As we reported over the weekend, it was another bad quarter – and bad year – for David Einhorn’s Greenlight, who in his latest just released letter to investors writes that he had “another difficult quarter and lost an additional (9.1)%, bringing the Greenlight Capital funds’ (the “Partnerships”) year-to-date loss to (25.7)%.”
And while the letter lists the fund’s various recent stock dispositions, including the sale of its last Apple shares, the exit of its multi-year long in Mylan, liquidating its stakes in Micron and Twitter, covering its 11 year old short in Martin Marietta, an amusing analysis on profitless companies…
The current market view is that profitless companies with 20-30% top-line growth are worth 12x-15x revenues, while profitable companies that lack that level of opportunity are worth only 5x-8x after tax earnings. As an arithmetic exercise, if you pay 12x revenues for a company that eventually makes a 10% after tax margin and trades at a 20x P/E, the company has to sustain a 25% growth rate for 8 years for you to break even, and for 12 years for you to make an 8% IRR (requiring 15x revenue growth). If the company is increasing the share count by paying employees in stock, the math gets worse.
… and so on (see full letter below for full details), what was most remarkable in Einhorn’s latest letter was his aggressive, all-out attack on Elon Musk, and Tesla, which he minces no words and compares to Lehman Brothers.
We present the full excerpt below:
While it hasn’t led to great returns so far, our opinion expressed in 2016 that General Motors (GM) will likely earn its market capitalization before Tesla (TSLA) makes its first annual profit seems well on its way to coming true. Speaking of GM and TSLA, during the market discussion about whether TSLA should go private, Catherine Wood of ARK Investment Management, one of TSLA’s most vocal shareholders, explained why TSLA could be worth $4,000 a share or $900 billion and provided an analysis to back it up.
The interesting thing about the analysis is that 84% of the value came from the assumption that TSLA would be operating a platform of three million robo-taxis in 2023. As of today, TSLA hasn’t even announced a plan to enter the robo-taxi business, nor is it possible for the company to develop the manufacturing capability to make 3 million robo-taxis within five years. Setting that aside, GM Cruise has made significant progress towards developing robo-taxis and expects to launch commercial service in 2019. All of GM is worth $48 billion or about 6% of what ARK claims to be the value of TSLA’s robo-taxi opportunity. Recently, Honda invested $750 million into GM Cruise at a headline valuation of $14.6 billion. However, when you peel back the deal, Honda plans to contribute an additional $2 billion over 12 years for non-exclusive technology rights – e.g. the right to be a customer. To the extent Honda’s support could be thought of as equity, Cruise’s implied valuation could reach up to $50 billion. As a result, GM Cruise’s development is in the traditional sense: funding secured!
In thinking through TSLA more, it brings us back to Lehman, which went bankrupt 10 years ago. One of our key insights into Lehman was that the company had faced a credit crunch in 1998, bluffed its way through and got away with it. In fact, rather than facing regulatory, legal or even market consequences for failing to own up to reality in 1998, the company was rewarded when its business turned. This emboldened management to be even more aggressive during the next credit crunch in 2007 and 2008.
Lehman threatened short sellers, refused to raise capital (it even bought back stock), and management publicly suggested it would go private. Months later, shareholders, creditors, employees and the global economy paid a big price when management’s reckless behavior led to bankruptcy. The whole thing might have been avoided had the authorities cracked down on Lehman in 1998.
There are many parallels to TSLA. In 2013, TSLA was on the brink of failure as customers who had paid deposits weren’t taking delivery of the Model S. TSLA’s cash reserves fell to a dangerously low level and CEO Elon Musk secretly and desperately tried to sell the company to Google. Rather than communicating the truth to shareholders, Mr. Musk bluffed his way through the crisis. There were no regulatory, legal or market consequences for failing to own up to reality. The business survived, and Mr. Musk was celebrated for his successful bluffing.
In our opinion, this has emboldened the TSLA CEO to embark on ever more aggressive deceptions. In 2016, Mr. Musk bluffed his way through the TSLA bailout of SolarCity by demonstrating a very exciting but fake product called Solar Roof. The company started taking $1,000 deposits in May 2017 and launched the product in August 2017, but as of May 31, 2018, reports indicate that only 12 Solar Roofs have been fully installed – 11 of which are owned by Tesla employees.
But, like Lehman, we think the deception is about to catch up to TSLA. Elon Musk’s erratic behavior suggests that he sees it the same way. In August he told the New York Times, “But from a personal pain standpoint, the worst is yet to come.” Given that prediction, we can’t understand why anyone would want to own TSLA shares. It really doesn’t get much clearer than that.
Here is our take on why we think Elon Musk is so despondent:
In 2016, the Model S had already become an iconic car selling for about $80,000. However, the market for $80,000 cars is small. TSLA announced the Model 3, which looked to be a stripped down version of the Model S, starting at $35,000 before a $7,000 tax credit. If the Model 3 was even 80% as good as a Model S, this was an incredibly exciting offer. Hundreds of thousands of people sent in $1,000 as a refundable deposit to get a spot on line. At the same time, TSLA promised it could make a 25% margin at that price point.
