Tag Archives: accounting fraud

Carvana: Financial Fraud Pays Well

CVNA’s valuation vs competitors like CarMax (KMX), Autonation (AN) etc is completely irrational. I was a CEO of a subprime company in this space. CVNA’s valuation is a crime of capitalism.” – @beaconstagezero

Ernest Garcia II was convicted on felony charges in connection with his involvement in the Charles Keating S&L Ponzi scheme which stole billions from innocent bystanders.  Garcia is the founder and Chairman of Carvana (CVNA).   His son, a chip off the old block, is the CEO.

This morning CVNA released a terse “preview” of its expected Q3 results in which it said the Company will achieve record revenues, units sold and gross profit per vehicle plus it said its EBITDA would “approximately” breakeven.

In the same breath it announced another $500 million bond financing. YTD including this deal, CVNA will have had to tap the capital markets for $1.7 billion.  Why?  Because it’s operations burn cash like a home furnace in Weimar Germany in the early 1920’s and because the founder/Chairman and his CEO son use CVNA as their personal piggy-bank.

The press release tandem can be read like this:  “Hey suckers, our results in Q3 will be ‘great’ so give us another $500 million loan because we can’t seem to make any money.”

Carvana’s Q2 2020 showed 15.3% YoY revenue growth vs Q2 2019. But the gross margin dropped 100 basis points from 16% last year to 15% in this year’s Q2. No wonder CVNA is generating revenue growth – just like every other overvalued “unicorn” company hatched in Silicon Valley, CVNA charges a price for its product that does not cover the cost of its business model.

How do we know this? Its operating loss soared 66.4% to $106 million of red ink from $64 million in Q2/19. The cash burned (used) in operations fell to just $7 million from $168 million in Q1/20. But this was attributable to a $215 million run-off of inventory from Q1. As I’ve discussed previously, CVNA does not price the cars it sells at a price high enough to cover the full cost of the business model. This is why it issues debt and stock quite frequently.

A big red flag for me is the fact that has had to issue stock three times raising $1.3 billion subsequent to going public in 2017 plus another $700 million in two separate junk bond deals in 2018 and 2019. Two of the three stock financings occurred in Q2 2020, yet the cash balance between Q1 and Q2 increased by just $76 million dollars, part of which is restricted cash.

The Company used $781 million to pay down a short-term revolver used to finance inventory. This also explains the run-off in  inventory.  Including the inventory run-off in Q2, the Company has raised $2.7 billion in funding since going public, including the $500 million bond deal announced today. This is essentially the amount of cash burned by CVNA’s operations since its April 2017 IPO.

This Company does not make money and it never will unless it charges a much higher price for the vehicles it sells, in which case its sales volume will plummet. CVNA is 60% owned by Chairman/founder, Ernest Garcia (a convicted felon), and 40% owned by the public. Garcia sucks money out of Carvana via a series of “related party” arrangements which include the leasing of office space and other facilities, paying a Garcia-owned business for used car reconditioning services and selling usage time on a corporate aircraft indirectly owned by Garcia. A Garcia-owned company also gets paid for servicing CVNA’s finance receivables. The conflict of interest and self-dealing between CVNA and Ernest Garcia II (Chairman) plus Ernest Garcia III (CEO) is mind-boggling.

The bottom line is that CVNA is functions as a vehicle (so to speak) that Ernest Garcia and his son use to raise money in the public capital markets and suck that money out of CVNA for personal gain.  It’s the epitome of fraud and corruption.

The short interest represents 30% of the share float, which explains the ridiculous run-up in the share price after the Company’s announcement today. Clearly I’m not the only one who has dissected the footnotes to the financials and determined that CVNA is to a large degree Ponzi scheme with an absurd market valuation.

Quite frankly I would bet that the asset value of the Company is not a lot greater than the amount of debt outstanding. The tangible assets – finance receivables (i.e. subprime loans extended to customers), inventory and unrestricted cash – are carried at $1.2 billion. The finance receivables ballooned in Q2 to $358 million from $199 million in Q1. This tells us that the Company lends aggressively to subprime borrowers.

There’s no way the market value of that crap is worth $358 million. PP&E is carried at $704 million. Thus, CVNA’s “hard” assets total $1.9 billion giving full value to receivables. Total debt plus payables was $1.4 billion at the end of Q2. Subtracting the debt from the tangible assets leaves $500 million of asset value. Beyond that, what is the value of a business that burns several hundred million in cash on an annual basis?

CVNA’s market cap at Friday’s close was $30 billion. If you laid out the numbers in the paragraph above and told me that the business described was valued this high, I would have thought you were hallucinating.

CVNA is an example of the type of business model, along with the operational and financial fraud crawling like cock-roaches beneath the surface, that has been enabled by 13 years of money printing by the Fed.  Thirty years ago when the financial regulator still maintained some independence from the big Wall Street banks, CVNA would not have survived very long.

