GAAP net income in Q3.

In addition to the items presented above, Tesla “achieved” significant and highly questionable reductions in the expenses taken for R&D and SG&A. In Q3 Tesla recorded $350 million for R&D and $729 million for SG&A – $1.079 billion combined. In Q2 Tesla recorded $386 million for R&D and $750 million for SG&A – $1.36 billion combined. Tesla wants the market to believe that R&D and SG&A expense declined by $290 million from Q2 to Q3, despite the fact that Tesla’s overall operations were expanded to accommodate a large increase in vehicles sold in Q3 vs Q2. On average, over the last six quarters, R&D plus SG&A has been running at 39.5% of revenues. In Q2 2018, these charges were 33.84% of revenues. But in Q3 2018, R&D and SG&A dropped to 17.7% of revenues.

To be sure, there are “economies of scale” with respect to R&D and SG&A expenditures as revenues grow. But for R&D and SG&A to decline nearly 50% as a percentage of revenues from Q2 is simply not credible, unless Tesla intentionally drastically cut back on R&D and administrative/sales functions in Q3. Without question, Musk and his CFO played games with the R&D and SG&A expense accounts in order to reduce the charges expensed for these categories in Q3 vs the previous six quarters and especially vs Q2 2018.

It’s quite possible that Tesla loaded R&D and SG&A expenses into Q2 that technically belonged in Q3 knowing that it was going to report a big loss in Q2 ($717 million loss in Q2) anyway and had promised profitability in Q3. But it’s impossible to know if this occurred without having access to the inside books and bank statements. The stunning plunge as a percentage of revenues for these items in Q3 vs Q2 is the equivalent of asking us to believe in the existence of Santa Clause.

If we give the Company the highly doubtful benefit of synergies which reduced R&D and SG&A to just 20% of revenues – despite the fact that it has been running nearly double 20% over the last six quarters – the combined charge for these accounts would have been $1.219 billion rather than the $1.079 billion used by Tesla (note, at the very least it would have been reasonable to assume that the expense level at a minimum stayed flat vs Q2, meaning I’m being overly generous in my assumption). Under this scenario, Tesla’s operating expenses would have been higher by $140 million.

Adding this $140 million in incremental expense to the $49.4 million warranty expense manipulation and $33.8 million inventory write-down manipulation implies that Tesla’s GAAP net income was overstated by $223 million. Using the historical experience for these expense accounts, including an overly generous benefit in the assumption I use for “normalized” R&D/SG&A, Tesla’s GAAP income as reported would have been $88 million instead of $311 million. Tesla’s $88 of net income as adjusted less the $189 million in income attributable to GHG/ZEV sales turns the $311 net income reported as net income into a $101 million loss.

In addition to the questionable accounting used by Tesla to generate $311 million of GAAP “net income,” Tesla engaged in questionable, if not problematic, balance sheet maneuvers to boost the level of cash presented at the end of Q3. The purpose of this was to create the illusion of solvency. In the Q3 10-Q, Tesla shows a cash balance of $2.96 billion. At the end of Q2 Tesla had $3.11 billion.

Tesla’s accounts payable jumped jumped by $566 million from Q2 to Q3. Companies will stretch out their bills in order to conserve cash. Tesla has made a habit out of dragging its feet on paying vendors, suppliers and service providers as evidenced by the large number of court filings from smaller vendors who are forced to get a court order for payment. The same dynamic applies to “other accrued liabilities,” which contains other short term liabilities for which payment has not been made (payroll, taxes, interest and smallish items).

While accounts payable and other accrued liablities will naturally rise with the organic growth of a company, the rise in Tesla’s payables year over year is nothing short of extraordinary. Through the first nine months of 2018, per the statement of cash flows, Tesla generated $1.6 billion in cash “financing” from “stretching out” its payables vs $170 million in the first nine months of 2017. While Tesla’s revenues nearly doubled over the same period, this amount of unpaid bills has a reason behind it.  The net effect of withholding payment of its bills longer than necessary is that it makes the cash on Tesla’s balance sheet appear larger than otherwise. Accrued payables and other short term liabilities are the equivalent of a short term loan to a company. These liabilities should be treated as a form of short term debt.

Subtracting current liabilities ($9.78 billion) from current assets ($7.92 billion) shows that Tesla has negative working capital of $1.86 billion. Technically Tesla is insolvent, which explains the games the Company plays with its supplier/vendors.

Another curiosity on Tesla’s balance sheet was accounts receivable, which more than doubled, from $569 billon to $1.155 billion. In the footnotes under “credit risk,” Tesla disclosed that “one entity represented 10% or more of our total accounts receivable balance” at the end of Q3, whereas previously no entity represented 10% of receivables. In other words, one entity owed Tesla at least $115 million.

When asked about the big jump in A/R during the earnings conference call, the CFO dismissed it by claiming that the quarter ended on a Sunday. It’s beyond absurd that the analysts on the call accepted this answer without further interrogation. Subsequent to the release of the 10Q, a company spokesman told a reporter from the L.A. Times who had inquired about the 10% disclosure that the receivable was attributable to a large partner bank for car loans issued to U.S. customers. The spokesman said that “all of this receivable was cleared in the first few days of Q4.”

The inference was that Tesla sold $115 million or more worth of cars after 5 p.m. on Friday and over the last weekend of its quarter financed by one bank that could not be processed by the banking system. If this were truly the case, why not just state this as fact openly rather than leaving the market guessing what might have happened? 10% of $1.155 billion is considered “meaningful” under strict GAAP, which means this issue requires more detailed disclosure. The CFO’s vague response to the question about the issue reflects intentional obfuscation of the matter.

Unfortunately, we may or may not be able to figure out exactly what happened when the 10-K is released. I’m not optimistic that the Company will come clean. However, an analyst posted an assessment on Twitter (@4xRevenue) which seems to be a very reasonable explanation to this mystery. This analyst believes that the 10% receivable is from a lease partner (a bank) who has underwritten leases that contain Residual Value Guarantees from Tesla.

Tesla had been offering Residual Value Guarantees (RVG) on leases as an incentive to generate sales. The RVG is a guarantee from Tesla on the value of the car at the end of a lease. In order to stimulate lease-based sales, auto companies will guarantee the lease-end value of car at a level that is typically above the market value for that car at the end of the lease. It’s a “back-door” mechanism used to lower the monthly cost of a lease to the lessee.

If the receivable in question is from a bank that financed Model S&X leases, it means that a large number of vehicles came off lease at the end of Q3 and the bank was returning these cars to Tesla. The “receivable” is the guaranteed residualy value of these vehicles. It also means that Tesla likely will have a large cash payment (at least $115 million) to make to the bank that would be connected to the RVG. Based on actual market data, that the resale value of used Tesla’s has been declining rapidly. This being the case, Tesla has a large make-whole payment to make to the bank who represents at least 10% of the receivable. Tesla will then look to unload these used Teslas and recoup as much as possible, though it will be substantially less than the guaranteed make-whole made by Tesla.

This analysis would explain why Tesla’s payables and receivables were unusually high at the end of Q3. If this transaction had been processed before the end of Q3, Tesla’s accounts receivable would have been lower by the value of the cars being returned to Tesla under the RVG. The accounts payable would have lower by the amount Tesla owes to the bank. Tesla’s cash balance would have been lower by the amount that Tesla paid to the bank under RVG.

Recall that the Tesla spokesman said that this specific A/R was “cleared” in the first few days of Q4. Holding off on processing this transaction until after the quarter ended enabled Tesla to show a higher cash balance than it would have otherwise. It also kept the used Teslas out of Tesla’s inventory, which further enabled Tesla to manipulate the inventory write-down by taking a much lower write-down than historical write-downs. This is because the market value of the used  Teslas received is lower than the amount Tesla paid under the RVG. This would have required Tesla to write-down the value of the used Teslas, thereby increasing the inventory write-down charge, increasing cost of goods sold, lowering the gross margin and lowering the amount GAAP “net income” reported.

This also explains why Tesla moved $73 million worth of cars out of finished inventory and into the PP&E account on the balance sheet. Tesla accounts for vehicles used as service loaners as part of PP&E. I don’t have a problem with that. But moving $73 million of these vehicles allowed Tesla to avoid including those vehicles as part of its inventory write-down expense. It also allowed Tesla to move the cars taken back under the RVG transaction described above without causing an unusual change in inventory that required explanation. In other words, it’s entirely possible, if not probable, that Tesla wanted to “make room” for the used Teslas.

The bottom line – Tesla pulled out every accounting manipulation available to it in order to produce the promised positive GAAP net income, positive cash flow, extraordinarily high gross profit margins and a higher quarter-end cash balance. It was accounting deception, and in some areas probable fraud, at its finest. The Wall Street ass-kissing analysts did nothing other than cheer the results and lob easy questions at management on the conference call. Many of them are likely clueless about the degree to which Tesla manipulated reality.

It will be very interesting to see how Q4 turns out for Tesla. Based on reports from China and Europe, car sales have fallen off a cliff in October. Norway reported the first week of EV sales, which showed that Jaguar i-Pace deliveries, new to the market, were 44 vehicles vs. just 11 for the Tesla models S&X combined (the Model 3 has not been approved for sale yet in the EU). In October the i-Pace sold 441 units vs 201 for the Tesla S&X. This gives us a valuable glimpse at the effect competition will have on Tesla’s sales. Soon the Audi e-Tron will be available. It will likely smother any demand for Teslas.

Tesla had to make a $230 million convertible bond maturity payment in a couple weeks. It then has to start figuring out how to generate enough cash to make another $930 billion convertible bond maturity payment in March. On the assumption that Tesla’s sales are highly negatively affected by competition and the economy, Tesla will have a hard time raising the money needed to refinance the March convertible bond payment. Accounts payable will also become a problem, especially if Tesla is unable to raise more cash selling ZEV and GHG credits. On top of this, the tax-credit that Tesla car buyers receive from buying a Tesla EV will soon run out. This will make buying a Tesla more expensive.

The above analysis is from my Short Seller’s Journal from November 11th.  I also provided some ideas for shorting Tesla using short term and long term puts.  You can learn more about this newsletter here:  Short Seller’s Journal information.  Note:  one of my subscribers emailed me this morning that he just took $3500 in profits on January KB Home (KBH) puts that I recommended a few months ago.

Upper Management Exodus At Tesla Continues – Why?

Phil Rothenberg, VP of Legal at Tesla, is leaving the company.  He’s been at Tesla for nearly 8 years; previously worked at the SEC.  I assume Phil has a lot of stock and a lot of stock options, having been at the Company for eight years, including a nice chunk of options he’s leaving on the table because they will never vest.  If everything at the Company was as amazing as presented by Musk and his meat-puppet CFO in the 3rd quarter earnings report, why leave now?

Apparently Phil, trained in securities law,  would have been the designee of reviewing and monitoring Musk’s Tweets and other social media venues per the terms of the SEC settlement.   Jonathan Chang, the other VP-level lawyer at TSLA, was not a trained securities lawyer.  I have to believe that the potential legal liabilities connected to being legally responsible for overseeing the manner in which Musk operates as his own PR organization weighed heavily on Phil’s decision to flee Telsa’s corporate Sodom and Gomorrah.

Although the SEC, for whatever reason, let Musk and Tesla off the hook on a slam-dunk securities fraud case with a mere wrist-slap, the provisions of the settlement will likely create a sticky legal spider web that can be utilized to snare Musk and those around him at the Company on several counts down the road.  I am certain a desire to legally disconnect from Tesla/Musk  explains the sudden exodus of high-level executives in the past 12 months.

After Tesla’s post-earnings price spike, the torrid stock market run-up that started October 30th played a major role in keeping Tesla’s stock propped up over the last two weeks. At the beginning of the week after Tesla reported (Monday, October 29th) Tesla’s stock was about to sell-off. But the major stock market indices began to shoot up, keeping Tesla’s stock supported. Today’s action in Tesla stock reinforces this theory, as TSLA plunged 5.5% while the SPX dropped just under 2%. Tesla’s stock is going lower – a lot lower.

Tesla will eventually implode – all Ponzi schemes fail. But Musk has proven to be adept at kicking the can down the road. In the analysis I did of Tesla’s Q3 10-Q that I presented to my Short Seller’s Journal on Sunday evening, I didn’t drill down into the 10Q as thoroughly as I could have because of lack of time. But I’ve never seen this degree of manipulation in the numbers from a company the size and profile of Tesla. Bernie Madoff’s company was private so there were never publicly available numbers to scrutinize. Tesla’s operations will eventually collapse under the weight of liabilities and a collapse in auto sales related to the economy and competition.

Tesla’s Bag Of Halloween Tricks

I have not had a chance to scour the 10-Q, which was finally filed this morning. GM and Ford are 7-8x larger than Tesla in terms of revenues and 40-50x larger in terms of number of vehicles sold worldwide.  Those two companies file their 10-Q almost immediately after filing the quarterly 8-K financial summary.  There’s no reason for TSLA to delay the filing of its 10-Q by over a week other than it needs the extra time to make its fraudulent numbers conform to SEC-filing standards (which have a low bar as it is).   I will be sharing my observations with my Short Seller’s Journal subscribers on TSLA’s 10-Q either this week or next.

For me the big event last week was Tesla’s earnings report. And Musk did not disappoint. With regard to that, I’m wondering if it’s possible to be astonished and not surprised at the same time.

Tesla originally was going to report earnings this week. But, curiously,  moved up its earnings release by a week to last Thursday. At the same time, the CFO exercised stock options that did not expire until 2022. While this is technically legal, it begs scrutiny. Why exercise options with a $31 exercise price that do not expire until 2022 unless your intent is to unload the shares when the blackout period is lifted?

For me the obvious answer is that the CFO knew the earnings report would cause a big spike-up in the stock price of which he wanted to take advantage. However, if the CFO truly believed that Tesla was undervalued and was going to be worth a lot more in the long run, he would have held onto the $160k in cash he spent exercising the options until the options approached expiration. Anyone who takes a basic finance class knows that you always hold free in-the-money money options for as long as possible, especially if you believe there’s a good probability that they’ll become more valuable over time – unless you have inside information and know that the stock is going to go lower before the options expire.

The Q3 earnings report produced by Telsa did not disappoint in terms of the high level accounting magic performed. It’s important to note that quarterly financials are not audited. The CEO and CFO can essentially do what they want with the numbers. Automotive sales soared from Q2 to Q3, from $3.1 billion to $5.8 billion. Yet, every other major expense and balance sheet item as a percentage of sales is completely out of whack with same items over the previous four quarters. Perhaps this chart captures the essence of the matter (@TeslaCharts has prepared a stunning visual summary of Tesla’s numbers):

In general, there should be some relative degree of continuity in any company’s income statement and balance sheet accounts, barring some major fundamental change, like a merger or large asset restructuring.

The cash from operations in TSLA’s Q3 this year sticks out like a sore thumb. Over 40% of this came from stretching out the accounts payable by $566 million (more on this below).
The other portion of this “cash” generated by operations came from “net income.” Over the last four quarters, TSLA’s average net loss per quarter was around $760 million. Then suddenly net income swings nearly a billion dollars from a $743 net loss in Q2 to net income of $255 million in Q3. This is simply not credible without fraudulent accounting schemes at work. Please note that these are GAAP accounting numbers. In order to verify that real cash was produced by Tesla’s operations, we would have to see an independent audit of Tesla’s bank accounts, something that will never happen.

From Q2 to Q3, TSLA’s automotive gross profit improved by $882 million based on delivering 42,760 more cars. That’s $20,655 of incremental gross profit on a car that sells for as little as $49,000. The weighted average sales price for the Model 3, S and X combined is around $63,000 (based on the number of each sold). This suggests a gross profit margin of nearly 33% per incremental car sold, which is impossible in the automotive business. No other auto manufacturer in the world comes even remotely close to this level of gross margin.

For it’s latest quarter, GM’s gross profit was 10%; in 2017, Daimler Benz’s gross profit was 20%. It’s simply not credible that Tesla generated this level of profitability on its vehicles without accounting fraud. This is especially true given that Tesla claimed that it built and used its own delivery trailers to make deliveries. This should have caused a noticeably large jump in cost of automotive revenues. Yet, miraculously TSLA’s automotive sales gross margin soared from 20.5% in Q2 to over 25% in Q3. Simply not believable and reeks of fraudulent accounting.

One area of Tesla’s income statement that contains probable fraud is SG&A expenses (sales, general and administrative expenditures). Over the previous four quarters, TSLA’s level of SG&A was running around 20% percent of revenues. It was 18.7% of revenues in Q2 2018. But this quarter, Musk somehow parted the Red Sea and was able drive SG&A down to 10.7% of revenues. SG&A outright actually fell from Q2 to Q3. SG&A has averaged $19,000 per vehicle delivered every quarter since 2014.

In Q3 TSLA reports that SG&A plunged to around $9,000 per vehicle delivered. We know Tesla brought in mechanics from its service centers around the country to help push production levels to the limit. This should have caused a large jump in SG&A.  It’s impossible to explain how a drop in SG&A expense like this occurred without access to the inside books. My best guess is that millions of dollars worth of expense invoices were mysteriously misplaced and not recorded for the quarter. This would partially explain by accounts payable soared by over half a billion dollars.

Another area of cost accounting that has red flags waving and warning flares firing is depreciation. Depreciation expense as a percent of revenues plunged from 12.1% in Q2 to 7.3% in Q3. It was 13.4% in Q3 2017.  Generically, part of the depreciation is straight-line useful life of equipment. The “tent” built in Q2 should have added to this part of depreciation.  But there’s also depreciation expense attached to each car produced and sold on a per car basis. This too should have caused an increase in depreciation. From the cash flow statement, TSLA’s depreciation expense in Q3 was $502.8 million, or $6,021 per car delivered. In Q2 the depreciation expense was $485.2 million, or $11,922 per car delivered. Again, this is theoretically and realistically unexplainable, other than fraud.

Tesla shows a cash balance of $2.967 billion at the end of Q3, up from $2.2 billion at the end of Q2. However, Telsa’s accounts payable surged by $566 million vs. Q2. It’s hard to imagine how this occurred when capital expenditures and SG&A declined. The only explanation is that TSLA stretched out its payment of bills to suppliers and vendors in order to conserve cash. This is consistent with the steady flow of smaller vendors who are forced to file legal complaints in order to get court-ordered payment judgments.

Accounting fraud would explain why there’s been a steady exodus of accounting and finance executives over the last year. The number of senior executives leaving the Company accelerated over the summer, including the Chief Accounting Officer, who quit in early September after less than a month on the job.

By the most stringent measure, TSLA is technically insolvent. Current assets less current liabilities is negative $1.855 billion. Cash balance less customer deposits is $2.062 billion. TSLA has a $230 million convertible bond payment due in November. Less this, cash is $1.832 billion. If we were to assume that accounts receivable and payable – theoretically the most liquid assets on a balance after cash – were settled tomorrow, net of cash it would leave a cash deficit of $609 million. That’s insolvency. On top of that, after the November convertible maturity, another $1 billion in debt is due by March 2019.

Keep in mind TSLA’s cash balance was artificially generated by stretching payables, slashing capex to the bone and somehow miraculously cutting back on expenses. This is simply not sustainable, let alone not credible. Note: Tesla’s capex as a percent of revenues was 7.5%. Over the last six quarters TSLA’s capex as percent of revenues has averaged 25% of revenues. In other words, Tesla is plundering its asset base and burning furniture to pay bills and show cash on the balance sheet.

To make things more interesting for the Company, it was reported last week that Tesla slipped several spots in the Consumer Reports reliability ranking. In its analysis of 29 auto brands, Tesla ranks 27th. CR characterized the Model 3 as having “average reliability.” Also of interest is the effect of newly available competition. In Norway month-to-date, Jaguar has delivered 365 newly available Jaguar i-Pace while there were 185 Tesla X+S combined. The EU has not approved the Model 3 for deliveries yet, but the i-Pace competes with the X and S models. When Audi’s e-Tron is available, I doubt there will be any demand for the Model 3 plus it will put a huge dent in European demand for Telsa’s X & S models.

Add on to this the news report that the FBI/Justice Department is probing whether Tesla misstated information about production of the Model 3 for the purpose of misleading investors. The FBI has subpoenaed former employees seeking to interview them. The FBI is looking into Musk’s public forecasts about Model 3 production vs. the actual production numbers, which turned out to be substantially lower that Musk’s continual assertions that deliveries would be significantly higher. It will be hard for Tesla to raise money with this investigation in process.

It’s been suggested that TSLA insiders knew that the FBI report was going to hit on Friday and that’s why the Company moved its earning release up a week with two days’ notice. It would also explain why the CFO exercised deep in-the-money stock options that do not expire until 2022. Musk knew that the news report would have less impact on the stock if it hit the tape a day after the fraudulently inflated earnings report. At some point, many of the large mutual fund companies with big positions in the shares will have to consider the possibility of facing breach of fiduciary duty charges for continuing to hold TSLA shares given latest the Justice Department/FBI development. Keep in mind the Justice Department has several other areas of inquiry and the SEC is examining other issues beyond the issue recently settled with Musk.

TSLA’s stock likely would have sold off this week absent the massive short-squeeze that has caused the Dow and SPX to go vertical. In fact, Tesla stock declined from it’s opening level on Monday through Tuesday’s close. In all probability, TSLA would be below $300 if the Dow and SPX simply flat-lined or drifted lower the past three days.

While not a Ponzi scheme in a strict sense because TSLA does generate revenues, TSLA requires a steady inflow of funding from the capital markets to remain solvent. At some point it will need a few billion to address the money it owes to suppliers and contractors and to service its enormous and growing pile of debt. Like Enron, at some point its cash furnace will run out of printed money to fuel it and the stock will collapse. I provide my Short Seller’s Journal subscribers with both short-term and long-term short-sell and trading ideas on Tesla.

Short Rallies, Cover Sell-Offs

I think we can all agree, it was an interesting week last week in the stock market, to say the least. For the week, the Dow was down 2.9%, the SPX was down 3.9% and the Nasdaq was down 3.8%. All three indices closed below their 200 dma. It can be argued that, on a short-term basis, the stock market is “oversold” using the MACD as an indicator. However, it appears that hedge fund algos are being re-programmed to start selling the “V” rallies that have characterized this stock market for the last ten years – something I suggested in a previous SSJ would eventually happen.

An argument can easily be made that the stock market could be cut in half from the current level and still be overvalued. I made this argument in 2007 to friends and colleagues. Back then the SPX dropped from 1,576 to 666 – more than cut in half (57%). And if would have fallen farther if the Fed and the Bush/Obama Governments had not intervened. If the SPX drops 57% this time around, it would take the SPX down to 1,274. I believe it could easily fall farther than that.

