“I honestly don’t really care about business all that much. It’s not really my first motivation.”
- Elon Musk
Today, Tesla represents the future of transportation. This is for good reason: the company is led by the brilliant inventor Elon Musk; it creates fantastic products; and it has cheap access to the large amounts of capital necessary to build cars. It’s hard to argue that another company is better positioned to make self-driving electric cars a reality.
This—however—does not make Tesla a good investment. The premise of investing is not betting on whether a company’s product is good or not, or if the founder is right about what the future holds; it’s simply about buying a business for less than it’s worth. And even if Musk does fulfill his loftiest promises, investors wouldn’t stand to gain much, because Tesla’s current value has become wholly detached from economic reality. It trades at 70% of GM’s value, despite selling 187x fewer cars and not generating a cent of profit—a level which is simply unsustainable. Yet most alarming are Tesla’s myriad of red flags: poor corporate governance, quixotic acquisitions, and a financial structure best described as a house of cards—to name a few. I’d argue, therefore, that Tesla is clearly a stronger short candidate than long. But investors have become so enamored of the company’s narrative and promises for the future that they are ignoring these risks with reckless abandon.
To illustrate, imagine that you have the opportunity to invest in “Tesla Pizzeria”—a local pizza place with the following characteristics:
IT HAS GREAT GROWTH PROSPECTS
- Small, but sales are growing at a rapid pace.
- Tesla Pizzeria makes the best pizza on the market, created by a brilliant chef/manager.
- Aggressively expanding into new markets and locations.
…BUT THE BUSINESS BURNS CASH
- For every $1 invested in Tesla Pizzeria, $2.02 has been lost, with no signs of abating.
- Tesla Pizzeria's costs are unpredictable, inconsistent, and are not showing signs of improvement.
COMPETITION IS HEATING UP
The pizza market is brutally competitive and dominated by industry giants. For every pizza pie sold by Tesla Pizzeria, the largest competitor sells 200. Companies like Pizza Hut, Dominoes, and Papa Johns have taken notice of Tesla Pizzeria's innovative products, and have signaled their intentions to make similar pizzas. And while Tesla Pizzeria has a similar paper valuation to its competitors, it severely lags behind them in both profit and experience. In fact, every competitor has been selling pizza globally for 50+ years, whereas Tesla Pizzeria has only been selling for eight years, all mostly in one market.
Since Tesla Pizzeria publishes all of their recipes and techniques for free, it won't take long for competitors to start making pizzas in the same fashion. To make matters worse, enormous companies in adjacent markets—like McDonalds and Starbucks—think they can make really good pizza too, and are poised to introduce their own products in the next few years. There are even well-capitalized global upstarts gunning for a "slice" of the market. And then there are the companies set on shifting consumer preference to pizza alternatives.
IT SUFFERS FROM POOR CORPORATE GOVERNANCE
- The top manager regularly makes grand predictions about price, cost efficiencies, and production schedules that rarely pan out.
- He is directly related to and/or involved with the other managers in various ventures outside of the pizzeria. Their other businesses have also not been profitable.
- Tesla Pizzeria's manager is compensated based on the size of the business, rather than how healthy it is.
- Bad news is often shared with the owners in a worryingly obtuse fashion (like the Sunday of 4th of July weekend when no one is paying attention).
AND NOW IT’S BUYING ANOTHER MONEY-LOSING BUSINESS…
The owners of Tesla Pizzeria have decided buy a tomato farm which lost $192 dollars for every $100 of tomatoes they sold last year. Alarmingly, many of them also happen to own the tomato farm (or are related to someone who does). And it's run by two of the manager's cousins. The sale—which is for a 35% premium—will net the manager of Tesla Pizzeria and his relatives ~$700m, despite the farm's deteriorating business model. In order to avoid insolvency, the farm recently raised $345m in “tax equity”—whatever that is; and some are even suggesting Tesla Pizzeria is "bailing out" the tomato farm so that its owners don’t lose their shirts. Thank goodness for the synergies!
BUILT ATOP A FINANCIAL HOUSE OF CARDS
The business is financed with a convoluted web of stock sales, private investments, warrants, convertible bonds, and exotic debt. And by taking out personal loans against his ownership stakes in his various companies, the manager is exposing the owners to significant risk.
So, is this a pizzeria you would want to own?
Investing isn’t about predicting the future or buying the company that will have the greatest impact on society; instead, it’s simply buying a business for less than it’s worth. And with a market value of ~ $35B, Tesla shareholders are almost assuredly paying more than the company is worth—even if Musk is right about the future. But if he’s wrong, the dubious acquisition, poor corporate governance, and risky capital structure ensure the losses be swift and steep. So whether or not Musk is right about what the the future holds, there’s only one smart move for investors to make: hope and pray he pulls it off, but to short Tesla.