The commentary above is from the August 9th issue of my Short Seller’s Journal. You can learn more about this newsletter here:  Short Seller’s Journal information.

Tesla Is The Poster Child For The Golden Age Of Fraud

“Elon Musk has personified the hopes and dreams of this bull market; Tesla burnishes its results through aggressive accounting; it’s a culture of deception because it is selling self-driving, which doesn’t yet exist.” – Jim Chanos from “We Are In The Golden Age Of Fraud” (Financial Times)

Jim Chanos is perhaps the most well-known remaining short-seller in this market. Don’t be fooled by his demure characterization of Elon Musk and Tesla. It’s calculated diplomacy. The numbers are far more than just polished up to look good and the accounting is not just “aggressive,” it’s fraudulent, and Chanos knows that as well as anyone. Large, successful hedge funds that have lasted as long as Chanos’ Kynikos Capital Partners spend a considerable amount of money hiring private investigators and financial forensic sleuths before putting on and sticking with large short positions. I don’t know if Chanos hires P.I.’s but he knows all well as anyone that the accounting is fraudulent rather than just “aggressive.”

Tesla’s stock ran up to $1650 in the two days before reporting Q2 numbers. After that, it closed lower every day, including losing $175 on Thursday and Friday combined after the earnings report. Tesla is promoted as a “growth story.” But its revenues unequivocally do not exhibit any growth (graphic courtesy of @TESLAcharts):

Anyone see any growth in those numbers? Tesla’s Q2 revenues declined 5% vs Q2/19, despite the continued ramp up the Shanghai factory and the addition of the Model Y to the revenue stream. The virus crisis was not a factor in the lower revenues because unit deliveries increased 3% from Q1 2020. Tesla cut prices on all of its models in every market multiple times during Q2. Outside of China, Tesla’s deliveries declined in every market, especially the Models S/X, which are rapidly trending toward zero deliveries. YoY total Model S/X deliveries including China plummeted 40%.

Tesla played the typical games it plays in order make the gross margin appear larger and to squeeze out an operating profit. The Company managed to show a $327 million operating profit. But $428 million of that is attributable to TSLA’s sale of emissions credits to OEMs. Most of this is from a deal with Fiat/Chrysler. Recall that emissions credits are a regulatory mandate in every country. The large OEMs do not produce enough EVs and thus need to buy some of the excess credits generated by TSLA. But as OEMs ramp up their production of EVs, they’ll no longer need to purchase these credits. Even the CFO admitted on the earnings call that the revenue/profits from this source will eventually disappear. Without this revenue source TSLA’s operations would have lost money again. In other words, without the Government mandated emissions regulations, TSLA’s business model does not generate income.

Tesla also once again slashed R&D expenditures, which were $279 million in Q2 vs $324 million in Q2/19. In fact, TSLA’s R&D expenditures averaged $331 million over the previous four quarters. And yet, despite supposedly developing an EV truck, semi and roadster plus working to develop full automatic driving, TSLA spent 16% ($52 million) less on R&D in Q2. Every dollar reduction in R&D translates into $1 of operating income. Additionally, TSLA’s capex expenditures every quarter continue to be less than its depreciation expense. TSLA is cannibalizing its existing manufacturing assets. This is apparent from the rising complaints about the quality control, especially with regard to the Model 3 and the Model Y. To some extent, reduced capex reduces the cost of revenues and helps pad the gross margin.

And of course I would be remiss if I didn’t touch on the Accounts Receivable (A/R). I detailed the A/R scam in last week’s issue. Refer to that if you want an in-depth review. Once again TSLA’s A/R hit an all-time high, soaring 29.4% higher Q2/19 to $1.48 billion. This is despite the 5% drop in revenues. The A/R was 24.6% of revenues in Q2 vs 18% of revenues in Q2/19. Recall that GM’s A/R is just 10% of revenues and GM is a sprawling global auto OEM and defense contractor. Furthermore, in the auto business, customers are required to pay for a vehicle (either with cash or bank financing) before they can drive away with their vehicle. There is just no conceivable explanation that can justify this red flag and the one given by the CFO on the earnings call was an exercise in blowing smoke.

Chanos referred to the regulators, like the bank puppets at the SEC, as “finanical archeologists” who tell us what happened after a Ponzi company implodes. As an example, Harry Markopolos laid out an air-tight case about Bernard Madoff’s Ponzi scheme and put the report in the lap of the SEC. The SEC ignored him. Madoff blew up in late 2008 and was arrested shortly thereafter.

The reason this occurs is because the SEC exists as big bank puppets. JP Morgan made a fortune on Madoff’s “business.”  Same applies to Tesla and Elon Musk. Goldman and Morgan Stanley will skim $100’s of millions in various fees between now and the time when Tesla blows up.  But don’t complain you weren’t warned if you get burned holding the shares or stuck with a dysfunctional EV that will no longer be serviced.

AMZN’s Free Cash Flow And Profitability Myth

Jeff Bezos was a master at GAAP accounting manipulation back when Elon Musk thought that “GAAP” was a clothing store chain. AMZN’s numbers are just as manipulated as Tesla’s. But the difference between Jeff Bezos and Elon Musk is that, whereas Musk is a pure caveman with his fraud, Bezos is clever about disguising and hiding the accounting manipulation. About six years ago I spent a considerable amount of time deep-diving into AMZN’s financials going back to 2004, which is when AMZN’s business really began to takeoff. After about two weeks of tedious but intensive study of the footnotes in 10Q’s and K’s, I pieced together a lot of the GAAP manipulation tools embedded in AMZN’s financials.

I will note that in 2018 Amazon denied a request from the SEC for more information about the Prime business, including disclosing in its financials the amount of sales attributable to Prime members. I’m certain Bezos rejected this request because Prime is a money-losing proposition and does not want to provide the evidence of that by breaking out the numbers. I recall sometime around 2013 or 2014 Bezos admitted in an interview with Bloomberg that Prime lost a couple billion per year.

AMZN pulled a lot of of the usual GAAP tricks to generate this quarter’s net income “beat.” Bezos slashed marketing expenses by a considerable amount as a percentage of revenue, as the marketing expense was essentially flat vs Q2 2019. Historically the marketing expense has grown YoY at a healthy rate. He may have just figured out a way to justify capitalizing some that expense – i.e. throwing some amount of the marketing expense into an asset account and amortizing it over time. This would reduce the amount of marketing expense shown in the income statement, thereby increasing operating and net income. Too be sure during Q2 a lot of companies cut back on web-based advertising, but if this was the case with AMZN, the cost-improvement is one-time, non-recurring.

Though AMZN reported EPS of $10.50 vs. $5.32 in Q2/19, several red flags for me point to the improbability of net income nearly doubling YoY. The operating income margin in the North America product segment (e-commerce + whole foods + sundry other small businesses) declined again to 3.7% from 4.1% in Q2/19. For the first time he showed a tiny operating profit in the International e-commerce business. I’m certain there were accounting games to accomplish this but I can’t prove it with just the publicly available numbers.

AWS (the cloud business) continues to experience slowing sales growth and declining margins. AWS contributed to 59% of the Q2 operating income but just 12.1% of the total revenues. And the percentage of revenues represented by AWS sales declined.

AMZN’s overall operating margin was 6.5% but the Products (online + WF) operating margin was just 3.1% vs 4.9% in Q2/19. This decline is attributable I believe to declining margins in the Whole Foods business. Again, AMZN offers fat discount specials to Prime members on many products at WF, which drives sales growth at the expense of profitability. Unfortunately, AMZN does not break out the sales and income attributable to the WF business – yet another layer of opacity on AMZN’s financials. I predicted when AMZN acquired WF in mid-2017 (at the time WF was 5% operating margin business being folded into a 3% operating margin business) that Bezos would drive margins lower at WF in an effort to generate revenue growth.

The cost of fulfillment rose – again – to 26% of product sales vs 25.6% last year. The Company generates sales by subsidizing the selling price of online products with 2-day free
delivery for Prime members. This is a money losing proposition and it enables predatory
pricing to drive out competition. Bezos is being grilled by Congress about the possible use of predatory pricing strategies to drive out competition, along other anti-trust issues. Rest soundly that this is nothing more than political theatre and nothing will be done to curtail AMZN’s effort to put the competition out of business.

AMZN’s debt increased again to $33 billion (41%) in Q2 but the Company is not using the funds to buyback shares. If the business really is generating free cash flow, why issue more debt? AMZN has to issue debt from time to time to fund cash needs. Without going into the complicated calculus here, AMZN’s free cash flow claim is an accounting mirage. At the end of Q2 2012, AMZN had zero debt. It had $24 billion in debt after closing the WF’s deal. Now it has $33 billion in long term debt. To my knowledge, unlike most other big companies that issue debt for the sole purpose of buying back shares, AMZN has rarely if ever repurchased shares. This is because it needs the debt funding to cover expenses.

Finally, AMZN used to disclose the amount of cash it spends every quarter for operating and finance leases plus that amount cash used to acquire PP&E under operating and finance leases at the bottom of the State of Cash Flows. No more. Now it discloses this information in the footnotes in a section titled “Supplemental Cash Flow Information.” This may sound trivial but the cash used for the PP&E purchases is not included in Bezos’ definition of free cash flow. In addition, very few analysts and investors ever bother to look at the footnotes.

Bottom line: If I gross up the the first 6 months of 2020 operating income and add a couple billion for growth, I get full-year estimated operating income of $20 billion. This stock is trading at 80x estimated operating income for a business that generates a 6.5% operating margin and said margin declines almost every quarter. 88% of the business model generates just a 3% margin and that margin is declining. Right now it doesn’t matter. The stock algos, Chinese retail gunslingers and Robinhood idiots will chase anything that moves. You make a dead skunk carcass move and the Robinhood morons will chase it.

