LONDON — After this week’s release of its quarterly results to end June, Tesla’s share price jumped from $300 to $330 because the company had burned through $730m in cash – less than the $900m Wall Street’s analysts were expecting. While Elon Musk’s fans went wild, cooler heads warned that there is still only enough cash to last until the end of the year. Steve Eisman, immortalised in The Big Short, is among those who are now betting that the Musk magic won’t last much longer. – Alec Hogg
This is The Rational Perspective. I’m Alec Hogg and in this episode, the genius who called the CDO bubble warns us about Tesla.
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After this week’s release of its quarterly results, Tesla’s share price jumped from $300 to $330. The bottom-line for three months to end June was that Elon Musk’s company had burned through $730m in cash but that was below the $900m that Wall Street’s analysts had been expecting. Here’s how David Kudler who is the Chief Executive at Mainstay Capital, reacted to that news.
I guess I’m happy for Tesla that they burned a little bit less cash than expected, but it’s still a cash burn rate that is near $1bn per quarter – down to $2.2bn in cash and they’re going to have to raise money before the end of the year at the current cash burn rate.
So, beating expectations by losing a couple of $100m less than everyone thought doesn’t actually change the reality that your cash pile is still shrinking. Indeed, all it seems to do is slightly postpone the day of reckoning. It certainly doesn’t remove it. Bloomberg’s Pimm Fox and Bob Every asked Kudler where he thought Tesla would get the cash from when it needs more money, just to keep going.
Well, what they’ve said is that they will be profitable in Q3 and Q4. In the third and fourth quarter, they’ll be profitable so revenue/cash from the sales of the Model 3 will be enough to get them through. So, that is the question. Will they build enough Model 3’s in Q3 and Q4? What will the profit margin be on those vehicles? They say that they’ve turned slightly profitable in Q2. We have concerns of what it costs to build those cars, the quality of those cars going out the door, the warranty, and other service costs for those cars. So, we’ll see but it looks as if it’s a high-risk strategy to count on just Model 3 revenue to make it to the end of the year.
David Kudler, just let me give you a list of the things that Tesla’s Elon Musk says will help the company turn the corner in the third quarter: pushing deliveries that produce cars from the second quarter into the third quarter that also prolongs that US Federal Tax Credit for another quarter, high margin performance Model 3 and dual motor versions plus unlimited free supercharging for performance buyers but that ends in September. Also, offering that long-awaited $1,500 upgrade for white seats and yes, laying off 9% of employees. Do you think that will get them to profitability?
Well, in there are a couple of things that will put a dent in profitability. One of the things that you mentioned is that they’re now starting to offer incentives. Supposedly, we still have the reservation (a long waiting list – 420,000 orders on the waiting list) and other demand out there so why the need to offer incentives? Maybe it’s just incentives on the higher revenue models. In terms of superchargers and in terms of what they’re doing on certain models. Also, what they’re doing in terms of bringing in workers from around the country, putting them up in hotels, paying all their expenses/travel expenses. There are some very high cost approaches that they’re using to meet their production goals to get to the production numbers for these revenue targets in Q3 and Q4. When you start to dig through that and net that out, it really leaves a question as to how profitable they can be in Q3 and Q4 – if at all.
“Do you still short the stock?”
Still short the stock.
“Not going to cover?”
Not going to cover yet.
“All right. Well, shares of Tesla are up by five percent in after-market trading.”
Good. I’ll short tomorrow.
“I think that Tesla shares need to go to 5th Avenue and shoot somebody before people start selling.”
Yes. At five percent in after-hours trading, they actually went up to a total of ten percent when the trade opened the next morning/the day after the financial results were released. What the Bloomberg guys are saying is that Elon Musk’s popularity amongst his supporters is so strong that no matter what he does, they just keep the faith – keep buying the shares. Fair enough, but they’re sure playing a dangerous game and amongst those who say so is Steve Eisman, the expert spotter of con jobs – a man who is immortalised in the Michael Lewis bestseller The Big Short. Eisman was among a handful of those who profited ahead of the 2008 financial crisis by selling collateral debt obligations (CDO’s) before they imploded. That in turn caused the financial crisis, which required hundreds of billions in Central Bank bailouts.
In the movie based on Lewis’ book, Eisman’s name was changed to Mark Baum. His character was played by Academy Award nominee Steve Carell. I’m sure you’ll remember it when you think back on that very good movie that had us at the edge of our seats and it’s not often that a financial story does that, but here’s the memorable scene where Baum aka Eisman has dinner with a slick CDO salesman. This YouTube clip has been watched almost 2.5-million times.
“I’m a CDO manager.”
“A CDO manager?”
“Yeah, at Harding Advisors.”
“I didn’t realise that there was anything to manage with CDO’s.”
“Oh, we select the securities that go into the portfolio and monitor the assets.”
“Do you represent investors or Merrill Lynch?”
“The investors.”
“You do?”
“Yeah.”
“But, Merrill Lynch isn’t going to send you any customers unless you put Merrill Lynch’s bonds in your CDO.”
“A good question. Let’s just say Merrill and I have a… we have a good relationship.”
“You have a good relationship with Merrill Lynch?”
“We’ve been doing business together for a long time.”
“And so, the CDO’s that you create are of the highest quality and the highest of value?”
“Absolutely.”
“Are you at all concerned about the rising default rates?”
“I assume no risks for these products myself, Mark.”
“Okay, so let me get this straight. The bank calls you up. They give you the bonds they want to sell. They give you clients. They give you money to run your business. They give you fat fees for doing so, but you represent the investors. Is that right?”
“Yeah, but we’re not in the Merrill Lynch building.”
“Okay. Where are you?”
“We’re in New Jersey.”
“Twenty minutes away.”
“Fly Visa helicopter…”
“That’s funny. That’s hilarious. Say that again. CDO-A has parts of CDO-B and CDO-B has parts of CDO-A but then they both get put inside CDO-C.”
“That one’s called CDO2 – a CDO of a CDO and then there are CDO’s made up of the opposite side of the bed. We call them synthetic CDO’s–.”
“What is a synthetic CDO?”
“Synthetic CDO’s.”
“That is f#*king crazy.”
“It’s not. It’s awesome.”
“Let’s say you have a pool of 50-million in subprime laws. How much money could be out there betting on it in your synthetic CDO’s and swaps – right now, tonight?”
“Fifty million dollars.”
“What? How much bigger is the market for insuring mortgage bonds than actual mortgages?”
“About 20 times. If the mortgage bonds were matches and the CDO’s were the kerosene-soaked rags, then the synthetic CDO is the atomic bomb with a drunk President holding his finger over the button. It was at that moment and with that stupid look on his face that Mark Baum realised the whole world economy might collapse.”
Brilliant, and I really urge you to go and have a look at the movie if you haven’t seen it yet – The Big Short. So, what is this genius, this man who went where others refused to go – Steve Eisman; what does he think about Tesla? Not very much, I’m afraid. This week Eisman, the Managing Director of the New York investment management firm Neuberger Bergman visited the Bloomberg studios in his hometown.
People who love Tesla, like to say he’s a genius. It’s been my experience over the years that there are a lot of smart people in this world but just because you’re smart, doesn’t mean you execute well and so far, he’s not executing well. He’s building a whole bunch of cars in a tent. He has negative cash flow. He’s at war with his safety regulator after the unfortunate crash for his autonomous driving car and he’s lost a tremendous number of executives over the last two years. Those are all negative signs. Maybe he can pull it out but as of now, it seems to me that all the fundamentals are pointing negatively.
“And, there’s some really peculiar behaviour, elsewhere. Do you factor that in when you have to create a short thesis or is that separate to what you’re walking us through at the moment?”
I factor some of that in. I factor more in that after the autonomous driving accident, he announced two weeks later that he was no longer cooperating with the National Safety Board. I thought that was a very poor decision. The other stuff I listen to but I don’t pay that much attention to it.
“Let’s talk about the execution of this short. How difficult is it to execute? How expensive is it? Just walk us through the fundamentals.”
It’s not an expensive short. It’s a very liquid stock. You can put the position on before you go out and get a cup of coffee and come back, so it’s the easiest thing in the world to either buy Tesla or short it.
“Elon Musk talks about stormy weather and shorts fill, quite often. Is it a risk that you do get a surprise to the upside and all of a sudden, the position gets wiped out? Steve, is that something you account for?”
Of course. You have to size it appropriately. It’s a very volatile stock so it’s not the biggest short in my portfolio. I think the stock could go down about 30%.
“Thirty percent?”
Yeah.
“Is there a bigger short out there for you, then if it’s not the biggest short in your portfolio?
Well, it’s not the biggest short, because of the volatility.
“Interesting.”
Volatility is wild and the stock tends to move on nonsense. I like to sleep at night so I’ve sized it in a way where sleep is still possible.
“Could you explain what you mean by that? That’s a word I use when I lecture and people go ‘what’. What do you mean when you say, “sized”? I’m looking and it’s called portfolio-sizing but what do you mean when you say sized?”
Firstly, my philosophy of investing in general about longs and shorts is that no position should be so large that your career is at risk. As I said on the TV, my biggest long position is over four percent and my biggest short position is about three-and-a-half percent. My smallest short position is about one-and-a-half percent. Tesla is sized more towards the smaller end of the scale, not because I don’t think there’s a lot of downside. I do think that potentially there’s a lot of downside but it tends to be an extremely volatile stock and what tends to happen with stocks like that is your day gets consumed completely by that one stock. When your day is consumed by one stock, you can’t think about the rest of your portfolio and so I try to avoid situations like that.
“Just to be clear here; the team here at Bloomberg has reached out to Tesla for comment. Representatives for Tesla have not immediately returned a call for comment on this position of yours, Steve. Is it about the space that Tesla is operating in or is it about Tesla? Do you think there could be winners in this space? Quite clearly, Elon Musk is having a very difficult time rolling this out in mass production.”
Well, I think that when you look at the car space, the real future is going to be autonomous driving. He’s gotten big in the electric car space but I really think that we’re leapfrogging now towards autonomous driving and the two largest players in autonomous driving are Google and GM. As far as I can tell, Tesla is a very distant party in that space.
So, who are you going to believe? The Columbo-like financial investigator who called the CDO ‘naked emperor’ or the South African born super-entrepreneur who ignores those whose money keeps him, because of their ‘bonehead’ questions? In this great money match-up between Eisman and Musk, I know where my money would be.
This has been The Rational Perspective. Until the next time, cheerio.