Despite the abrupt nature of the sell-off over the past month, the stock market potentially still has a long way to fall:

The chart above is a weekly time-frame that encompasses the 2007-2009 decline. The stock bubble this time around is significantly more extreme than the previous bubble. In fact, by many measures, this is the most overvalued stock market in history. I included the MACD to illustrate that, on a weekly basis, the SPX is not even remotely oversold. I sketched in a white line of “support.” While I’m sure every market analyst their favorite “technically-based” area of support, the line I drew is around the 2,550 area on the SPX.  Below that line, there’s about 400 points of “air.”

The above commentary is an excerpt from the latest Short Seller’s Journal. Some of my recent home run shorts include Tilray, Wayfair and Netflix. The issues includes strategies for shorting Tesla, Amazon and several semiconductor stocks. You learn more about this newsletter here:   Short Seller’s Journal information.

“I’m up about $40k because of your short ideas. So thanks for that!” – Subscriber who joined in mid-June, 2018

Overvalued Stocks, Undervalued Gold And Silver, Insolvent Tesla

Craig Hemke, the well-known proprietor of the TF Metals Report  invited me on this his new “Thursday Conversation” podcast to discuss the stock market,  economy, precious metals and Tesla.

“If you adjusted the current S&P 500 earnings stream using the same GAAP accounting standard that were applied in 1999, the current S&P 500 P/E ratio – expressed in 1999 GAAP accounting terms – would be the most overvalued in history.”

“Deutsche Bank is a zombie bank that would have blown up in 2012 if the Bundesbank, ECB and German Government hadn’t bailed it out.”

“Elon Musk used a Halloween bag full of accounting tricks to generate GAAP ‘net income.'” The fact remains that Tesla is closer to insolvency this quarter than it has been at any point in the history of the Company.

“Mining stocks are cheaper now in relation to the S&P 500 and to the price of g old than they were at the bottom of the 20-year gold bear market in 2001”

You can listen to my conversation with Craig “Turd Ferguson” Hemke by clicking on the graphic below:

(NOTE: You can download the MP3 by using this LINK and right clicking on the audio bar)

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If you are interested in ideas for taking advantage of the inevitable systemic reset that  will hit the U.S. financial and economic system, check out either of these newsletters:   Short Seller’s Journal  information and more about the Mining Stock Journal here:   Mining Stock Journal information.

The Cracks In The Market’s Floor Grow Wider

“The only time we’ve ever seen a confluence of risk factors anywhere close to those of today was the week of March 24, 2000, which marked the peak of the technology bubble.” – John Hussman, Hussman Funds, in his October Market Commentary

The yield on the 10-yr Treasury has broken out, hitting its highest level since July 2011:

By the end of June 2011, the Fed had only reached its half-way mark in money printing. It was shortly thereafter that the Fed had implemented its “operation twist.” Operation twist consisted of selling the Fed’s short term holdings and using the proceeds plus extra printed money to buy Treasuries at the long-end of the curve – primarily 10-yr bonds. That program is what drove the 10-yr bond yield from 3.40% in July 2011 to as low as 1.33% by mid-2016. At one point the Fed owned more than 50% of all outstanding 10-yr Treasuries. The Fed’s massive money hyper-stimulated the housing and auto markets.

What should frighten market participants and policy-makers – and really, everyone – is that the 10-yr yield has soared the last Thursday and Friday despite the big sell-off in the Dow/SPX. I say “despite” because typically when stocks tank like that, the money flows into Treasuries as a “flight-to-safety” thereby driving yields lower. When stocks drop like last Thursday and Friday in conjunction with the sharp rise in the 10-yr yield (also the 30-yr yield), it reflects the development of financial market problems that are not superficially apparent.

The media narrative attributed Friday’s jump in Treasury yields to the “strong” jobs report. But this is nonsense. The number reported missed expectations. Moreover, the number of working age people “not in the labor force” rose to an all-time high,which is indicative of substantial slack in the labor market.

More likely, yields are soaring on the long end of the curve (10yrs to 30yrs) because it was quietly reported that the amount of outstanding Treasuries jumped by $1.25 trillion in the Government’s 2018 Fiscal Year (October thru September). This means that the Government’s spending deficit soared by that same amount during FY 2018. To make matters worse, the Trump tax cut will likely cause the spending deficit – and therefore the amount of Treasury issuance required to cover that deficit – to well to north of $1.5 trillion in FY 2019.

Who is going to buy all that new Treasury issuance? Based on the Treasury’s TIC report, which shows major foreign holders of Treasury securities, over the last 12 months through July (the report lags by 2 months), foreign holdings of Treasuries increased by only $2.1 billion. The point here is that, in all likelihood, the biggest factor causing Treasuries to spike up in yield is the market’s anticipation of a massive amount of new issuance. Secondarily, the rising yields likely reflect the market’s expectation of accelerating inflation attributable to the deleterious consequences of the trade war and the lascivious monetary policies of the Fed. The market is assuming control of interest rate policy.

On Tuesday last week (October 3rd), the Dow closed at a record high (26,828). Yet, on that day three times as many stocks in NYSE closed at 52-week lows as those that closed at 52-week highs. Since 1965, this happened on just one other day: December 28, 1999. The Dow peaked shortly thereafter (11,722 on January 10, 2000) and began a 21 month sell-off that took the Dow down 32%.

I don’t necessarily expect to see the stock market tank in the next few weeks though, based on watching the intra-day trading action the past couple of weeks leads me to believe that the market is vulnerable at any time to a huge sell-off. The abrupt spike in Treasury yields plus market technicals – like the statistic cited above – lead me to believe that the cracks in the stock market’s “floor” are widening.

The above commentary is an excerpt from the latest Short Seller’s Journal. In that issue I presented LULU as short at $153. It’s already dropped $8 and several subscribers and I have more than doubled our money on put ideas.  You can learn more about this newsletter here:  Short Seller’s Journal information.

The SEC Settlement With Musk: Crime Pays Once Again

“…when you see that money is flowing to those who deal, not in goods, but in favors–when you see that men get richer by graft and by pull than by work, and your laws don’t protect you against them, but protect them against you–when you see corruption being rewarded and honesty becoming a self-sacrifice–you may know that your society is doomed.” – Francisco D’Anconia’s Money Speech, “Atlas Shrugged”

The SEC ended up settling with Elon Musk for violating securities laws with his “funding secured” tweet. Musk and Tesla will each pay $20 million in fines and Musk will be barred from acting as Chairman of Tesla but will remain CEO. I doubt the SEC will investigate to what extent, if any, Musk and his family and friends took advantage by accumulating stock and call options ahead of Musk’s tweet, which triggered an $87 move higher in the stock price. Certainly we know Musk and his family controls an offshore stock account in the Cayman Islands.

Thirty years ago, Musk would have been forced to serve jail time for securities law violations. Ask Michael Milken and Ivan Boesky about that. The last time a corporate CEO was incarcerated for securities laws violations was Qwest’s Joe Nacchio in April 2007.

Notwithstanding the fact that Musk remains CEO of Tesla, the Company is on a path toward insolvency within 12-18 months. Just like Enron’s auditors before it, I’m sure Price Waterhouse will have no problem cooking up financial statements for Q3 which show a GAAP-manipulated profit of some sort. But make no mistake, rigged GAAP accounting can not change the fact Tesla continues burning billions in cash – nearly $2 billion in the first six months of 2018 between operating activities and investing activity.

I’m hopeful the Justice Department investigation of Musk and Tesla will produce results that are more reflective of Rule of Law than the SEC delivered. Clearly the SEC has once again sent the message to the world that crime pays in the United States if you have a bank account large enough to cover the tab. But, at the end of the day, the fate of Tesla is subject to the Laws of Economics. That is a battle Musk and Tesla have no hope of winning.

What a fucking comical charade. They take a slam dunk case and settle??? At least now we know how serious they are about prosecuting securities fraud among the privileged few. And people wonder how Madoff could get away with such a gigantic heist for so long??? Seems pretty clear the rules are set up to protect the elite crooks in our financial system. – Short Seller’s Journal  subscriber