The Historical Stock Bubble, Idiot Stocks And Gold

The Fed has blown the current stock bubble to an unprecedented magnitude. While the most outrageous overvaluations are concentrated in the tech sector, the valuation insanity has engulfed the entire stock market. Bubble chasers ran Hertz, a bankrupt company that will either liquidate or restructure, up to a valuation close to $1 billion after the Company filed for bankruptcy.

Perhaps the poster-child for this historic stock market Hindenburg is Tesla. Its valuation makes a mockery of our markets and shows what a complete farce the regulatory, legal and judicial systems have become in our country. It is the perfect reflection of the Banana Republic into which the U.S. has transformed over the last 10 years.

The precious metals sector is just getting warmed up. Since late March, when the Fed opened up the floodgates of its digital money printing press, gold is up 21%, the SPX is up 37%, silver is up 54% and the mining stocks are up 86%. Expect the large cap gold/silver producers to produce another round of big earnings beats for Q2 and Q3, which will drive the mining stocks even higher.

Lior Ganz invited me onto his Wealth Research Group podcast to discuss the current stock market insanity and what’s ahead for the precious metals sector:

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Tesla’s Warranty Expense “Income”

Note: Tesla is a fascinating case in fraud and of the “wizard” behind the fraud, who has managed to pull the wool over a large population of stock gamblers. Tesla is a saga for the ages and likely the biggest Ponzi scheme in U.S. history.  The Company and its CEO are truly emblematic of the fraud and corruption that has engulfed the entire U.S. economic, financial and legal/political  system. If this country survives what’s coming, there will be semester long classes in top-10 business schools and psychology masters programs devoted to the case study of Tesla.

A long-time Tesla critic published an article in Seeking Alpha outlining the fraudulent nature of Tesla’s accounting for “warranty expense.” I did not read the article beyond the summary because it was placed behind Seeking Alpha’s subscription firewall.  But I’ve detailed this aspect of Tesla’s accounting fraud in previous issues of the Short Seller’s Journal . Tesla has been reducing its provision for warranty expenses relative to the number of vehicles it sells for several quarters. While the warranty provision should rise in correlation with the rising number of vehicles delivered, Tesla and its auditor have decided an inverse relationship between these two variables makes more sense.

In addition, as it turns out Tesla in many instances allocates warranty expenditures incurred to “goodwill” and other non-warranty expense categories, which enables it to move the expense – a cash expense incurred – off its income statement and on to the balance sheet or to the “operating expenses” section of the income statement.

GAAP accounting no longer requires a company to amortize goodwill evenly over time as an expense on the income statement. Those of you who might know GAAP warranty accounting rules might say that the warranty expenses as they incur only affect the income statement to the extent they exceed the “provision for warranty expenses” that accumulates on the balance sheet.

However, in all likelihood Tesla is playing these games with its warranty expenditures because it has already exceeded the amount it has previously reserved for warranty expenses. OR over time if Tesla reports – fraudulently – less on actual warranty expenditures than it has reserved for them, it can “release” the warranty expense reserve into the GAAP income statement as a contra expense to boost gross margin and operating margin. This in turn contributes to the accounting manipulations used in any attempt to generate positive net income.

Furthermore, understating current warranty expenditures enables Tesla to understate future provisions for warranty expense, which should be expensed every quarter as part of the cost of goods sold. In other words, moving warranty expenditures into other expense categories or into goodwill reduces the cost of goods sold thereby artificially and fraudulently boosting the reported GAAP gross margin.

Moreover, the amount of warranty expenditures tossed fraudulently into goodwill never hits the income statement. It sits in the goodwill asset account on the balance sheet which no longer has to be amortized into operating expenses, thereby boosting operating and operating margin OR reducing operating losses. Yes, there is an accounting rule that applies to the revaluation of goodwill but don’t hold your breath waiting for Musk to adhere to any accounting regulations.

This is crucial to understanding the breadth and scale of Tesla’s accounting fraud. Tesla has made it a point of emphasis to boast about its gross margin, which is much larger than the gross margin for the legacy auto OEMs.  Also, Wall Street analysts focus on Tesla’s gross margin. When the gross margin reported is higher than expected, the stock price jumps. This accounting scheme also fraudulently boosts Tesla’s operating and net incomes. In fact, if Tesla adhered to strict GAAP accounting, its gross margin would be substantially lower and in all likelihood the Company would have never been able to report positive earnings per share in Q3.

But wait, there’s evidence that backs my assertion above that Tesla fraudulently misclassifies warranty repair expenditures. Tesla owners who have taken their car in for warranty-related repairs have been reporting that on the final invoice the warranty service repair is classified as “Goodwill – service.”  You can see a photocopy of one such example in an article published by InsideEvs.com. There are also several lawsuits filed against Tesla with documentation showing that Tesla’s misclassification of warranty service expenditures is standard operating procedure at the service centers.

As it turns out, Tesla labels warranty service expenditures for two more fraudulent reasons. First, under California’s Lemon Law, in many instances Tesla would be required either to buy back for full price the tarnished vehicle from the owner or replace it with a brand new vehicle. Likely this law is similar in most States. Second, repeated warranty repairs for the same problem would require per NHTSA regulations for a recall of the defective parts involved. But labeling these repairs as “goodwill” enables Tesla to fraudulently avoid both of these costs of adhering to the law.

Musk’s business per se is not to be sell cars but sell stock in a company that sells cars.  Musk’s accounting schemes are aimed directly at pushing the stock price higher. The primary motive behind this effort  is Tesla’s insane CEO compensation plan, which would award Musk with $364 million in stock/options if the market cap hits $100 billion (which is more than Ford and GM combined).

Though I can’t prove it without access to the actual records, I suspect that Goldman Sachs and Morgan Stanley have a lucrative fee-generating business lending money to Musk against the value of his Tesla shares.  In other words, Musk – along with Gold man and Morgan Stanley,  will do and say anything to try and force the stock higher in order to achieve that compensation milestone level and to protect the value of the collateral used secure loans to Musk.

Netflix’s Business Model Is Headed For An Epic Fail

How does NFLX manage to show positive net income yet burn hundreds of millions of dollars each quarter? It’s the magic of GAAP accounting. I did a detailed analysis for my Short Seller’s Journal subscribers back in 2017. Each quarter NFLX has to spend $100’s of millions on content. Most companies like NFLX capitalize this cost and amortize 90% of the cost of this content over the first two years. Amortizing the cost of content purchased is then expensed each quarter as part of cost of revenues. Companies can play with the rate of amortization to lower the cost of revenues and thereby increase GAAP operating and net income.

In the analysis I did for my subscribers, I demonstrated this accounting Ponzi mechanism:

The ratio of cash spent on content in relation to the amount recognized as a depreciation expense can be used to determine if NFLX is “stretching out” the amount depreciation recognized on its GAAP income statements in relation to the amount that it is spending on content. In general, this ratio should remain relatively constant over time.

For 2014, 2015 and 2016, this ratio was 1.42, 1.69 and 1.80 respectively. When this ratio increases, it means that NFLX is spending cash on content at a rate that is greater than the rate at which NFLX is amortizing this cash cost into its GAAP expenses. If NFLX were using a uniform method of calculating media content depreciation, this number should remain fairly constant across time. However, as content spending increases and GAAP depreciation declines relative to the amount spent, this ratio increases dramatically – as it has over the last three years. A rising ratio reflects the fact that NFLX has lowered the rate of depreciation taken in the first year relative to previous years. It does this to “manage” expenses lower in order to “manage” income higher.

In the first nine months of 2018, this ratio was 1.70, which explains largely why NFLX’s rate of GAAP “earnings” growth is declining. To pay for its massive cash flow burn rate, NFLX has to continually issue more debt and stock.

NFLX’s 2019 Q3 income statement contained the usual GAAP games in order to show gross, operating and net income. But as I’ve detailed in the past, NFLX’s treatment of the amortization of the cost of buying content is highly questionable if not outright fraudulent. While the GAAP net income reported provides terrific headline material, the truth shows up in the statement of cash flows. Through the first nine months of 2019, NFLX’s operations burned nearly $1.5 billion in cash. On top of that, NFLX spent another $145 million on content acquisition. Keep in mind that NFLX’s North American subscriber growth has hit quick-sand.

But not only is NFLX’s business model a literal cash incinerator, the Company robotically issues debt. Through the first nine months of 2019, NFLX issued $2.24 billion in debt, which was $343 million more than the same period in 2018. But NFLX wasn’t finished issuing debt this year. Seven days after reporting Q3 numbers, NFLX issued another $2 billion in bonds. This brings its total debt issuance in 2019 to $4.24 billion. NFLX now has a total of $14.4 billion in debt. But we’re not finished. On top of this, the Company has $19.1 billion in streaming content obligations, $16.9 billion of which is due over the next three years. This makes a total $31.3 billion in debt and debt-like commitments.


On top of all of this, NFLX now faces stiff competition from well-funded companies which have started to roll-out their own content streaming operations at lower price points. In some cases, NFLX will no longer have access to desirable content. As an example, Disney rolled out its Disney+ streaming service on November 12th, signing up more than 10 million users by opening day. Verizon offers a free one-year subscription to Disney+ to wireless customers on unlimited plans. Disney’s service is $6.99/month. Apple rolled out its AppleTV streaming at $4.99/month. NBC Universal debuts streaming in early 2020 and is considering offering it for free. AT&T/Warner will soon launch a streaming service that will be similar to Netflix from a cost standpoint but will be built around HBO. Additionally, more and more homes seem to be using cable more regularly these days. Due to the selection of programs available on cable, people seem to be finding ways to make their cable bill more affordable so that they can enjoy the various programs and movies that are available (read this source here to save on cable bills). Cable is still a popular way of watching tv shows despite these streaming services, so it’s clear that Netflix has a lot of competition.

I believe part of the reason NFLX’s stock has run up like it has is due to the release of “The Irishman,” a highly acclaimed movie it produced that is directed by Martin Scorcese and features Robert DeNiro, Al Pacino and Joe Pesce, among other marquee actors. But the movie cost $160 million to produce, an amount NFLX will never recoup.

The movie debuted this past week in a limited number of theaters. Several major theater chains refused to show it because NFLX demanded a 3-week window of exclusivity before sticking it on its streaming platform. Three weeks is the minimum amount of time a movie must spend in public theaters to qualify for the Oscars. Movie production companies rely on huge box office revenues plus revenue sharing deals on concessions to cover the production cost of blockbuster movies. After raking it in from the theaters, they look to milk huge fees from content syndication agreements. NFLX cut short its ability to pocket huge box office revenues and will not benefit from the ability to sell the rights to “The Irishman.”

NFLX sacrificed a large portion of box office revenues with the idea that it could use “The Irishman” as “bait” to catch new subscribers. However, people who don’t already subscribe to NFLX will likely either see it while it’s at the theaters or sign up for the free month to watch it and then cancel, which is what I’m going to do.

NFLX’s business model will lead to an epic fail. Eventually Netflix’s stock is dead meat. While Netflix has a viable streaming business, it simply has too much debt. It will never be able to service its debt load, especially in conjunction with the its content payment obligations.

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The commentary above is an excerpt from the Short Seller’s Journal. Each weekly issue contains macro economic analysis, market analysis, and short ideas. I To learn more about this short-sell focused newsletter, click here: Short Seller’s Journal info

Tesla Is A GAAP Accounting Dumpster Fire

“If there is any brilliance to TSLA, it is in the accounting slight of hand” (from @georgia_orwell)

Unfortunately, the key regulatory agencies in the Government, like the SEC, have been co-opted by the big banks and by Wall Street lawyers who built a lucrative practices assisting big banks in  breaking the law.  As we’ve seen,  when caught the banks at worst receive a small financial wrist-slap that could be considered the cost of doing business. The same holds true with the big accounting firms. Witness this quote from a Wall St Journal article detailing the rationale used to justify burying accounting fraud in Mattel’s financials:

[S]senior finance executives and Mattel’s auditor, PricewaterhouseCoopers, decided to change the accounting treatment of the Thomas asset, effectively burying the problem…It was known within Mattel that if we took this approach, at worst we might get a slap on the wrist from the Securities and Exchange Commission” (this disclosure is from a whistleblower who was the director of Mattel’s tax reporting at the time).

Mattel considered disclosing the accounting “error” and restating its financials. But instead, the Pwc partner in charge of the Mattel account figured out a way to completely bury the issue, after which the partner was seen “walking down the hall, high-fiving people, after this decision was made.”

I’m certain that the PwC partner would have never buried the accounting fraud if he thought there was any risk of an SEC audit or of a whistleblower emerging to tell the truth.

It’s becoming increasingly apparent that Tesla’s accountant, Price Waterhouse (PwC), is readily complicit with looking the other way on Tesla’s accounting frauds, if not in fact helping the Company implement illegal accounting gimmicks.

In light of the Mattel situation, I am certain that PwC is fully aware of TSLA’s openly reckless accounting.  PwC earned $9 million in fees from Mattel while the accounting fraud scheme occurred. TSLA’s revenues are 3x larger than Mattel’s so I’m sure PwC is getting paid significantly more than $9 million in fees either to look the other way or to help with the accounting deception.

The Solar City acquisition deposition was a dumpster fire for the Tesla.  As it turns out, a lawsuit file by certain Tesla shareholders who assert the deal should have never happened  is working its way through the court system.  Notes from a recent deposition disclosed that Solar City’s form audit firm, Ernst & Young, testified that Solar City was insolvent at the time Tesla’s board “agreed” to pay $2.6 billion to acquire the zombie company.

The deposition of Kimble Musk, Elon’s brother, reads like a chapter from “The Gang That Couldn’t Shoot Straight.” The skilled questioning by the plaintiff’s attorney made it clear that the acquisition of Solar City was rife with extreme conflicts of interests.

After Kimbal was deposed it was clear that the acquisition served as a quasi-bailout for Kimble and possibly Elon, as they both had Solar City shares pledged as collateral against various loans, some of which were extended by Wall St banks. Solar City may well be the Company’s undoing rather than the implosion of the EV operations.

It’s likely that Tesla will be left alone by the regulators, who serve as hand-puppets for the big Wall St banks, until firms like Goldman Sachs and Morgan Stanley – financial advisors to both Tesla and Elon Musk – have completely milked any possible fees from the Company.

Eventually Telsa’s business model will dissolve from intensifying, superior competition and an inability to service its massive and growing load of debt and other fixed obligations.  This is happening already, as numbers for October from the U.S. and the EU show a stunning decline in Tesla registrations across all three models.  The only unknown is China.  But auto sales in China are falling like a rock every month. In October auto deliveries plunged 6%. The industry fundamentals are not conducive to the fairytale told by Musk that TSLA will eventually sell 12,000 cars per month in China.

Perhaps in the end justice will be properly apportioned and served on PwC for its role in helping Tesla and Elon Musk perpetrate what will eventually emerge as a largest financial fraud in U.S. history…but I’m not holding my breath

Tesla’s Shock And Awe

The degree to which Elon Musk manipulates GAAP accounting in awe-inspiring. That the various regulators in charge of protecting investors allow Musk to commit accounting fraud is shocking.

Note: The commentary below is an excerpt from the latest issue of the Short Seller’s Journal. It’s based on Tesla’s earnings press release. In the next issue I’ll layout the facts about Tesla’s numbers based on a close-reading of the 10-Q which was filed Tuesday.

Tesla both shocked and awed short-sellers with its earnings report. The financials Musk presented to the public were produced from a contorted interpretation of GAAP accounting standards which stretch beyond legality. Any analyst with an intermediate level understanding of accounting can quickly see through the skeletons beneath what can only be described as a financial report awkwardly fit with a Halloween costume. This probably explains why Elon Musk and the CFO did not sign the quarterly letter for the first time ever.

From what has been made available in the earnings release, Musk has outdone all of his previous works of artistic accounting with his latest masterpiece in an attempt to deflect attention from declining revenues and cover-up poor earnings. On a YoY basis for Q3, total revenues declined 7.6%, with automotive sales revenues down 12.7%, with revenues in the U.S. down a shocking 39%. The difference in total vs automotive sales is predominantly revenues derived from services.

Tesla’s gross profit fell 22%, operating profit plunged 37% and net income free-fell 54%. Of the $143 million of reported net income, $107 million was Government subsidies in the form of environmental credits that Tesla sells to the large OEM’s who need to buy them to remain in compliance with environmental regulations (auto manufacturers are required to produce a certain percentage of zero-emission vehicles; if they do not meet the test, they can buy ZEV credits from companies like Tesla which generate a surplus of these credits). But the ZEV sales will eventually disappear as the large OEMs ramp up their line of EVs.

Some portion of the revenues was the recognition of deferred revenues. Deferred revenues occur when a company sells a product for which the complete product is not delivered but which is paid for up-front by the end user. Typically companies that derive revenues on a contractual basis have deferred revenues.

Tesla’s source of deferred revenues includes features like auto-pilot,smart summons and supercharger access which are sold up-front  but available only a limited basis or not yet available. Deferred revenues are set-up as a liability on the balance sheet and amortized into revenues. When recognized, deferred revenues are non-cash because payment from the customer was received at the time of the sale. The amount of deferred revenue recognized, for the most part, flows through the income statement to the bottom line.

In June Tesla said it planned to recognize about $500 million in deferred revenue over the next 12 months, which means Q3’s income statement contained at least $100 million in non-cash deferred revenues. The amount of deferred revenue in any given quarter shows up in the cash flow statement as a source of cash. The cash flow statement in the earnings letter did not have deferred revenues as a line-item in the cash flow statement but there should be a disclosure of the amount amortized into revenue in the 10-Q when it’s released.

The bottom line is that Tesla recognized some portion of deferred revenues in the revenue line, which means that gross profit, operating profit and  net income are overstated by the amount of deferred revenues that was used in Q3’s revenue number.

There several more highly problematic aspects to Tesla’s Q3 financials. The 10-Q will help shine light on most of the areas in which Musk and his financial goons impose the questionable interpretations of GAAP standards on s financials.

Why did the stock jump $73 in two days? Revenues missed Wall Street analyst estimates. Margins were lower than expected. Net income smashed estimates. The net income “beat” expectations because the degree to which Elon Musk is willing to commit accounting fraud is unpredictable.  It certainly can’t be modeled into an analyst spreadsheet.

I believe the move in Tesla’s stock was an orchestrated short-squeeze in conjunction with rabid momentum-chasing by daytraders and hedge fund algos. Let me explain first by sharing this tweet from Charles Gasparino (Fox News business reporter): “Senior management tell bankers they have the short sellers where they want them (on the ropes) with the latest financials.”

Assuming that’s true, and I’m 99.5% certain that it is, it shows that targeting short-sellers is one of Musk’s primary agendas. Reading between the lines, it implies that Tesla manipulated the financials specifically to cause a short-squeeze. I also believe that Musk orchestrated the short-squeeze in conjunction with a couple of Wall St banks, likely Goldman and Morgan Stanley, both of which have significant financial exposure to Tesla stock and to Musk’s personal financial health.

How to orchestrate a short squeeze.  Keep in mind when you short shares, your brokerage firm borrows shares from funds which make shares available to borrow. They do this because they can earn interest on the shares loaned. In the case of stocks with a high short interest like the TSLA, the stock loan rate can be double digits.

Goldman and Morgan Stanley would contact a few of the large “friendly” fund shareholders and ask them to recall the shares they have loaned out.  If they agree, their back office contacts the back office of the hedge fund or broker-dealer to whom the shares are loaned and asks for the shares back (a “recall”).  No reason has to be given. The entity being asked to return the borrowed shares either has to find a new source from which to borrow shares or buy back the shares in the open market to return them.

Keep in mind that, outside of Musk and his circle of friendly shareholders (Larry Ellison, Bailey Gifford, etc), the true free-float of Tesla shares is maybe 30% of the shares. A lot of those shares are borrowed and shorted as a hedge against Tesla’s outstanding convertible bonds.

In the case of a large short-seller, like Greenlight Capital (Steven Einhorn) or Kynikos Partners (Jim Chanos), it might be difficult to find a source from which to borrow the amount of shares being recalled. In that situation, the short-seller has three days to find and return the shares borrowed. It’s likely that large short-sellers were forced to cover part of their short position and then look for a new source of borrow to re-establish the short. In a situation like this, the stock can be driven up sharply in a short period of time.

The move made by Tesla’s shares on Thursday and Friday is similar to the short-squeezes that occurred during the internet bubble. Most of those internet stocks were very obviously highly overvalued and were aggressively shorted. The slightest positive news headline would cause the stocks to move 20 to 30 percent in a couple days from a short-squeeze despite the obvious superficiality of the news reported. Goldman and Morgan Stanley were two of the largest Wall Street promoters of internet stocks.

There’s no telling when the short-squeeze will subside but I think it might be running out of steam. The stock is now – per the RSI – more overbought than it was when it squeezed higher after the “funding secured” tweet by Musk. The stock dropped $120 in 20 trading days after that.

Tesla, Gold, Silver And A Historical Stock Bubble

“Tesla’s headed for bankruptcy. It’s got a flawed business model; costs are way too high for the price charged for the vehicles and its riddled with accounting fraud. But the regulators will look the other way until it’s too late.”

Silver Liberties invited me on to its podcast to discuss reality. We spend 35 minutes trying to blow away the Orwellian “smoke” that is engulfing the United States’ economic, political system:

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Tesla’s Phony Quarterly Numbers

Tesla reported its Q2 numbers this past Wednesday. It reported $4 billion in revenue, up 43.4% year over year. Its net loss widened to $742 million, or $4.22 per share (some of you may have seen lower net loss and loss per share numbers but the numbers I’m using come directly from the SEC-filed 8-K, which means those are the “official” numbers).

The market was excited and the stock soared because the cash “burn” was lower than expected and Elon Musk reassured everyone that the Company is still on track to show positive net income and cash flow in Q3 and Q4. I can assure you that you have a better chance of standing on the eastern shoreline of Egypt and seeing the Red Sea part for Moses.

The cash balance of $2.23 billion that is presented on TSLA’s balance sheet was higher than expected – with an alleged implication that TSLA burned less cash than expected. But this was accounting sleight of hand. TSLA achieved this feat by stiffing its suppliers as evidenced by the ballooning of the accounts payable entry on the balance sheet. From Q4 2017 to Q1 2018, TSLA’s accounts payable rose $213 million, or 8.2%, to $2.603 billion. But from Q1 to Q2 this year, TSLA’s payables rose $427 million, or 16.4%.

In other words, TSLA slowed down the rate at which is pays suppliers by a considerable amount, which enables TSLA to hold the cash it owes to suppliers on its balance sheet, thereby giving the appearance of a higher cash balance.

Netting out customer deposits of $942 million, TSLA actually only has $1.29 billion in cash. That said, there are some other balance sheet items on the liability side of the balance sheet that increased and will require the use of cash, like “other long term liabilities,” that I won’t be able to analyze until the 10-Q is filed, which is when I can study the footnotes. Furthermore, the 8-K does not contain a full statement of cash flows – it’s missing the details of the “cash from operations” – which will enable me to determine other areas on its balance sheet TSLA stretched in order keep cash net of deposits above $1 billion.

All of that said, I have discovered a clever manner in which TSLA has rigged its financials to look better than they should by keeping cash expenditures it will have to incur off the income statement and balance sheet in Q2. To my knowledge, I am the only analyst who has figured out this devious form of accounting manipulation.

The commentary above is an excerpt from the latest Short Seller’s Journal, which was released today.  Tesla shares several traits with Enron and some parallels with Bernie Madoff.  Elon Musk is a gifted con-man.

In the latest Short Seller’s Journal I layout the methodical manner in which Musk’s financial architects manage to defer cash expenditures for the purpose of making the Q2 financials appear better than expected.  I suspect the scam was used to set-up an attempt to raise more money later this year.  You can learn more about my newsletter here:  Short Seller’s Journal information.