Why did TSLA think it could make the car so cheaply? At the 2016 shareholder meeting Mr. Musk said, “We realized that the true problem, the true difficulty, and where the greatest potential is – is building the machine that makes the machine. In other words, it’s building the factory. I’m really thinking of the factory like a product.” He thought he could improve car manufacturing by an order of magnitude and claimed that manufacturing would be TSLA’s competitive advantage.
Fast forward one year, and Forbes wrote about Mr. Musk’s vision, “In fact, robots will move so quickly and so efficiently that humans won’t be safe on the factory floors. So, just a skeleton staff of engineers will be on hand – and they will merely monitor production.” The faster speed would mean much more productivity and much lower manufacturing costs. In July 2017, TSLA turned on the machine that was to build the machine… and it didn’t work.
Instead of producing TSLA’s forecast of 5,000 Model 3s a week in the month of December, TSLA produced only 2,425 for the entire quarter. Elon Musk realized that full automation is impractical. Humans replaced some robots. Adding humans into the production process means that TSLA can’t improve the factory speed to achieve its vision of improving manufacturing by an order of magnitude. As Musk said in 2016, “You really can’t have people in the production line itself, otherwise you’ll automatically drop to people speed.”
In 2016, TSLA thought its Fremont plant could make 5,000, 10,000 and 20,000 vehicles a week in late 2017, 2018 and 2020, respectively. This can’t happen at people speed. Consequently, the cost structure of the Model 3 is much higher than Elon Musk expected when he took deposits from hundreds of thousands of people for a $35,000 car. It’s a promise he can’t keep.
UBS did a teardown analysis and estimated that the cost to make a stripped down version of the Model 3 is $41,000. That’s a long way from $35,000, let alone $26,250 – the level needed for TSLA to make a 25% margin.
In May, Elon Musk tweeted that the $35,000 version would be launched 3-6 months after the company achieved 5,000 cars a week. That milestone was hit with great fanfare in June. However, investor relations has leaked that the company now expects the $35,000 version in the second quarter of next year. Tellingly, TSLA has stopped taking orders for the $35,000 version, as it may already know that it won’t be releasing a $35,000 version anytime soon or ever. The company has changed its policy on refunding deposits so that customers who are tired of hoping TSLA makes a car that doesn’t exist and want their money back have to wait 45 days. It reminds us of Jane and Michael Banks in Mary Poppins: https://www.youtube.com/watch?v=xE5klz0yUT0
We think this may explain Mr. Musk’s erratic behavior. He can’t make the car without losing too much money and he can’t bring himself to cancel the program and refund everyone’s deposits. His conduct suggests that he is doing his best to be relieved of his position as CEO to avoid accountability. Quitting isn’t an option because it prevents Mr. Musk from claiming he could have fixed the problem had he stayed.
But, it’s a Mexican stand-off: the Board is too close to him to fire him and also doesn’t want to be blamed. The same can be said for the SEC, which backed off on its threat to bar him as an officer. Thus far, TSLA has produced several more expensive variants of the Model 3 with an average price of about $60,000. The addressable market at that price point is no more than one third of the addressable market at $35,000. A fraction of the customers who placed deposits for the Model 3 have been willing and able to buy one of the premium versions. To date, TSLA has made about 95,000 Model 3s, and given that some versions are now available for immediate sale to people who weren’t on the wait list and that TSLA is offering promotional discounts like free supercharging, it seems clear that the backlog for premium versions is nearly exhausted.
TSLA is expected to make and deliver more than 65,000 Model 3s in the December quarter. It might be able to make them, but without an order backlog there is very little chance that there is enough demand to sell them. We expect a large revenue and earnings disappointment in Q4. The exposed demand shortfall should ruin a key pillar of the bull case. Next year, TSLA loses the government Zero Emission Vehicle subsidy, which will make it even harder to attract demand. The September results are likely to be as good as it gets for TSLA.
Meanwhile, the brand is in trouble. The blocking and tackling of the Model 3 rollout is leaving customers unhappy. There have been lots of reports of delivery snafus and poor quality cars. There are anecdotes about TSLA accepting full payment for cars and then not delivering them. There are many stories of cars (even Model S and Model X) in service shops for months for lack of spare parts. With so many new TSLA cars on the road, the problem is overwhelming TSLA’s limited service infrastructure. The Model 3 is the least reliable car on the market.
If you add in the pending disappointment of customers who paid deposits and may find themselves as involuntary unsecured creditors, TSLA appears on the verge of losing all but its most dedicated fans.
This section of the letter has run more than a bit long, which doesn’t leave space to address the infamous “funding secured” market manipulation tweet and a number of apparent accounting red flags at TSLA. But, we would be remiss to fail to note that in August TSLA hired a well-respected finance executive to be its new Chief Accounting Officer. He was to receive $10 million worth of stock over four years. Suffice it to say, that is not the going rate for accountants. He lasted a month and quit before ever being associated with a reported financial statement. TSLA may be in accounting hell.
Our TSLA short was our second biggest winner during the quarter. The biggest was Brighthouse Financial (BHF), which announced a satisfactory quarter, but more importantly announced a $200 million buyback, thereby commencing capital return a full 2 years sooner than projected at the spin-off road show.
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Full letter below: