Coyote Blog

Since a number of folks have asked me via email: yes, I am OK and would someday like to get back to active long-form blogging (I still make a foray into twitter now and again).  However, things have been a bit crazy here.  A number of business owners over the last 2 years have approached me to buy their business and help with their retirement.  In several cases the request was humbling, as they turned down offers from other companies believing my company would best take care of their employees, customers, and partners.

The net effect of all this is that, without really intending to, my business that was perfectly large enough for me at about $13mm revenue 18 months ago will have $80mm in revenue this year.  As you can imagine, I have been busy.  It is one thing to make sure one's company is keeping its promises to employees, partners, and customers when it is small enough that the owner knows everything going on.  It has been a real learning experience, one I hope to write about in depth, learning to do this with a much larger company.  Not to mention overcoming the fear and culture clashes inherent in mergers (though it could have been harder -- not one penny of these acquisitions was justified on consolidation so we have done no layoffs or the like -- in fact we are hiring like crazy in certain functional areas).

There is always a lot of interest in buying and selling businesses.  My series from way back in 2004 still generates a lot of email.

I would dearly love to get all that I have learned since that series committed to electrons, but for now I will leave you with a new podcast from my friend Walt Lipski.  Walt helped get me into this business 20 years ago and was deeply involved in 2 of the 3 acquisitions we have made over the past months.  He has a ton of experience in middle-market business M&A and in generational transfers.  He also is a stand up guy, and probably the only investment-banking type I have seen walk away from a lucrative fee when he didn't feel good about the deal.

Phone company: To make your suggested change, we need your PIN first

Me: I don't know that I have a PIN, though since we opened the account 18 years ago I may have forgotten.

PC:  We only started using them about 5 years ago

Me:  I don't remember being asked to set a PIN 5 years ago

PC: No, you probably would not have.  On old accounts they were simply assigned by computer

Me: So I can't possibly know what it is.

PC:.... I need your PIN before I can process the change your have requested

I just bought a company with a few seasonal gift shops and camp stores but they have this expensive kludgy NCR Point of sale system they use.  It reminds me of doing business with IBM in the 80's.   Apparently every piece of hardware costs a fortune -- I kid you not an add-on credit card chip reader was priced at $1000 -- and they have to have their own server somewhere running software rather than a cloud solution.

I want a simple cloud-based POS system that might be appropriate to a 3000-sq-ft store with a half million in sales a year.  Anyone have good experience with one.  Hit the contact button or email me at coyote - at - this blogs name dot com.   Needs to be more capable than square, maybe several hundreds sku's, but not some mainframe system that might have been developed for Sears.  I am not a merchandising / retail guy at heart so I don't even know where to start.

Over the past year, I have spent a staggering amount of my time trying to get service providers who are supposed to be the leaders of their business to do their damn job.  I literally keep a list at my desk with a list of reminders I need to send out to service providers to do what they promised.  This list is never less than 30 names long.

More than the COVID life disruptions, more than the fear-mongering, more even than our merger, the most exhausting thing for me over the last year has been the utter inability to reliably delegate anything to a third party without constantly having to coach them through their job.

I see many reasons this is occurring.  These include:

• Lack of employees due to either sickness or else difficulty in competing against high unemployment payments.
• Closure and elimination of services that companies always wanted to eliminate but they can now blame on COVID.  For example
  • Hotels stopping maid services and room service
  • Banks closing tellers and branches
  • Airlines not serving meals or drinks
• Unwillingness to adjust to the current reality.  Banks are high on this list, demanding things they have always demanded but that are impossible to do in the last year

But these do not encompass the whole problem.  There are a lot of companies in their core functionality that seem to have simply forgotten how to do what they do.  Even after 6 phone calls, Amerigas can't take and fulfill a simple order for bulk propane delivery;  Iron Mountain, who I like and invest in, can't reliably provide any of their core services accurately and on the first try; I don't think Intuit even picks up the phone anymore.

My hypothesis is that people are getting too far ahead of themselves in saying that COVID proves that the centralized workplace is dead.   I think we are going to find that this is not true at all, that there are networks in the office that spread both knowledge and accountability that are lost with all this home work.

I have run a company for 20 years where every employee works out of their home, or more accurately, where every employee moves their home (RV) to the workplace.  My employees work in over 400 spots.  And one thing I have learned vs. years of working in Fortune 50 offices is that you have to build a special process for this situation.   In particular, my constant focus is how how to centralize complexity.  I keep trying to take complexity out of field locations and managers and centralize it in a few office people where it is easier to train and build tools and create backups, etc.

My hypothesis is that companies did OK for the first month or two with work at home as well-trained employees carried the momentum of office work styles to their house.  But as time passes, and the staff turns over, the lack of traditional knowledge-sharing, support networks, and accountability systems are causing service functionality to degrade.

From reading various comments on Trump's taxes, it is clear to me that many people do not understand even the basics of corporate accounting and taxes.  I sometimes forget, as the owner of a medium-size business, that everyone does not live and breath this stuff.  The following is meant to illustrate a few concepts I see the most confusion about.  This article is not written to be exculpatory of Trump's tax or business practices -- in fact I did not even read the NY Times article because at this time of year the last thing I need to do is spend time burying myself in someone else's taxes.

We are going to take a very simple example from my world.  Let's imagine my startup company has a piece of land we acquired years and years ago.  Suddenly in the pandemic we have an idea -- we are going to buy 50 Airstream trailers (as if we could actually obtain them in this market, but ignore that) and put them on our land and rent them out.  Let's say in the first year we bought them all on January 1 for $5 million using $5 million of bank debt (banks actually are happy to finance this sort of asset) and they ended up generating a net income (after expenses and interest) of $1 million.

So how do we account for the year?  We know we have a million dollars of operating income, but what do we do about the $5 million in capital spending on the trailers?  By GAAP accounting, capital investments of this sort that have a long service life are not expensed immediately.  They are depreciated over the life of the asset. So if we say these trailers have a 20 year life, we would expense 1/20th or 5% of their cost each year.  For our $5 million investment, that is $250,000 a year in depreciation.  In this case our final income statement for  the year would show $1 million in operating income less $250,000 in depreciation expense for a net income of $750,000.  One might expect that is what we report to the IRS and pay taxes on.

But we live in a more complicated world.  Our Congress loves to express its preferences for how business should operate in the form of changes to the tax code.  For example, Congress prefers we buy electric vehicles and solar panels, so it gives special tax credits for these.  Relevant to our example, Congress strongly prefers that companies reinvest their profits in new capital spending.  It provides incentives for this by allowing accelerated depreciation for capital investment in certain types of assets and equipment.  We can argue about the tax code -- I have not checked this particular example with my CPA -- but it is very likely that current law would allow us to depreciate our $5 million investment in trailers not in 20 years but in one.

So how does this change our example?  Well suddenly, in year one, we still have a million dollars in operating income but $5 million (100%) depreciation expense for taxes.  This means we have a $4 million loss we will report to the IRS.  This loss is carried over and used as a credit in later years.  If we continue to make a million dollars in operating profit a year, this means we will go five years without paying taxes.  The owners, for example if it is an S-corp or LLC with no double taxation of distributions, might be pulling hundreds of thousands of dollars out of the company every year, living the dream, while neither they nor the corporation pay any taxes.

This is what everyone is calling a "loophole" but I think that is a misnomer.  "Loophole" implies people are taking advantage of some drafting error or unanticipated use of an IRS rule.  That happens all the time, but our example is not an unanticipated use.  In our example we are using IRS rules exactly as Congress intended -- the company is being rewarded by Congress for the investment it made in new equipment with a multi-year tax deferral.

Note that this is only a deferral.  Once the five years is up, the company will pay its full taxes on the million dollars (unless it makes more investments with the profits which would allow it to defer more taxes).  Even if the company keeps investing and keeps getting accelerated depreciation, eventually when it sells the business it will have a large tax bill in the form either of depreciation recapture or goodwill in the business.

There are of course many other tax dodges that range from legal but ugly to outright fraudulent.  I don't know what Trump was doing.  But I wanted to show an example of how it is perfectly possible to legally (and I suppose socially responsibly) pay no taxes while generating a lot of income.  The key in this case is to reinvest profits, a behavior Congress has chosen to reward.

Via Andrew Sullivan

What Freddie [DeBoer] is arguing is that, far from treating genetic inequality as a taboo, the left should actually lean into it to argue for a more radical re-ordering of society. They shouldn’t ignore genetics, or treat it as unmentionable, or go into paroxysms of fear and alarm over “eugenics” whenever the subject comes up. They should accept that inequality is natural, and construct a politics radical enough to counter it.

For DeBoer, that means ending meritocracy — for “what could be crueler than an actual meritocracy, a meritocracy fulfilled?” It means a revolutionary transformation in which there are no social or cultural rewards for higher intelligence, no higher after-tax income for the brainy, and in which education, with looser standards, is provided for everyone on demand — for the sake of nothing but itself.

This has been coming for years in the labor movement -- requirements to use seniority over performance for layoffs, ban the box laws, lawsuits over reference checks, attacks on gig economy where rewards are tied to performance, etc.  Way back in 2010 I worried that the increasing restrictions on what information could be used in hiring stemmed from this same desire

That being said, as someone who has 500 service employees working for me, I understand the insatiable desire for information on employee reliability and conscientiousness.  A large number of our employees we hire who interview well tend to get released within 60 days of their hire.  I can't tell you how many people who seem totally normal and friendly turn out to be raving maniacs in stressful customer contact situations.

The elephant in the room that neither McArdle or folks like Kevin Drum mention is that businesses are starved for [reliable] information on potential employees.  It used to be the best source was to check job references.  Nowadays, though, very few employers will give a honest job reference, or will provide any information at all.  I know I am guilty of that -- my company does not allow any manager to give out performance data on past employees.  I only needed to be sued once over somehow interfering with someone's living by giving honest information about that employee's reliability to change my behavior.

I understand that this is exactly what the Left is shooting for - an environment where the competent have no advantage over the incompetent.  If employers are resorting to FICO scores, it just demonstrates how all the other reasonable avenues of obtaining information have been closed to them.

A number of folks thought the bit in bold overwrought, but I still feel this is directionally correct.  Clearly DeBoer defines an extreme.  I think the actual goal of the Left could be better stated as wanting to make all employment decisions based not so much on competence but on credentials, credentials that are awarded via processes and institutions controlled by the Left (and that might over time be awarded as much for political orthodoxy as for learning relevant skills).  Which, by the way, is pretty much exactly how the Soviet Union worked.  And is pretty much how tenure works at most universities today.

Granted, I am not a large tenant in my building.  I have about a thousand square feet of office space, but we are doubling the size of the company and I sent a note a number of days ago to my building management asking if I could look at getting perhaps twice as much space.

The building is at least half empty and many of the tenants they do have look to be checking out.  So I sortof expected some response, but today I had to follow up to a list of several people at my landlord with an email that said

Uh, hello?

I know I am a small tenant but with a half empty building and COVID uncertainty I sort of expected some sort of positive response

The one thing I have learned is that there are definitely some odd incentives in the real estate world.  One that I have found striking is that, at least for my landlord, maintaining growing average rental rates is more important than occupancy or cash flow.  In several cases, in a perennially half-empty building, they have let even large tenants walk and leave space open for years rather than give on rates.  Is this maybe an agency problem, where the rental staff have different metrics and incentives than the owners?  Or maybe it is a function of trying to sell the property, where a new owner who thinks they are good at filling space will care more about average rental rates than occupancy?

Chinese online educational company GSX announced today that the SEC had opened a probe into their finances, potentially reminiscent of the Luckin Coffee and Wirecard investigations that revealed all sorts of fraud inflating reported revenues and profits.  In all these cases, private investors and journalists began reporting the fraud long before government agencies ever got interested.

I have always found stories of business frauds to be fascinating.  I am not sure why this is, but it may be in part because I really got sucked into the Enron cult, in part due to my working briefly with Jeff Skilling at McKinsey on Enron.  It took me a long time to accept the core of the Enron fraud (thanks to combined efforts of Smartest Guys in the Room and Conspiracy of Fools)** and since then I have taken a won't-get-fooled-again approach, I think.   So much so that I have probably become unhealthily skeptical, unable to get excited about investing in much of anything in this market and shading towards the Zero Hedge permabear stance.

Anyway, I like a good business fraud and discovery story (Bad Blood about Theranos and Billion Dollar Whale about Jho Low and 1MDB are good recent examples).  To that end, I found that the Muddy Waters Research paper on GSX is pretty interesting, detailing how they came to the conclusion that most of GSX's customers are actually bots rather than real paying customers.

Disclosure:  I am short GSX

So as of the morning of 1/17 when I started writing this, the enterprise value of Tesla (market value of its debt and equity) was somewhere around $110 billion.  I can't even pretend to explain how a company that over 10+ years has never made an annual profit and which produced less than 400,000 vehicles as this sort of valuation (Volkswagen, which has about the same equity market value, makes about 11 million vehicles a year).  Tesla has an enterprise value of $300,000 per annual car produced (each of which, on average, lost money for them last year).

I don't have the energy to repeat my concerns on Tesla, but I do want to give a few updates from the last 12 months

• Tesla is not seeing a lot of organic growth.  I know that seems an odd statement given that deliveries have been up the last few quarters (though even this growth has been pretty modest for a company with such a large valuation growth premium).  In retail there is a useful concept called "same store sales".  Revenue might be growing due to addition of new store locations, but what is happening in the core stores you already have?  In this case, one can say that Tesla's same stores, or more accurately "same product-geography sales" have been disappointing.  They enter new markets with a big splash and a lot of pent up demand -- Model 3 US, then Europe, then UK left hand drive, etc.  But in each case, after 2-3 quarters, lacking some specific one-time boost, deliveries begin falling.  Deliveries fell in the US the last 2 quarters.   Apparently they fell in CA last quarter.   They fell in strong Tesla markets like Norway the last quarter.  They are falling in most of Europe.  Tesla is eeking out small increments of growth each quarter by one time effects -- first the introduction of the model 3 in Europe, then in the 3rd quarter in the UK, then in the 4th quarter with a huge burst of sales in the Netherlands as EV subsidies in that country expired at end of year.  Tesla as a whole has some growth (though still more modest than you might guess from the hype) but look at each constituent market and you see a more disturbing story.
• The model 3 has cannibalized Tesla's high end, high margin Model S and X products.  In a post last year, I criticized Tesla for under-investing in refreshing the Model S and X, whose designs were getting long in the tooth.  Today, it's becoming increasingly clear that Tesla is on a path to abandoning these products, which have already seen steady sales declines as they are cannibalized by the less expensive model 3.  The problem with this approach is that it is creating a mix shift from higher price/margin to lower price/margin products.  Even as deliveries go up, revenues are not rising nearly as fast and there is downward pressure on gross margins.
• Given the above two points, I was as surprised as most people that Tesla reported a profit for 3Q2019.  It made almost no sense that they produced more vehicles but with essentially unchanged revenues and had net income go up.  I am still tremendously skeptical about Tesla's financial statements but for what its worth, they seeming to be getting them past the auditors.
• My guess is that they will show a profit of 4Q2019 but probably still a loss for the year, but if anyone can stretch 2019 into a small positive net income gain, Tesla will find a way.  Maybe a massive sale of emissions credits or some sort of one-time supplier rebate or recognition of self-driving revenues.  No matter what, though, 1Q2020 almost has to be a disaster.  Tesla fans seem to think that China will fill in the hole, but I believe Tesla is exaggerating the ability of its new Shanghai plant to produce in volume, while the Chinese auto market is pretty sick right now anyway.
• Tesla still does a lot of counter-productive stuff to buff up quarterly numbers.  Just one example, I noticed around Dec. 20 that two Tesla showrooms in Scottsdale had zero display vehicles on the floor.  I was told that this is now a common Tesla practice to sell out all of its display inventory each quarter to show a few extra delivery numbers (with 3 cars each at 200 showrooms this is maybe another 600 deliveries or about 0.5% of quarterly sales).  This strikes me as tremendously short-sited.  They went for weeks in the busy holiday shopping season without any demonstration models in their stores just to increase quarterly deliveries by maybe a fraction of a percent.  Elon Musk and Tesla seem to expend an inordinate amount of energy trying to get short-term boosts in the stock price.  The only other person who spends as much time on twitter pumping stock prices is Donald Trump, who IMO shares a number of personality traits with Musk.
• The market apparently does not care one bit that the Tesla makes promise after promise that are not only broken, but entirely forgotten.  The Semi, the roadster, battery swap, a million robotaxis by 2020, a thousand solar roofs per week in 2019 -- all these promises and more were introduced to much fanfare and stock pumps and then promptly forgotten by all.  Each new promise that comes out, no matter how unbelievable it smells, is treated by the stock market as an occasion to run the stock up another 20 points.
• The Tesla acquisition of SolarCity was at least as corrupt as I thought it was at the time it happened.  Recent disclosures in the shareholder suit challenging the SolarCity acquisition as a bailout of the extended Musk family have confirmed that a) SolarCity was on the verge of bankruptcy when Tesla stepped in; b) despite the shaky financials and no other interested parties, Tesla paid a premium for the company with almost no negotiation and c) for at least 2 years afterwards Tesla was essentially shutting down that business, doing fewer installations every quarter and closing sales locations.  Then, in the same week that Musk was deposed in the shareholder suit, Tesla began announcing new solar roof initiatives and making more Musk-like promises of huge future growth.  I am convinced this activity is a sham meant to give Musk the ability to truthfully testify that Tesla is committed to the solar business, and that all this activity will go the way of the Tesla Semi and battery swap once the trial is over.  From recent prototypes it does not appear that Tesla has solved the long-standing installation issues of solar shingles and that at the currently-promised pricing Tesla will lose thousands on every installation.
• Tesla's biggest mistake IMO is still the lack of a 3rd party, well-capitalized dealer network.  Tesla is the only major auto manufacturer that refuses to participate in JD Power satisfaction and reliability surveys, so we don't have super-good satisfaction data, but the little data we have seems to point to massive reliability and service problems with Tesla cars.  I had thought that 2019 would be the year that such problems would hit the mainstream press, but apparently not.  Part of the reason Tesla is able to hide these problems is the codependent relationship they have with Tesla owners.  Tesla message boards are full of posts that begin "I love my Tesla, but..." and then go on for 3 pages describing product defects and the impossibility of getting service.  From time to time Musk will promise huge new service investments -- particularly just after a blue check mark complains on Twitter -- but all evidence is that they greatly grew their installed based of cars in 2019 with only tiny investments in their service network.
• I was mostly happy that Vern Unsworth lost his libel suit against Musk for calling him a pedo.  Look, Musk acted like a totally entitled pr*ck in the whole affair, but there are important reasons to keep a very very high bar on libel.  For $TSLAQ fans who are now mad at me for giving even this slight accommodation to Musk, imagine that the US had a much lower bar for libel suits.  Which thin-skinned billionaire CEO of an overvalued automobile manufacturer would likely be first to take advantage of this regime and weaponize the courts against his critics?

Postscript:  I will add a note that people seem unable to separate the company's valuation from how much they like the products.  Certainly Apple has wonderful products AND is a very valuable company.  But this does not have to be the case.  WeWork rents beautiful offices -- heck, it turns out they are giving me $10 of office for every $5 I pay, what's not to love? But it was and still is overvalued as a company because it has no reasonable plan to ever make money.  So saying that Tesla makes great cars or Tesla cars suck are both largely irrelevant statements to my thinking about whether $tsla stock is overvalued.  My personal view is Tesla could have been a nice niche automaker and is probably worth $10-$20 billion -- at which price they might get purchased by another major auto maker.

Postscript #2: I have explicitly left out discussion of Tesla autopilot.  There is no question it has been overpromised and oversold, but I can't quite form an opinion on whether it is safe.  I personally would not trust my own safety to a self-driving technology that did not include LIDAR -- there are just too many ways for a vision-only system to make mistakes.  Tesla AP clearly has made mistakes and hurt and killed people.  Alert drivers make mistakes that hurt and kill people.  I don't know which is more prevalent, though one can be suspicious of Tesla when it does not really make it easy to analyze the data on this and produces clearly flawed analyses.   I certainly don't trust Tesla AP just because of the aura of Elon Musk supposedly being a genius, because I am pretty certain he is not  (things like the hyperloop I DO have a lot of background to understand and its a joke).  As a libertarian I don't want to see the government restricting the hell out of self-driving development and progress with stacks of regulations, and I refuse to call for such regulation just because it would help the value of a Tesla short position.  As should now be clear, I have limited knowledge and mixed feelings on the topic, so I avoided it in the main body of the post.

Several years ago, a new brokerage called Robinhood successfully began penetrating the millennial market for stock trading with a zero brokerage fee model.  In recent weeks, Fidelity, TD Ameritrade and Interactive Brokers have all followed suit (I have accounts with the latter two).  This sounds cool until one sits back and wonders how these companies expect to make money instead.

We know one way Robinhood does it -- they route consumer stock orders to large companies who pay for this order flow.

Payment for order flow is a decades-old practice that can be traced to the early years of electronic trading. It was pioneered by Bernie Madoff at his regulated securities firm. (He later became infamous for a multibillion-dollar Ponzi scheme he ran on the side.)

Read more: How high-speed traders are transforming the stock market 

Here's how it works: Retail brokers like Robinhood focus on recruiting customers and building the trading interface, but don't actually execute their clients' orders. They outsource that to firms—including Citadel, Two Sigma and Wolverine Securities—that pay for the right to handle those trades. While orders from large, sophisticated investors can burn the market maker who executes the trade, retail trades are considered relatively safe.

These firms earn a tiny bit of money off each transaction, often 1 cent or less per share. Some see payment for order flow as a critical piece of market infrastructure—facilitating the fast and cheap buying and selling of stocks. But critics of high-frequency trading have long argued that the practice actually hurts the little guy, to the advantage of large firms.

Federal rules dictate that brokers must seek the best execution for clients’ trades, but finding the best price possible is not necessarily a requirement. Consumer advocates say the system creates an incentive for brokers to route orders to the market maker that pays the most.

During last year’s fourth quarter, regulatory disclosures indicated that Robinhood shipped virtually all of its orders for stock trades to four high-speed market makers. The bulk was bought by Citadel, which paid Robinhood an average of “less than $0.0024 per share" on the trades it was routed in that quarter. Those small numbers add up—Robinhood’s users have executed more than $150 billion in transactions.

While companies like TD Ameritrade also accept money for order flow, these payments are far less than the ones helping to keep Robinhood afloat, though that may change now.

I am sure if I bothered to Google search, I could find articles and studies that go both ways as to whether this directed order flow costs a retail investor (in the form of a slightly worse transaction price) more or less than a $5 or $12 commission.  Here is my default on this, and it goes back to the saying that if you don't see the sucker at the poker table, then you are it.  If something is opaque in the financial world, it is not very likely it is breaking in favor of the retail investor.  As such, I would MUCH rather a cost a I see that is well defined than one I do not.

As I promised readers of this blog, I have mostly taken my Tesla obsession offline from this blog and, when I need to, scratch that itch on Twitter.  But there is an interesting story developing in the Tesla world that I think gets at the heart of the unseriousness, perhaps even amorality, of its management.  For those of you who follow all things $TSLAQ on Twitter, there is likely to be little new for you here.

When last I blogged about Tesla, it was struggling to still be the growth company that its equity valuation implied.  Last year I wrote a fairly comprehensive take on why I thought Tesla was done as a growth company (I argued, among other things, that Q32018 might be their high water mark -- remember that in a second).  That was intended to be my last post as my kids were worried about my obsessive behavior, but I just couldn't resist posting in May when Musk announced that Tesla was no longer really a car company and would be a robotaxi company by 2020 with a million automated rideshare vehicles on the road.

That was not the end of Tesla news this year.  Since that time it has become increasingly clear what I have said form the very day the acquisition of SolarCity was announced, that that transaction was a thinly-veiled bailout of Musk and his family to the detriment of Tesla shareholders.  And for added bonus points, Tesla was recently sued by Walmart when its SolarCity installations on the roofs of various Walmart stores started catching on fire and threatening to burn the stores down.  And I don't even think I have mentioned on this blog the Musk fake $420 buyout announcement or the Musk "pedo" lawsuit by the Thai cave diver hero.

So obviously I continue to be tempted out of my vow of silence.  And it is happening again.  Several days ago, in fact just before the end of Tesla's 3rd quarter, Tesla released by OTA update a "Smart Summon" feature in its cars, part of a package of autonomous driving features Tesla has promised for years and for which many Tesla owners paid in advance with their purchase (many years ago).

Smart Summon is a sort of automated car valet.  When one comes out of, say, the mall she can pull out the Tesla app, hit a button, and have their Tesla start up and drive itself to them.   Unfortunately, this feature sometimes works and sometimes is a real fail (here and here, for example).  Already people are reporting damage claims to their car when in summon mode, though Musk and his enablers in the hipster media claim its all operator error. This by the way is right out of the Musk playbook:  go on social media and hype Tesla autonomous driving uses that go beyond the terms and conditions, and then defend themselves in court that users violated the terms and conditions (Musk taking his hands off steering wheel in a 60 Minutes show demonstration and Musk retweeting people having sex in a Tesla while in autonomous driving mode are just two examples).

So why would Tesla release what appears to be at-best beta software that could easily lead to people getting hurt?  One reason is that Musk is totally steeped in the Silicon Valley "fake it before you make it" culture, all the way back to Paypal.   Given its paint and reliability issues, the Tesla Model 3 should arguably have been tested for much longer than it was before release, just as one example.  And certainly there was a lot of pressure on Musk as he has been promising this release as imminent for months, and some folks have been waiting literally years since they first paid for the feature to actually get it.

The problem with this is that there is a difference between the consequences of screwing up at Paypal and screwing up with a motor car.  A half-baked Paypal feature might have led to someone not being able to pay for their beanie baby they bought on eBay.  A half-baked summon product can lead to children getting run over (just as a half-baked Theranos product led to thousands of people with potentially life-threatening diseases getting false and misleading blood tests).  At some point there is going to have to be a reckoning of where to draw the line against this culture -- perhaps Tesla will give us that opportunity.

But I (and many others) think there is another reason this was rushed to market.  To understand this reason, we need to put together four pieces of data

• Tesla has collected over a billion dollars in pre-payments for autonomous technologies like Smart Summon.  Because customers have not gotten an actual product, these sit on its balance sheet and have not been recognized as revenue in Tesla's financial reports.  Releasing Smart Summon could allow Tesla to recognize some of this billion dollars as revenue in the quarter it was released, which happens to have been, just barely, the third quarter.
• In the third quarter of 2018, Tesla really starting selling the Model 3 in mass.  It had a big quarter as it worked through years of pent up orders, and a profitable quarter in part because it focused all its production on fulfilling only the highest margin variants in the order queue.  Remember what I said above -- because it was blowing through all its pent up orders and selling an unusually profitable mix, I predicted Q32018 might be its high water mark.  Even with record unit deliveries in Q32019, Tesla's revenue and profit is likely to be down year over year.
• Tesla's stock, while down substantially over where it was a year ago, still trades at sky-high valuations for a company that is a) in the auto industry, which typically trades for very low multiples; and b) loses billions of dollars with little prospect of making any money.  The reason it has such high valuations is expectations of growth that Tesla fans have for the stock.  Obvious evidence of stalled growth could knock a huge percentage of the value off the stock, perhaps even driving it below Musk's margin call price.
• In the SolarCity story linked above, we found out just how far Musk is willing to go and how many ethical corners he will cut to defend his investment in a failing growth company.

My hypothesis is that Musk demanded that Tesla rush release of Smart Summon, whatever condition it was in, to market before the end of the third quarter so he can book hundreds of millions of dollars of customer pre-payments as revenue in the quarter and perhaps prevent a year over year revenue decline.  Yes, that would be super cynical, but this is the man that essentially faked the solar shingle product in order to get Tesla shareholders to bail him out of his soon-to-be bankrupt SolarCity position.

Trade carefully.  As disclosure I am current short Tesla via long-dated put options.

The spectacular flame-out of Pets.com is the event that many folks of my era use to mark the end of the late 90's internet bubble.  In turn, it looks like WeWork is vying to mark the end of the current Silicon Valley unicorn bubble.  I won't go into all the problems of its IPO, but suffice it to say that they can't get retail investors to bite anywhere near their last private funding round valuation, and in fact are scrambling to maybe go public at half the value that companies like Softbank invested at.

The incredible thing about WeWork is that it is really a minor repackaging of a quite mature real estate model.  Companies like Regus have for decades leased large blocks of space and then released it in small blocks to individuals and small businesses, sometimes packaged with additional services.  WeWork just took that model, then added some new age language and some espresso machines.

While WeWork is growing rapidly, the service it offers is not new. The Belgian company IWG, which operates under the brand name Regus and a variety of other, smaller brands, utilizes the same business model of leasing office space, refurbishing it, and sub-leasing it under shorter terms to tenants.

IWG has more square feet of office space than WeWork, earns more revenue, and actually earns a profit. However, IWG has a market cap of just $3.7 billion, less than 10% of WeWork’s most recent valuation. The primary difference between the two is that WeWork describes its business model in the faux-tech lingo of “space-as-a-service” and its mission as “elevating the world’s consciousness.”...

Another difference is that WeWork operates with a much higher degree of risk by taking on significantly more operating lease commitments with longer terms and more geographic concentration.

I compared this to Pets.com but actually I think a better analogy is to the late 70s/early 80s Texas real estate and S&L bubble.  In the runup to the S&L crash, land investors played a game wherein they flipped a piece of real estate back and forth between related parties, raising the price with each sale.  Having pumped up the value on paper, they then got some S&L to lend at 100% or even 105% LTV and when the land values all crashed, S&L's were left holding the bag.

This process of pyramiding the value of an illiquid asset in private sales is very similar to what is going on in the Silicon Valley unicorn world.  Companies like Lyft and Uber and WeWork have seen private funding rounds at ever-increasing valuations.  These are done outside the accountability of the broader market and untethered to any sort of normal valuation metrics like earnings or even revenues.

These unicorns often promote custom metrics like engagements or users rather than any traditional financial metrics, because their financials generally are awful.  WeWork, for example, consistently spends $2 for every $1 of revenue it brings in.   All you have to know about the complete corruption of valuation metrics can be gained by looking at WeWork's preferred metrics:

More than its cash-burning ways, WeWork’s IPO will test investor tolerance for made-up accounting metrics. You might recall “Community Adjusted EBITDA,” the gauge WeWork devised to measure net income before not only interest, taxes, depreciation, and amortization, but also “building- and community-level operating expenses,” a category that includes rent and tenancy expenses, utilities, internet, the salaries of building staff, and the cost of building amenities (which WeWork has described as “our largest category of expenses”).

• ARPPM (annual average membership and service revenue per physical member). “[R]epresents our membership and service revenue (other than membership and service revenue generated from the sale of WeLive Memberships and related services) divided by the average of the number of WeWork Memberships as of the first day of each month in the period.” (Note: this is not just creative accounting, but also creative acronym construction.)
• Adjusted EBITDA before Growth Investments. “[A]n additional supplemental measure of our operating performance, which represents our Adjusted EBITDA further adjusted to remove other revenue and expenses (other than revenue that relates to management fee income from advisory services provided to Branded Locations) and what we define as ‘Growth Investments,’ which are sales and marketing expenses, growth and new market development expenses and pre-opening community expenses.”
• Location Contribution. “[R]epresents our membership and service revenue less total lease costs included in community operating expenses, both calculated in accordance with GAAP, excluding the impact of Adjustments for Impact of Straight-lining of Rent included in community operating expenses.”

Or, you could just throw your money on the street.

This has been a pyramid scheme, pure and simple (with more than a touch of founder self-dealing at WeWork).  There is no way Softbank could have imagined that WeWork was actually worth $47 billion if they were to hold it and manage it for 30 years.  The only way they thought $47 billion made sense was that they were sure they could unload it on the next group, probably retail investors, for a higher number.  This is greater fool investing, and works right up until there is not another fool available.

Postscript:  WeWork founder Adam Neumann reminds me a lot of Donald Trump in his business life.  All the investors will lose money. The company will likely go bankrupt.  Building owners will have leases broken and banks will lose money on defaulted loans.  But Adam Neumann will walk away from it all with hundreds of millions of dollars.  That is the typical Trump deal in a nutshell.

From an interview the other day

Q I can read you the tweet, Mr. President. You said that, “Badly run and weak companies are smartly blaming these small tariffs instead of themselves…”

THE PRESIDENT: Yeah. A lot of badly run companies are trying to blame tariffs. In other words, if they’re running badly and they’re having a bad quarter, or if they’re just unlucky in some way, they’re likely to blame the tariffs. It’s not the tariffs. It’s called “bad management.”

The first answer to this is, LOL.  This is the man with a string of failed businesses (steaks, college) and multiple bankruptcies in his core business.  In fact, I would list one of Trump's most useful business skills is his ability to get other players in the capital structure to take the losses for his bad business decisions and management.

But as far as trade is concerned, if one is worried about bad management in US businesses, then the right thing is certainly not to protect those businesses from competition.  The US auto business in the 60's and 70's as well as almost the entirety of the British industrial base in the 20th century are good examples of the problem.  Protecting businesses from international competition, as is Trump's objective, only shelters those businesses from accountability and reduces the pressure to fix whatever bad management may exist.

As a special bonus, I would argue that many of the bad habits of large US companies today are directly attributable to the stimulative Federal Reserve policy which Trump wants to increase.  Returning profits to shareholders in the form of share buybacks rather than dividends is a perfectly valid strategy, particularly when the tax code favors capital gains over dividends.  But when companies borrow billions just to buy back more of their own stock, rather than reinvest it in new opportunities, something is broken.  A large part of the blame are twin Federal Reserve policies of low interest rates and a QE-created equity and asset price bubble.

Apparently California is close to a new law mandating that Uber drivers (and other "gig" economy workers) be treated as employees rather than independent contractors.  Progressives are cheering this as a victory for the drivers:

Billionaires who say they can’t pay minimum wages to their workers say they will spend tens of millions to avoid labor laws. Just pay your damn workers! https://t.co/PtyP4JZ7W0

— Lorena (@LorenaSGonzalez) August 29, 2019

I have explained before why this will likely kill Uber (e.g. here) but let me summarize quickly the argument of why this is bad for most drivers (self-plagiarized from a Twitter thread).  The key issues are driver productivity and driver agency.

Let's define worker productivity as far as Uber is concerned as the amount of customer revenue a driver brings in per paid hour. In the current model, this is not a real concern for Uber as they are only paying Uber drivers when they are actually driving customers.  Essentially, Uber drivers and Uber have a revenue share agreement to split customer revenue. Uber has set the share low enough to maximize its revenue (of course) but high enough to still attract drivers. It tweaks this formula fairly frequently.  Uber driver productivity as we have defined it is essentially locked in by the formulas in this revenue share agreement.

Given this arrangement, note what Uber does NOT have to worry about. It does not have to worry that drivers are working hard enough or are positioning themselves in productive locations and productive times of day.  Uber drivers can drive anywhere they want at any time they want.  An Uber driver currently can turn on the app at 4am in the suburbs of Peoria and Uber does not care, even if this positioning is unlikely to get many rides. Why? Because Uber only pays if there is a ride.  It doesn't care if the driver is sitting around unproductively, because it is not paying the driver for that time.

So today, it is left up to the driver to make trade-offs between the most productive time & positioning and the demands of their own personal schedule & life choices. This sort of flexibility has real value to many drivers. It is agency that many hourly workers don't have, and that has attracted many people to become Uber drivers.  My neighbor, for example, sits in his living room all day with the app on and runs out to the car whenever he accepts a ride (and then turns the app off so he can come back home).  He gets few rides in our area but he is happy with the lifestyle and the little bit of extra money he makes from Uber.

But this all changes if drivers must be Uber employees and subject to wage and hour laws.  The key difference under such wage and hour laws is that Uber would have to pay drivers whether they have a passenger or not, as long as the app is turned on.  Suddenly, forced to pay for labor whether the labor is working or not, Uber is going to get real interested in driver productivity.

If Uber pays by the hour, my neighbor's preferred way to drive is a dead loser for the company. In fact, if I am a driver and paid by the hour, I could go find a library in an out of the way place at an odd time of day and sit and read and collect hourly paychecks -- All without having to drive much. Now, instead of productivity choices being in the driver's hands because it's the driver that makes more or less money with greater or lesser productivity, these choices now land in Uber's lap. Uber can no longer allow so much driver agency.

If making Uber drivers hourly workers does not kill Uber altogether, then Uber is going to be forced to monitor driver productivity and do one or both of two things:

1. Establish productivity rules, such as driving time windows and allowed geographic ranges and/or
2. Set a minimum productivity threshold below which Uber will have to let those drivers go

Interestingly, like a lot of labor regulation, this one will benefit the middle while hurting the lower-paid drivers.

1. Top drivers will be unaffected, because they already make the minimum
2. Middle drivers may get a small boost
3. Lower-earning drivers will lose their driving jobs entirely

A better way to characterize this law is that it will greatly reduce the flexibility many Uber drivers love, while causing the lowest paid drivers not to make more, but to lose their driving gig altogether.

I wrote a great deal more about how much of labor regulation actually hurts the lowest rungs of unskilled workers in an article here for Regulation Magazine.

ACC Business is apparently a subsidiary of AT&T that provides high speed dedicated data lines (think T1 lines if they still call it that).

Long rambling customer service nightmares are hard to describe in a coherent or engaging manner, so I will mostly avoid it.  The episode began innocently, 6 months ago, with an ACC Business salesman calling us asking if we would like to take advantage of lower pricing.  We said yes, signed off, and that should have been that.  Unfortunately the sales person filed the papers incorrectly internally as a new service, setting us off on a kafka-esque adventure were two accounts were created for the same service and it seemed to be impossible, given ACC's internal systems, to merge the accounts without terminating the physical service in the field.  Every month ACC Business merrily billed us twice for the same service, and threatened immediate extinction if we refused to pay one or the other bill.

After spending over a dozen hours of my personal time on the phone with this company I discovered the ACC Business unwritten customer service rules:

1. No matter how many people told you that the person you are contacting is (finally) the right person, the person you are talking to is NEVER responsible for whatever it will take in their internal systems to fix the mess
2. Any past mistakes made by ACC (e.g. their creating a second account by accident) are actually the customer's mistakes, somehow
3. No matter how much time you spend on the phone with them, all past conversations are forgotten and inaccessible to the person you are talking to and thus require you to start from scratch trying to describe the issue and history to yet another new person.

I turns out there is a whole cottage industry of paid consultants whose entire job is to try to act as an intermediary between customers and ACC Business to fix these kinds of (apparently) frequent SNAFU's.  The very existence of such people should tell you all you need to know.  Such a consultant fixed my problem 2 months ago, I thought.

Until I got a note this morning from their disconnect department, saying in part:

If the information is not received within 2 business days, your request will be cancelled. At that time, you will be required to start the process over by contacting our Customer Care Department.

If you need assistance completing the required information or have any questions, please contact our Customer Care Department at 888-286-2686

Of course, per standard ACC Business procedure, the people at that phone number provided me in the email knew nothing about the email, and disavowed any involvement whatsoever with the disconnect department.  This is roughly equivalent to American Airlines telling you that you need to contact them about your upcoming reservation and then giving you a contact number in the catering department.   ACC Business customer "service" could not give me a direct number for the disconnect team or any way to contact them about this email.  So I called my consultant again and prepared to write them another check.

If there is any other way, any way imaginable, to achieve your goals without involving ACC Business I would highly recommend that alternative.

Postscript:  ACC Business has to be bad to displace my previous awful customer service award winners, which were several dying Yellow Page companies that went to quasi-fraudulent ends to try to avoid stopping my ad and ceasing to bill me.  Seriously, your customer service really has to be bad when your otherwise legal business model has worse customer service than a company resorting to fraud.

My family often jokes about my obsessive behavior vis a vis Tesla and Elon Musk (on the off chance you are unaware of my thoughts, the most recent are here).  My daughter texted me last night that "Wealthy millennials seem to love Elon."  And that is true.  My answer to her is the title of this post, "People who express opinions outside of their domain seldom have really looked into it much."

Of course, I am not in any way arguing for some sort of strong credentialism wherein people should not express opinions outside of their domain.  God forbid, I would have to shut down this blog.  But I am saying that just because someone is really smart and successful at A does not necessarily mean their opinion on B is worth squat.  As always, as a consumer of opinions, caveat emptor should always be the watchwords.

The first time I really encountered this phenomenon (outside of obvious examples such as the political and economic opinions of Hollywood celebrities) was related to climate change.  I don't see them as often today, but for a while it used to be very common for letters to circulate in support of climate change science signed by hundreds or thousands of scientists.

The list of signatures was always impressive, but when you looked into it, there was a problem:  few if any of the folks who signed had spent any time really looking at the details of climate science -- they were busy happily studying subatomic particles or looking for dark energy in space.  It turned out most of them had fallen for the climate alarmist marketing ploy that opposition to catastrophic man-made global warming theory was by people who were anti-science.  And thus by signing the letter they weren't saying they had looked into it all and confirmed the science looked good to them, they were merely saying they supported science.

When some of them looked into the details of climate science later, they were appalled.  Many have reached the same general conclusions that I have, that CO2 is certainly causing some warming but the magnitude of that warming or in particular the magnitude and direction of its knock on effects like floods or droughts or tornadoes, is far from settled science.

So it is often the case that people who show strong support for ideas or people outside of their domain do so for reasons other than having made use of their expertise and experience to take a deep dive into the issues.  Theranos is a great example from the business world.  Elizabeth Holmes convinced a bunch of men (and they were mostly all men -- women seemed to have more immunity to her BS) who were extraordinarily successful in their own domains (George Schultz, the Murdochs, Henry Kissinger,  Larry Ellison) to become passionate believers in her vision.  Which is fine, it was a lovely vision.   But they spent zero time testing whether she could really do it, and worse, refused to countenance any reality checks about problems Theranos was facing because Holmes convinced them that critics were just bad-intentioned people representing nefarious interests who wanted her vision to fail.

Which now brings us to Tesla and Elon Musk.  I used to love Elon like everyone else.  I still think that having four or five billionaires in a space race against each other is finally the world I thought I was going to get growing up reading Heinlein.  The Tesla Model S was probably one of the most revolutionary cars of the last 50 years.  But he lost me when he committed outright fraud in the Solar City - Tesla deal and since then have only become more skeptical about he and Tesla.

I sort of laugh when folks tell me that really smart successful rich people believe in Tesla.  You mean like James Murdoch, on the board of Tesla and who also was lost his entire investment in Theranos?  Or like Larry Ellison, an adviser and fan of Elizabeth Holmes who invested $1 billion in Tesla just 6 months ago and has already lost 40% of it?   The window on this is probably closing, but over the last 10 years if you wanted to get Silicon Valley investors to throw a lot of money at you, find a traditional bricks and mortar business and devise a story in which you take that industry and convert its economics to that of the networked software world (see:  Uber, WeWork, Tesla, and even Theranos is some of its strategic pivots).

Or how about true millennials and Elon Musk?  Name a wealthy millennial supporter of Elon Musk and Tesla and I can bet you any amount of money they have not looked at Tesla's balance sheet or cash flow or the details of its global demand trends.  They have not thought about its dealership strategy or manufacturing strategy and the cash flow implications of these.  They just like what Elon says.  It sounds big and visionary.  They buy into Elon's formulation that he is saving the environment and everyone opposed to him is in a cabal with big oil (ignoring the fact that Elon routinely uses his Gulfstream VI to commute distances less than 60 miles).  So saying that rich millenials adore Elon is effectively saying that they want to be associated with the same things Elon says he is for -- the environment and space travel et al.

Elon Musk is Ferdinand DeLesseps.  He is PT Barnum.  He is Elizabeth Holmes.   He is the pied piper.   He is fabulous at spinning visions and making them sound science-y.  But he is not Tony Stark.  There is a phenomenon with Elon Musk that everyone thinks he is brilliant until they hear him speak about something about which they have domain knowledge, and then they realize he is full of sh*t.  For example, no one who knows anything about transportation or physics or basic engineering has thought his Boring Company and Hyperloop make any sense at all.  His ideas would have been great cover stories for Popular Mechanics in the 1970's, wowing 13-year-old boys like me with pictures of mile-long cargo blimps and flying RV's.  He is like a Marvel movie that spouts science that is just believable-enough sounding that it moves the plot along but does not stand up to any scrutiny.

All of this would be harmless if he was not running a public company.  I don't really care about the rich folks who were duped by Elizabeth Holmes, but hundreds of thousands of small millenial investors who have totally bought into the Elon hype are literally putting their last dollar into Tesla, and sometimes borrowing more.  Tesla shorts often laugh at these folks on Twitter, calling them "bagholders," but it is a tragedy.  Unless Tesla finds a sugar daddy sucker, and the odds of that are getting longer, I think it is going to end badly for many of these investors

As a disclosure, I have been short Tesla via puts for a while now.  It you really want to understand Elon, the best book I can recommend is The Path Between The Seas about the building of the Panama Canal.  First, it is a great book you should read no matter what.  And second, Ferdinand DeLesseps is the best analog I can find for Musk.

A prior version of this article was published accidentally before it was complete.

I know I swore not to write about Tesla here and to confine myself to talking about Tesla on Twitter, but I can't help myself.  This is the company that is going to spawn a thousand business school case studies.  It is Enron but in the Internet Age with more transparency (or at least less sophistication in hiding their problems).

Over the weekend I re-read "The Smartest Guys in the Room" about the collapse of Enron.  I will admit I was an Enron fanboy at the time -- I drank the Kool-Aid and totally overlooked the problems.  I knew Jeff Skilling a little and worked for him on Enron when we were at McKinsey.  I believed he was brilliant and was doing what he said he was doing.  The crash of Enron took me years to accept, and only on my recent second reading of that book did I have the distance and objectivity to really understand it.  And I realized something else -- I was the same guy back then that I criticize today.  Skeptics of Tesla (including me) make fun of Tesla fanboys and their cult of Elon Musk and their belief of everything he says and their certainty he is the smartest guy in the room.  I understand them because I was that guy with Enron and Skilling.  Maybe Tesla is my chance to correct my past gullibility.

Anyway, just when I thought the story couldn't get any more dramatic (or weird), Elon Musk raises the bar.  Apparently Tesla is now only tangentially and largely irrelevantly an automobile manufacturer.  Instead, it is an autonomous ride-sharing company:

Citigroup and Goldman Sachs, who are underwriting Tesla’s latest effort to raise $2 billion in new funds, held a “broad investor call” on Thursday, where CEO Elon Musk and CFO Zach Kirkhorn answered brokers’ questions about their plans for the electric vehicle maker.

According to two invitees who attended the call, CEO Elon Musk talked up Tesla’s self-driving strategy right off the bat, expanding what he and other execs said at a recent event for investors that the company dubbed “Autonomy Day. ”

Musk confidently told investors on the call that autonomous driving will transform Tesla into a company with a $500 billion market cap, these people said. Its current market cap stands around $42 billion. He also said that existing Teslas will increase in value as self-driving capabilities are added via software, and will be worth up to $250,000 within three years.

This call was in the context of Tesla's offering this week of about $2 billion in new stock and convertible bonds.  The really interesting thing about the call:  Virtually 100% of the discussion on the call was about ride-sharing and autonomy, while neither word was even mentioned in the official written prospectus for the offering.

Before we can understand what the hell is going on here, and why Tesla is going all-in on a business it was barely talking about 60 days ago, we need to do some review.  I want to review where Tesla was last time I wrote about them, and also discuss new Tesla news and actions over the last 3-4 months.  From there, we will try to dissect what Elon Musk is doing.  TL;DR: I believe Musk is doing exactly what Jeff Skilling did at Enron, chasing new business strategies based on what stories he thinks will most likely goose the stock in the short term, rather than which strategies make the most sense in the long-term for his investors.

Where I was on Tesla at year end 2018

I had a lot of criticisms about Tesla's strategy towards the end of last year (here and here, for example).  But let me summarize some of the key points

• Tesla has taken what was already a risky entry into a capital-intensive industry and has made it even more expensive and risky by choosing to own both the dealer network and fueling networks for its cars -- this means it has to invest not only in auto manufacturing capacity but also in a world-wide network of sales and service centers and in a global network of charging stations
• Inexplicably, just as its production volume began ramping up in mid-2018 with the introduction of the mid-priced model 3, Tesla ramped down on its capital spending, R&D, and SG&A spending.  By the first quarter of this year, capital spending was no longer even keeping up with maintenance needs.  This was absolutely inexplicable for a growth company that has promised many new products in the near future (new coupe, semi truck, model Y crossover), all of which will need a plant and equipment to produce.  Further, Tesla slowed investment in its sales, service, and charging networks at the exact time its fleet size exploded, leading to a lot of customer dissatisfaction
• The decrease in these expenditures was likely tied to Tesla's hard to fathom (I seem to be searching for a lot of synonyms for "inexplicable")  decision not to raise capital last year.  Its stock was over $350 a share and it had huge momentum from its first two profitable and cash flow positive quarters.  By almost everyone's analysis, they should have raised $5 billion or more, which might have only created 10% dilution.  (Instead they waited until this week after a terrible quarter and after the stock had fallen to about $235 to raise just $2 billion, barely enough even to fill their accounts payable hole).
• Tesla and Musk claimed that the growth and performance of the 3rd and 4th quarters of 2018 were harbingers of the future and he extrapolated hockey sticks from these data points.  Skeptics like myself believe that this was merely a one-time bulge, that Tesla had sold through 2-3 years of demand in their order book in just 2 quarters, and that the first quarter would be a disaster now that the tank was dry.  In addition, Tesla has culled its order book of all the highest margin variants where it could actually make money, leaving what remained of the unfilled orders as low-margin variants it was barely worth selling.  [By the way, I figured none of this out on my own, and owe a lot to the great folks at $TSLAQ on Twitter, who bring a lot of free research to bear that made it easy to see these patterns].
• My admiration for Musk as having really shown the automobile world that electric cars can sell at high price points (and not as little sh*tboxes) and for his space entrepreneurship really ended with the SolarCity deal.  In that deal, Tesla shareholders overpaid for a failing business simply to bail out Musk and his family from a sinking ship.  The acquisition made absolutely no strategic sense and Tesla has done zero to try to develop it, and in fact has been slowly shutting it down from the moment it was purchased.
• Elon Musk has steadily lost any credibility he might have had by initiating product launches of products he claims are nearly ready for sale but never get introduced.  Tesla got a higher level of subsidy from California based on a single suspicious battery swap demo that has never been repeated or even discussed since.  Musk sold SolarCity to Tesla in part based on a flashy reveal of a solar shingle product that still has not seen the light of day.  Musk had a big reveal of the Tesla semi and started taking customer deposits but there are still no clear plans for its production.

What has happened at Tesla this year

• The first quarter of 2019 was a disaster, with deliveries down despite initiation of Model 3 sales in Europe.  Worse, since the Model 3 seems to be cannibalizing Model S and X sales, Tesla was not only selling fewer cars but its mix shifted to lower priced less profitable cars.  It lost an enormous amount of money, and only after the conference call with analysts about first quarter results did Tesla reveal that this loss would have been far worse without a huge sale of government EV credits
• Tesla burned a staggering amount of cash in the first quarter, and was forced to pay off nearly a billion dollars in debt when the stock price did not remain high enough for the debt to convert.  While Tesla's cash balance at the end of the quarter looked OK, there were two huge red flags. First, the cash barely covered a huge hole Tesla had in its net working capital.  Second, given the large number of vehicles Tesla sold in its end of quarter push in the last 2 weeks of the quarter, it appears that Tesla was nearly out of cash in Mid-March and perhaps days away from a default (analysis below).
• The Tesla financial statements still include a number of unexplained oddities, including a billion dollars of accounts receivable, or about 20% of quarterly revenues.  How does a company that demands payment in advance before delivery have 20% of its quarterly revenues tied up in receivables?
• Tesla announced, out of the blue, that it was closing all its retail stores and going online only.  Given the drop in demand for the quarter, it was a head-scratcher as to why eliminating the sales force was going to help.  The decision seemed to be almost off the cuff, as Tesla seemed surprised that they would still have to continue paying their expensive long-term mall leases.  After this was revealed, Tesla partially reversed the closure decision, but no one -- including their own retail folks -- seems to know what the plan is now.
• Tesla constantly fiddled with its prices and model lineup.  It cut prices several times, but also announced a small raise as well.  It eliminated certain options for cars, added new ones, and then reintroduced eliminated ones.  Even long-time Tesla watchers are confused about the model lineup today.
• Tesla continued to see an outflow of executive talent, including the exit of their very well-respected new General Counsel after just over one month on the job  (Mr. Buttswinkas returned to his old law firm and purged Tesla from his resume).  This seemed to parallel the rapid exit of an outside chief accounting officer last year who gave up millions of dollars to exit in just 60 days.
• April car deliveries stayed on the same pace as the first quarter -- ie, way worse than Tesla's guidance
• Elon Musk continued to get in trouble with the SEC, firing off production and sales guidance on Twitter that was different from Tesla's official published guidance.  Mr. Musk and Tesla are still guiding to a total delivery number for the next year that is well in excess of what most anyone else looking at the first four months believes is possible
• Tesla announced a reveal of their Model Y crossover that will not go on sale until at least the end of 2020.  Unlike past Tesla reveals, this one seemed hastily set up and the prototypes shown were weird.  They looked more like the existing Model 3 with a few modifications than a promised crossover that could incorporate a third row of seats.  Tesla asked customers to start making deposits (skeptics will argue that the whole point of the reveal was just to get some free financing from Tesla fanboys) but unlike past reveals, this one fell flat.  There was apparently little interest in making deposits, though Tesla (unlike with past products) has not revealed the deposit numbers.
• Lyft went public for over $20 billion and Uber is planning a $70+ billion IPO, despite having a history of negative earnings and promising investors they may not make money for 10 years (more on this in a minute)
• After the Model Y went nowhere, Tesla set up what they called "investor autonomy day."  Tesla outlined their strategy for creating a fleet of self-driving cars, and promised fully autonomous cars by the end of 2020.  With these fully autonomous cars, Musk promised that Teslas would become an appreciating asset in that they earned income for their owners as autonomous taxis when the owners were sleeping.  He also said Tesla would own a fleet of taxis itself, using off-lease model 3's for this purpose.
• As described at the top of the article, Tesla raised over $2 billion on verbal promises by Tesla (not echoed in the deal prospectus) that Tesla was soon to be a $500 billion autonomous taxi company

So what is Tesla doing?

Having written all of the above, I realize I have left so much out -- the product quality problems, the worker lawsuits, the autonomous driving deaths, the spontaneous car fires -- but I only have so much time.  If you are interested, @teslacharts on Twitter is a good place to follow Tesla from the skeptic side.  But given all this, what the hell is going on?  The following is my theory.

I think in the 3rd quarter last year, Elon Musk honestly believed that the huge ramp in sales and profits at Tesla represented Tesla permanently turning the corner.  He extrapolated from that growth and believed it would continue for years -- he did not see it as simply the one time working through of years of pent-up orders and demand.  As a result, he put off the capital raise he should have been doing, and instead had dreams of taking the company private and getting away from all the scrutiny by analysts and shorts that seem to irritate him.  Thus was launched the ill-considered "420" tweet when he claimed he had funding secured for a go-private transaction at $420 a share, when in fact this was an outright lie.  Once the SEC stepped in to investigate, a new funding round was almost impossible.

Then, in the first quarter, reality hit Tesla in the face.  For all their public optimism, Musk had to see that the demand he expected was not there and Tesla was likely running low on cash.  I think Musk had convinced himself the convertible bonds due in the first quarter would surely convert (and would have at the third quarter stock price) but now Tesla was doing the opposite of raising capital, it had to pay off debt.  Cash was going out the door and demand was weak.  What to do?

Musk has a demonstrated pattern that whenever he needs the stock price to be higher, or he needs to sell stock, or he needs some other kind of favorable financial outcome, he will do a new product demo. It worked for battery swap and the solar shingle and the model 3 and the semi, so it would work again.  The model 3 reveal had collected hundreds of millions of dollars of cash in the form of deposits.  That's what he needed now.  The problem is, they didn't have a prototype to show.  I believe Musk had the company hastily create a Model Y prototype built on top of a model 3.  It did not really have to work, it just had to be something he could talk about.  Interestingly, his VP of engineering quit at exactly this time, for reasons unknown -- was their some internal dissention about this Y prototype?

Anyway, the Model Y reveal was essentially a flop, and likely garnered few deposits.  Certainly not enough to fill in Tesla's growing cash hole.  And by Mid-March, Tesla may have been almost out of cash.  Tesla says it delivered half its vehicles for the quarter in the last 10 days of March, so about 31,500 were delivered in those hectic days.  At an average price of $50,000 each that would mean Tesla brought in nearly $1.6 billion in cash those last 10 days (this is conservative, may have been more if the average price was higher).  But they only had $2.2 billion at the end of the quarter, meaning Tesla was scraping bottom in mid-March, particularly since hundreds of millions of that cash is restricted and not supposed to be spent.

Somewhere in this period of March-April, after his usual product reveal trick with the Y did not work, I think Musk came to the conclusion that the Tesla car business as currently defined was not going to work.  Or, more accurately, it was never going to make enough money to support its sky-high stock valuation.  I have always said that Tesla would make a fine $10 billion niche car company, but nothing about it justifies a $50 or $60 billion valuation.  But at this point Musk can't accept a $10 billion company, even though that would ostensibly still leave him a very rich man.  But like Ken Lay at Enron, Musk has borrowed against at least half his Tesla stock and a falling stock price could lead to financial death by margin call (Musk, for some reason, also mortgaged all his multi-million dollar homes last December). His other investments are also struggling -- SpaceX has been unable to attract the capital it needs of late and Musk has poured a lot of money into the Boring company, an absolute embarrassment of a company that helps refute, in my mind, his "smartest guy in the world" rep.

As Musk looked around for a way to save the stock valuation, the Lyft and Uber IPO's must have had an influence.  Uber is losing as much money as Tesla and folks are talking about it IPO-ing at a market cap of $70 billion.  What if Tesla could call itself a ride-sharing company, only better.  Wouldn't that garner Tesla an even higher valuation?

So I see investor autonomy day and Musk's autonomy soliloquy on the capital raise call the other day as evidence that Musk has, in his mind, capitulated on auto manufacturing and has decided the way to keep Tesla's stock price up is to promise it will -- in just 20 months -- sell fully autonomous vehicles and be making tons of money selling taxi rides.  In other words, it is a robotaxi company that happens to be backward integrated into manufacturing the taxis.

I am skeptical for a number of reasons.

• This reeks of desperation and capitulation.  If Dell says they are going to reinvent themselves as a search engine, it's time to sell the company
• There is no evidence that Tesla can achieve full autonomy by end of next year and a lot of reasons to think they can't.  Most experts think full autonomy is decades away, and when they rank companies on their progress on autonomy, Tesla is usually near the bottom (e.g here).  Waymo and GM, the leaders, often go thousands of miles between driver interventions.  Tesla is hundreds of times worse.   Even over the short course at Investor Autonomy Day (where Tesla likely trained and practiced in advance) investors reported a driver intervention was needed.  Now imagine the same car with no driver.  In snow with the road markings obscured.  Driving through construction where new routes are confusingly marked off with cones.
• The basic business numbers Musk throws around are absurd.  Just as one example, he extrapolates from current ride-share prices and assumes Tesla will make a ton of money because they will get the same price but not pay the driver.  But this is crazy.  If Tesla suddenly throws a million taxis into the rideshare supply equation, rates are going to fall.  Already, since 2012, Uber reports its average fare per mile has been reduced by over half.  If everyday folks are having their cars drive autonomously at night to earn extra money, the fee per mile is going to be competed down close to the cost per mile of operating the vehicle (or even lower, since most folks underestimate their all-in cost per mile on their vehicle).  Musk is basically proposing to commoditize the market but still reap premium margins.  Not going to happen.

Warning

Note that this article is simply my analysis and in some cases my guesses.  I think the story holds together but I can be wrong.  I am short TSLA via put options but note that this is a modest investment that is a small percentage of my portfolio.  Tesla is a dangerous stock to short.  Right through the bad news, individual investors at RobinHood have been loading up on the theory they are buying the dip.  20,000 people added TSLA to their portfolio at RobinHood just AFTER the horrible first quarter report.  Be very careful

Bonus -- Tesla's Largest Mistakes

No matter what happens, Tesla will always be remembered as the company that brought EV's mainstream.  But like any tragedy, they have made some fatal mistakes.  This is my attempt to get out ahead of future business school cases and rank their largest mistakes:

1. The Model 3.  Tesla could have been a profitable luxury car maker but with the Model 3 tried to go for the low to mid end of the market.  But it does not have the manufacturing expertise or cost position (it assembles in California, for God sakes) to pull it off.  The quality problems it encountered have reduced its brand luster, and the volumes of cars have overwhelmed its service and charging networks.  Investments in the Model 3 have distracted it from real refreshes of its S and X and in fact the Model 3 has cannibalized those more profitable cars.  A higher end crossover would have been a better choice
2. No third party dealers.  Tesla chose to bring the sales and service function in house.  This was a mistake.  Not only did it eat up capital, but it robbed it of valuable marketing partners such as Penske that could have really helped its sales ramp.
3. No 2018 capital raise.  Rather than tweeting 420, Musk should have been raising capital based on its third quarter results.  The money was there to be had and Tesla needed it.  $5billion at least could have been raised with little dilution effect
4. SolarCity Purchase.  This was a complete sham to bail out the Musk family and friends.  Did absolutely nothing for Tesla except drain billions of valuable capital
5. In-house Manufacturing.  Musk often says he wants to be like Apple, but Apple is a design company.  It does not manufacture and for quite a while did not do its own retail.  Tesla would have been better off finding a manufacturing partner rather than manufacturing itself in the highest cost location in the country
6. No Charging Partner. I think Tesla had to build out its charging network at first to eliminate one of the greatest consumer barriers to purchasing an EV.  But they should be partnering to share the costs.  Instead, Tesla still thinks of its charging stations as a competitive moat.  But as other car makers form consortia for charging networks based on faster charging technologies, Tesla is stuck with an expensive network that needs upgrading.  Its more of an anchor now than a moat

2nd Bonus -- Another Musk parallel if you are tired of Enron comparisons

Even more than Skilling and Enron, the person Musk most reminds me of is Ferdinand de Lesseps, whose attempt at building a French canal in Panama ended in spectacular failure.  I highly recommend the book "Path Between the Seas" for folks who want the whole story.  When I have time, I may post on the parallels. I presume Tesla critic @ElonBachman would agree since he uses de Lesseps' picture as his twitter icon but I have never seen him discuss it.

I was listening this evening to the excellent Hidden Forces podcast on Tesla and they said something that really resonated with me -- its hard to discuss Tesla because there is so much crazy stuff going on:  A CEO who in many ways channels Donald Trump's worst characteristics; multiple SEC investigations, an ongoing contempt hearing; a story yesterday about thuggish behavior towards a whistle blower; strategic moves that are made, unmade, and then changed again in just a few weeks; astoundingly high turnover in management ranks, including an esteemed general counsel who couldn't hung around for even 60 days and then purged all reference to Tesla from his CV; fantastically passionate bull and bear communities; expansive promises that are seldom kept; outright fraud -- all in a company valued at $60 billion dollars and whose stock price rose 2% today under a barrage of negative news that would melt companies that have 100-year track records.  I have been meaning to do an update on Tesla but where to start?  How can I even bring readers unfamiliar with the story up to date?  I have started and stopped this article about three times, but now I am going to plow through and get something out.  If it is not entirely coherent and far from complete, my apologies.  If you want more, go to @teslacharts on Twitter as a starting point and you will discover a lot of really smart people who are, believe it or not, even more obsessed by the Tesla train wreck than I.

In the past I have limited myself to two issues.  The first is the outright fraud of the Tesla acquisition of SolarCity, another Musk company that was going down the drain until Tesla bailed it out.  The transaction appeared (even at the time) so transparently self-serving to Musk and his family that it just screamed fraud, and time has only made this clearer.  Musk sold the synergy-less acquisition to Tesla shareholders based on a solar shingle technology he portrayed as ready to go, but that still has not seen the light of day 2 years later.  In retrospect, it is crystal clear the solar shingle was a sham that was fraudulently hyped to make the deal go through.  This fire and forget approach to new product announcements has become very familiar at Tesla -- Musk scored extra subsidies from California with a battery swap technology he demonstrated one time and then has never been seen again, and Musk announced a new Semi truck and harvested a number of deposits for the vehicle and then has not even mentioned the product for months.  Since the acquisition, SolarCity new installations have fallen precipitously every quarter, demonstrating that Tesla had no real commitment to the enterprise, and this is only going to get worse as Musk announced that its last remaining sales channel is going to be closed.

The second Tesla issue I have tangled with is the strategic dead end that Tesla has reached, and the bizarre fact that a company in a capital intensive industry that is valued as a growth company has, over the last 12 months, virtually shut down R&D spending and now does less capital spending for its size than does even staid companies like Ford.  I won't cover all this ground again, I refer you to posts here and here-- If you are new to the Tesla story, start with these.   But in short, Musk made the fateful choice to take what was already destined to be an uphill climb for a new company to penetrate an extraordinarily capital intensive industry and made it an order of magnitude more capital intensive by his strategic decisions.  Specifically, Musk chose not only to start up car manufacturing from scratch, but to also build out his own sales and service network AND build out his own fueling network.  Kia was the last brand I can remember that penetrated the US market, and it only had to worry about investing in building cars -- it relied on third parties like Roger Penske and Exxon to build the sales, service, and fueling networks.  But Tesla is committed to building out all three.

This strategic decision really began to drag on the company in 2018.  Tesla's decision to do its own manufacturing -- in freaking California no less -- held back its growth as it spent years relearning auto manufacturing lessons already well-known to other players.  It has fallen behind in Model 3 production vs. its own stated goals and there is no apparent progress adding manufacturing capacity for a raft of announced but still theoretical products (semi, coupe, Model  crossover, pickup truck, revamped S&X).   A better approach might have been to contract for manufacturing like Apple does with the iPhone, especially since there seems to be a lot of excess capacity right now in Chinese auto production.  Even worse, as their fleet grew with the Model 3 ramp, Tesla was not able to invest fast enough to grow its sales, distribution, and service networks in proportion, leading to a lot of disgruntled customers that had bad delivery and servicing experiences.  The same is true for their charger network, where they have again not been able to keep up with investment and are now falling behind technologically as new entrants have faster charging times, times Tesla can't match without a major investment in upgrade of its network.  More manufacturing capacity, a better distribution network, more sales locations, more servicing capacity, more body shop capacity, more parts production capacity, more chargers and massive charger upgrades -- Tesla fell behind on ALL of these in 2018.

And then the really weird thing happened.  Sometimes growth companies fall behind when they grow to fast, but Tesla seemed to have stopped even trying to keep up with capital needs in the second half of 2018.  Their R&D fell, despite many promised new products that were a long way from delivery.  Their Capex levels fell to barely maintenance levels (what might be expected to just keep current plant running) and were reduced to levels as a percentage of sales that were lower than staid, traditional, non-growth auto makers.  Right when they really needed to make a capex push to make their strategy a reality, they stopped spending.

Tesla claimed, and claims to this day, that any slowdown is just the result of efficiency and responsible management.  But this is crazy.  Growth companies slow down and focus on profitability when the market is saturated and the growth phase is over.  Uber has not slowed down.  Even Amazon 20+ years in has not slowed down.  Slowing down is death for the stock price of a growth company, and Musk is -- if anything -- obsessively focused on the stock price.  Tesla is currently valued north of $60 billion. Without enormous growth expectations, a $20 billion valuation might be too high.  Added to this is the fact that after having the luxury EV market to itself for years, competition is finally coming from nearly every luxury care maker.  Tesla's 10-year moat is down to maybe 6 months.  It needs to be updating the S & X and rushing new products out ahead of competitors.  But they have almost given up on the S & X and Audi has beaten them to the market by at least a year and maybe two with a crossover model (the e-tron), a very popular format in the US right now.

And at first there does not appear to be any reason for this slowdown in spending.  Tesla has a stock that a dedicated group of fans gorge themselves on.  With a $60 billion valuation and a passionate fan base that thinks the company is still undervalued by at least a third, this company should be able to raise billions of capital easily.  They could theoretically raise $5 billion with less than 10% dilution -- Tesla almost dilutes itself that much every few years just from employee stock-based compensation.  Add its lofty valuation to what was reportedly $3.5 billion or so of cash on their balance sheet at the end of last year and consumer demand that the CEO describes as near-infinite, and this does not look like a company that should be slowing down.

How do we reconcile these facts  -- a near halt in growth investments despite lots of cash and a sky-high stock valuation?  Here are a few things going on under the surface:

• While Tesla had over $3 billion in cash, they also had over $2 billion in payables.  The company has a reputation of stretching payables to the absolute limit.  It may well be that the end of year cash number was the result of a lot of window dressing.  In fact, Tesla skeptics have looked at the interest they earned on their free cash in the fourth quarter and have argued that for this number to be as low as it was, Tesla's average cash balance must have been much lower than their end of year reported number.
• Savvy observers (of which I am not one) who know Wall Street argue that Tesla may well have either regulatory (e.g. SEC investigations) or practical (e.g. information they do not want to disclose in a prospectus) barriers to raising capital, and that the lack of a capital raise for many months can only mean that for some reason Tesla can't raise.
• Tesla just had to pay off nearly a billion dollars in convertible bonds when the stock price was not high enough to trigger the conversion
• Demand for Tesla cars in the US has fallen substantially in the first 2 months of this quarter.  Musk liked to portray the huge Model 3 sales ramp in 3Q18 and 4Q18 as the start of an S-curve, but now those quarters look more like a one-time bulge as Tesla blew through over 2 years in orders in just a few months.  Aggressive pull-forwards of demand by Tesla in the fourth quarter as well as the reduction in US and Dutch EV subsidies have also hurt.  [I have to add one note here just for color.  The Tesla fan boys have argued to me on Twitter that Musk has already explained this to their satisfaction -- that Tesla is diverting cars away from the US for their European Model 3 introduction.  This makes ZERO strategic sense.  What company ever enters a new market by giving up hard-won market share in their core market?  There is plenty of evidence that everyone who wants to buy a Tesla in the US is getting one with a very short lead time, implying this is a real demand drop and not Musk's typical supply-constraint story.]

A month or so ago I thought it very possible given these headwinds that Tesla may soon be facing a cash crunch if it cannot do an equity raise.  However, new events that have occurred over the last week convince me that this cash crush is almost a certainty.  There is no way I can explain Tesla's most recent actions as anything but a company desperately trying to stave off a near-term bankruptcy.  These actions include:

• In early March, Tesla's February sales numbers in the US were announced, and they were a disaster.  Within mere hours of this reveal, Musk teased an announcement (on Twitter, where else).  This event turned out to be a quasi-secret invite-only conference call involving what appeared to be hand-selected media members who had historically been generous to Tesla (only a later uproar by bulls and bears alike forced Musk to release a transcript. On the call Musk announced two things --
  1. Tesla would begin taking deposits for the long-awaited $35,000 Model 3 (though delivery dates were hard to pin down).  Musk had said not too long ago that Tesla was not able to make this car yet profitably, and he refused to discuss margins on the vehicle.  Skeptics like myself suspected that the car can't be made right now for a positive gross margin, and instead this was a back-door attempt to gain new financing via customer deposits.  A couple hundred thousand (theoretically) deposits of $2000 each could yield some real money for a cash-strapped company.  The only thing Musk would say about controlling costs on this product was #2:
  2. In a totally unexpected (even to most of Tesla employees and management) announcement, Musk said Tesla was closing its stores and going to an online-only sales model.  This would supposedly save 6% of the cost of the new cheaper Model 3's, ignoring of course that SG&A reductions do nothing to fix a zero or negative gross margin.  Everyone, including most especially Tesla store employees and maybe even the Tesla BOD, was stunned.  Here is a company whose US sales are going over a demand cliff and they respond by ... eliminating their stores and sales force?
• Simultaneously, Tesla has been announcing a series of price cuts on, worryingly, many of their highest margin products including the S and X and high-margin upgrades like paint and autopilot on the Model 3.  Almost no one can see how the company makes any sort of viable gross margin at these prices, and they have the look of desperation.  All these cuts did was aggravate buyers who had just paid the higher prices and who faced a suddenly lowered resale value for their car.
• Within days of the store closing announcement, the WSJ and others published stories about how Tesla was unlikely to see much savings from these closures as their leases all had expensive cancellation clauses that Tesla could still be on the hook for as much as $1.5+ billion.  Incredibly, this seemed to come as a surprise to Musk and helped reveal just how slapdash these announcements were.  Since then Tesla has announced that maybe some stores would stay open and maybe some sales people would not be fired but just have their bonus eliminated.  As I write this, no one really knows what Tesla is going to do, but to many observers this move looks more like what one does in a bankruptcy than in the normal course of growing a business (in fact, bankruptcy is the one time lease cancellation costs can sometimes be evaded).
• Tesla, furthering their management Abbot and Costello act, partially reversed their price cuts saying that prices would now rise a few percent, barely days after they were cut.  The net of the two announcements still result in vehicle prices substantially lower than in 4Q2018.
• In an incredibly bizarre move (and there is a pretty high, or low, bar with Tesla for saying something is truly bizarre), it was recently revealed that Tesla last November bought a trucking company, or really they bought a bunch of trucks, with stock.  Essentially, this is a $60 billion company with supposedly $3+ billion in cash and they are paying their suppliers in stock.  Oh, and by the way, remember when I said above that Tesla had already vertically integrated too much and could not afford their capital needs already?  Well, this is yet another silly vertical integration.  Tesla has no business being in the trucking business, a highly competitive business with a lot of incentives to offer good deals and great service for an incremental bit of demand from a growing company like Tesla.  My sense was always that there is plenty of 3rd party trucking capacity out there, but that truckers just did not like serving Tesla because Tesla pays its bills so slowly and acts so unpredictably and imperiously.
• Tesla continues to produce Model 3's near full volume (around 5500 a week, despite what the nutty Bloomberg model says) even given a fall in demand.  Tesla seems to be building inventory, and certainly the recent price cuts are not a sign they are supply constrained (as Musk continues to insist).  Tesla skeptics believe that Musk has signed a number of supplier deals where Tesla got rebates and price cuts in exchange for volume guarantees, and that Tesla is stuck over-producing cars or it will have to return a lot of money.  [update: @Paul91701736 who goes by Machine Planet on Twitter spends a lot of time observing and researching Model 3 production and says "there's one thing in this piece I can't agree with, a 5500/wk Model 3 production rate. I think ~4700 is the absolute max sustainable rate and it's been well below that most of the quarter"]
• Tesla is asking customers in Europe, as they did late in 4Q18 in the US, to pay Tesla the full price of the car even before they see it or schedule a delivery.  Frankly, I am staggered anyone would buy a car this way, especially with the fit and finish problems Tesla model 3 customers have found on delivery.
• Tesla added about $500 millon to its asset-back bank line of credit and continues to roll over some SolarCity debt.
• When it was obvious that the Model 3 announcement had not created enough deposit activity, Musk then announced they would introduce the long-awaited Model Y crossover, in a reveal set for Thursday afternoon March 14.

Tesla has admitted that it still has not even decided where to build the Model Y, much less started building the plant and tooling up for it.  Given that, the car HAS to be 18-24 months away.  So why reveal now?  Remember that Musk and Tesla have a history of using new product reveals as fund raising tools.  The fake solar shingle product got Tesla to buy SolarCity.  The fake battery change demonstration got Tesla millions in added subsidies from California.  The complete vaporware Tesla semi reveal gained Tesla millions in deposits from corporations that probably didn't expect to ever get the truck but wanted to virtue signal their green credentials (Tesla seldom mentions this product and has announced no plans for actually building it).  The announcement in April, 2016 of early reservations for a $35,000 Model 3 which turned out to be over 2 years ahead of it ever being available in volume occurred just ahead of a funding round.  I am sure experienced Tesla observers could list many more examples, but the point is that there is very good reason to believe that the Model Y reveal (and maybe a pickup reveal in the same way the coupe was thrown in on the semi reveal) is a cynical, desperate attempt by Tesla to raise some cash from consumer deposits.  My guess is that it will not work so well -- the recent $35,000 Model 3 announcement garnered few deposits and Tesla had disappointing deposit activity when they opened up Europe.  Surely folks have observed that putting down a deposit does not get one a car any faster, and just makes one an unsecured creditor of the company (and may even, as was the case recently, sign one up to pay a higher price than folks who come in only a few weeks later).

As an aside, you folks know that as a libertarian I do not advocate for a lot of extra regulation so take the following as a prediction rather than necessarily a recommendation.  Tesla has pioneered the deposit-taking, go-fund-me model for new car introductions, and I think that when this all blows up and the dust clears, one of the results will be tighter regulation of how companies handle deposits on their books.  I would expect the SEC to require better transparency on deposit numbers and that customer deposits be escrowed in some way and not co-mingled with general operating funds.  And while we are at it, I will recommend one regulatory / accounting change -- the ability of car companies to leave ZEV credits off their balance sheet entirely and use them like magic pixie dust out of the blue to spice up random quarters needs to end.  These are real assets and need to be disclosed on the books like real assets.

Disclosure:  I am short Tesla via long-dated puts.  Shorting Tesla seems to make a lot of sense but it can be dangerous and harrowing.  Yesterday we were looking at news of Elon Musk acting like a Mafia thug with whistleblowers and still dealing with the fallout of Tesla's rapidly changing and contradictory strategic announcements, and the stock was up 2%.  Be careful.

I have written before that the caller ID system in the US is totally broken.  It is bad enough at home, but there are legal protections against spamming home numbers that mitigate some of the issues.  I will tell those of you who complain about spam on your cell phone or home phone that you have not seen anything until you have a business line.  The calls are endless, and caller ID is totally useless because every telemarketer seems to spoof the caller ID.  I have almost stopped answering by business number (more on that in a minute).

I did answer one call the other day that said it was from something like Loretta Smith.  I picked up and answered (thinking it might be a customer) and the person, obviously a male, said "I am calling from Such and Such capital company".  I get these all the time - banks won't make cash flow loans to any small business, even one with over $10 million in sales, but everybody and his dog wants to do equipment leasing.  So I began calling the person Loretta.  After a few times of this he got mad and asked why I kept calling him Loretta.  I said the caller ID system said he was Loretta, and that if that is incorrect it likely means his company is spoofing the system and that I was super unlikely to make a major financial transaction with a company whose very first contact with me was based on fraud.

As I said, I have mostly stopped taking calls.  I have a voice mail message that tells folks my email and that they are welcome to email me and I will get back to them promptly, which I do.  I still encourage front line employees and customers to contact me personally if they are having an issue my local managers can't fix.  I used to get these calls by telephone but I just can't answer my phone any more, it wastes too much time dealing with spam.

I have written about my personal frustrations before but what really got me to write this post was a contact with a sales rep for a product I was buying.  This person's entire income comes from phone calls from customers wanting to buy this company's product (for which they are the exclusive local distributor).  This is a one-time product sale and so typically she does not know her customers, they are all new.  When I first called, I got her voice mail.  In the middle of leaving a message, the person picked up and said she was sorry but she hesitated to answer her phone due to all the spam.  Can you imagine?  A salesperson who depends on people calling to buy product that doesn't want to pick up the phone.  That is a broken system.

Perhaps it was always this way, but I am just at the end of my rope dealing with service businesses.  Whether it be my roofing contractor or my bank or my background check provider -- really almost everyone -- absolutely no one seems to be able to follow through on service promises.  Increasingly I have to keep a long tickler list of things that my service providers should just reliably do as promised, but that I have to repeatedly follow up on with reminders and such to make happen.  It is exhausting.

In the spirit of something John Scalzi has done in the past -- he posts some of his 1-star Amazon book reviews online as a sort of therapy -- I like to share some of my favorites.  This one is not quite a one-star review but it made me laugh this morning:

Lol, we are closed for the winter (the TVA, who owns this campground, requires that the campgrounds near its dams be closed in winter).

By the way, this is from my daily report at Reputology.com.  They work well for me managing reviews over multiple locations.

Today after the market closed was Tesla's analyst conference call to review  fourth quarter earnings.  TL:DR It was as weird as ever, maybe weirder.  Even before the call, Elon Musk said that the numbers released today would be un-audited, and the call ended by saying -- in a sort of "oh by the way" over the shoulder parting shot -- that their CFO was leaving and being replaced by a 36-year-old with only Tesla experience and no prior CFO role (not unlike the random young dude that the Arizona Cardinals just hired as their coach, but that is another story).  Neither Musk statement was a big confidence boost given the myriad questions swirling around the legitimacy of Tesla's reported financials.  But the REALLY weird stuff was in between.

The LA Times, which really has had some of the best Tesla coverage, has the best summary I have found so far of the call.  Before I get into some things we learned that helped support my article I wrote the other day, I want to share some of the priceless other highlights of the call.  All from the LAT article:

Tesla faces questions about whether enough new Model 3 sedans can be sold to generate substantial profits.

“The demand for the Model 3 is insanely high. The inhibitor is that people don’t have the money to buy one,” Tesla Chief Executive Elon Musk told analysts on the call.

Yes, I am like an addict on Tesla but I find the company absolutely fascinating.  Books and HBS case studies will be written on this saga some day (a couple are being written right now but seem to be headed for Musk hagiography rather than a real accounting ala business classics like Barbarians at the Gate or Bad Blood).

I still stand by my past thoughts here, where I predicted in advance of results that 3Q2018 was probably going to be Tesla's high water mark, and explained the reasons why.  I won't go into them all.  There are more than one.  But I do want to give an update on one of them, which is the growth and investment story.

First, I want to explain that I have nothing against electric vehicles.  I actually have solar panels on my roof and a deposit down on an EV, though it is months away from being available.  What Tesla bulls don't really understand about the short position on Tesla is that most of us don't hate on the concept -- I respect them for really bootstrapping the mass EV market into existence.  If they were valued in the market at five or even ten billion dollars, you would not hear a peep out of me.  But they are valued (depending on the day, it is a volatile stock) between $55 to $65 billion.

The difference in valuation is entirely due to the charisma and relentless promotion by the 21st century's PT Barnum -- Elon Musk.  I used to get super excited by Musk as well, until two things happened.  One, he committed what I consider outright fraud in bailing out friends and family by getting Tesla to buy out SolarCity when SolarCity was days or weeks from falling apart.  And two, he started talking about things I know about and I realized he was totally full of sh*t.  That is a common reaction from people I read about Musk -- "I found him totally spellbinding until he was discussing something I am an expert in, and I then realized he was a fraud."

Elon Musk spins great technology visions.  Like Popular Mechanics magazine covers from the sixties and seventies (e.g. a flying RV! a mile long blimp will change logging!) he spins exciting visions that geeky males in particular resonate with.  Long time readers will know I identify as one of this tribe -- my most lamented two lost products in the marketplace are Omni Magazine and the Firefly TV series.  So I see his appeal, but I have also seen his BS -- something I think a lot more people have caught on to after his embarrassing Boring Company tunnel reveal.

Anyway, after a couple thousand words of introduction, here is the update:  In my last post linked above, I argued that Tesla is a growth company that is not investing in growth.  Sure, it is seeing growth in current quarters due to investments made over the last decade, but there is little evidence it is actually spending money to do anything new.  It stopped managing itself like a growth company trying to maintain its first-mover advantage.

Tesla has explicitly chosen to pursue a strategy that needs a TON of capital.  Everyone understands, I think, that building a new major automobile franchise takes a ton of investment -- that's why they are not popping up all the time.  But Tesla actually has made choices that increase the capital needed even beyond these huge numbers.  Specifically, they chose not just to manufacture cars, but to also own the sales and service network and to own the fueling network.  Kia was the last major new brand in the US that I can remember, but when it started it relied on 3rd parties to build and operate the dealer/service network and relied on Exxon and Shell to build out and operate the fueling network.  So Tesla has pursued a strategy that they need all the capital of Kia and of the Penske auto group and of Exxon.  Eek.

And for years, they were valiantly trying to pull it off.  They created showrooms in malls and created a new online selling process.  They built some service locations but as has been proven of late, not enough.  They built a supercharger network.  It was a gutsy call that seemed to be paying off.

And then something weird happened.  Somewhere in late 2017 or early 2018 they stopped raising capital and greatly slowed down both R&D and capital investment.

• They slowed expanding the service network at the very time that their installed base of cars was going up exponentially and they were getting bad press for slow service.  Elon Musk promised that Tesla would create its own body shops but nothing has been done on this promise.
• They slowed the Supercharger network expansion at the same time their installed base has dramatically increased and at the same time new competitive networks were begun by major players like Volkswagen.
• They stopped expanding the Model 3 production line at the same time it was clear the current factory could produce only about 5,000 cars per day (with some quality tradeoffs at that) and Musk continued to promise 10,000 a day
• They promised production in China by the end of this year but so far the only investment has been a groundbreaking ceremony in a still muddy field
• They promised huge European sales but only just now got European regulatory approval for sales, dragging their feet for some reason on this approval despite lots of new EV competition starting to hit the European market.
• They pumped up excitement with new product concepts like the semi and the coupe and the pickup truck but there is no evidence they have a place to build them or even have started to tool up.
• Everyone thinks of Tesla as having leadership in battery technology but that is the one area they have actually outsourced, to Panasonic.
• Through all of this, through all these huge needs for capital and despite Tesla's souring stock price and fanboy shareholders begging to throw money at the company, they have not raised any capital for a year.

Since my initial post, we have seen a few new pieces of news

1. Tesla still has not raised capital and in fact faces a $1 billion bond repayment in just over 30 days
2. Tesla admitted that it has not even started working on a refreshed design for the aging Model S and X, despite increasing EV competition coming at this high end from Audi, Porche, and others.  These refreshes should have been started years ago.
3. In fact, Tesla announced it was cutting back on production of the S and X.  Ostensibly this was to focus on the Model 3.  Most skeptics think this is BS, and the real reason is falling demand.  But it doesn't matter -- growth companies with great access to the capital markets don't make these kinds of tradeoffs.  This is further proof that Tesla is no longer managing itself like a growth company.  These cuts are particularly troubling because the S and X are where Tesla gets most of its gross margins -- the Model 3 margins are much worse.
4. Tesla laid off 7% of its work force.  Again, this is not the act of a company that is behind in implementing its growth initiatives, growth initiatives that perhaps 80% of its stock market valuation depends on.

Tesla has always had an execution problem, or more rightly an over-promising problem.  But it was still actually investing and doing stuff, even if it was disorganized and behind in doing so.  Now, however, it is a company valued as an exponential growth company that is no longer managing itself like a growth company.  It has billions of investments that are overdue -- in new products, in product refreshes, in the service network, in a second generation supercharger -- that should have been started 2-3 years ago and for which there isn't any major activity even today.

As a disclosure, Tesla stock is one of the most dangerous in the world to trade, either way.  You really need to understand it before you trade it and no one really understands it.  I have a couple of long-dated put options on Tesla that I consider more of a bar bet than anything else.  I also have a couple of cheap short-dated calls as I usually do in the runup to the quarterly Tesla earnings call.  Musk is great at the last minute stock pump during earnings call week, and the stock often pops only to fall soon afterwards as people dig into the numbers.  But again, these are "investments" that are less than 0.1% of my portfolio.

Postrcript:  When I wrote "Tesla is a growth company that is not investing in growth" I was picturing the Jim Cramer cameo in Ironman -- "That's a weapons company that doesn't make any weapons!"  Of course it took a work of fiction to see Jim Cramer advocate for the short side.  Doubly ironic given Musk sometimes styles himself as the real life Tony Stark.

I have written in the context of both the new marijuana stocks (e.g. Tilray or Canopy) and Tesla in EV's that the market is putting a whole lot of value -- in some cases 90+% of their current market value -- on these companies being first movers in potentially large and lucrative new industries.

It is hard to predict early on where in an industry's value chain the profits will be, or if the industry will be profitable at all.  Who will make money in marijuana -- the growers?  the retailers?  the folks that package the raw material into consumer products?  The early marijuana entrants are focusing on cultivation, but in tobacco do the cultivators or the cigarette makers who buy from them make the most money?  And as anyone at Myspace could tell you, being first is not always a guarantee of success, and in some ways can be a disadvantage.  Second movers can avoid all the first-movers costly mistakes.

I though of all this seeing the infographic below on changing leaders in the Internet world.  Almost all the top 20 companies in the first year are largely irrelevant today -- AOL and Yahoo are technically still in business but only because they have been bought up by Verizon in a group of other dogs they seem intent on collecting.

I have a confession -- at Harvard Business School (HBS), I loved business strategy cases.   This is a confession because most ex-HBS students have at best a love-hate relationship with cases in the same way that the Band of Brothers, or the 506th PIR, had with Curahee Mountain.  The first 8, 10, 12 cases were fine and you could handle them. But the problem is that they kept coming and coming, two or three a day, like a North Korean human wave attack.

There is a pretty well defined template for B-school cases, at least in my day (I love being old enough to say that).  A typical example begins with the CEO-on-the-Gulfstream-jet trope, e.g.

Jessica Stevens, CEO of Acme Enterprises, leaned back in her seat on Acme's brand new Gulfstream VI corporate jet, thinking about the meeting that lay ahead of her.  She was flying back to her Pittsburgh headquarters for the quarterly board of directors meeting, and the board was expecting real answers and a specific plan for how she intended to deal with Acme's mounting problems.

Over the last 3 years Acme's growth had plateaued at the same time a slew of new companies had entered its industry, putting pressure on Acme's traditionally strong margins.  In addition, Acme had just lost the bidding on two critical government contracts, its largest plant had just burned down, its CFO was under SEC investigation, a strong unionization drive was in the works supported by Antifa protests outside her house, and she had damaged her favorite Chanel purse when she launched it into the face of her lying mancy VP of manufacturing who she had just caught in bed with her husband.

OK, that last sentence is probably an exaggeration (cases were not quite THAT interesting).  But for me, strategy cases were like who-done-its or locked-room Agatha Christie mysteries.  Would the CEO extricate herself, and if so, how?  What would I do?  If someone were to write business strategy mysteries I would eat them up (the closest I can think of is Clavell's Nobel House -- how would the Nobel House extricate itself -- and even despite the absolutely unrealistic Dallas and Dynasty-like portrayals of business, I love that book).  It is telling that the only novel I have written (OK, more accurately, the only novel I have finished) has heavy doses of business strategy in the plot.

A lot of people write me and say, "Coyote, why the fixation on your blog and Twitter with Tesla?"  Unlike what Tesla fanboys guess about me, I actually like electric cars (though I am not thrilled with my having to subsidize them, but that is not a narrow Tesla problem).  I am riveted to the Tesla story because it totally feels like a great HBS case study of the future.

Long-time readers know I think that there is fraud here -- the SolarCity buyout, to my eye, was totally corrupt.  But if I found fraud fascinating, I would write constantly about Enron and Theranos (heck, I worked for Jeff Skilling at McKinsey on the Enron study so I could even be quasi-insider).  But fraud is only fleetingly interesting.  I can think of 5 companies that I am shorting today that I think are engaged in fraud, and I can't remember mentioning one of them on Twitter or this blog.   I find Theranos mildly interesting, but only because my wife is borderline diabetic and really was enthusiastic for Elizabeth Holmes's vision.

But here is the situation a couple of years ago at Tesla.  Think of this as the case study introduction:

• Tesla has introduced a real, desirable EV in an industry where EV's were basically crap cars no one wanted produced for PR and some regulatory reasons.
• For the first time ever, Tesla has demonstrated there was a large market for luxury EV's
• With the model S, Tesla had what has proved to be at least a 7 year lead over competitors (introduced in 2012 and similar products from several companies coming out in 2019)
• Tesla had the Model 3 ready to be introduced, with projections of topping 10,000 per week shortly, which could be one of the largest selling sedans in the world, EV or no.  Tesla had as many as 400,000 reservations already in hand for this car.
• Tesla had a founder (sort of, Musk is credited as founder but really isn't) with the Midas touch, sometimes called the real world Tony Stark, with a huge legion of followers who believe that he is the smartest and most ethical (given his green vision) engineer in the world and can do no wrong.
• Tesla had shareholders almost literally throwing money at the company, giving it a higher total market value than GM or Ford and with valuation metrics orders of magnitude higher than traditional car companies, based in part on visions of world-leading self-driving capabilities and comparisons to Apple.  The closest thing I have ever seen to the Simpson's take my money meme.

I can imagine the case study now -- should Tesla focus on the high-end of the market now and seek an immediate profit and a potentially sustainable long-term niche?  Or should it go all-out to do nothing less than become the major player in the entire worldwide automotive market, taking advantage of its high valuation to raise billions of capital to fund years of cash burn?  These are super interesting questions that I will not address today.  Tesla's apparent choice in this question is ... neither.  It has clearly gone all in, at least in rhetoric, on dominating the automotive market and Elon Musk has announced (at least on Twitter) future new products in nearly every automotive niche.  But at the same time Tesla has refused to leverage its high stock price to raise capital and actually has been cutting back on capital spending and slow-rolling expansion plans. I frankly cannot explain it, and won' try here.

What I want to discuss is the frequent comparison to Apple.   Elon Musk likes to compare himself to Steve Jobs and Tesla to Apple, but I don't think the comparison is very apt.  A big part of this is the differences in their in-source and out-source decisions.

As background, my thinking is shaped by several aspects of my HBS education.  The first is a business strategy curriculum crafted from the very first class to make one skeptical of flashy, sexy businesses.  Our first two cases in first year business strategy were an incredibly sexy electronics company, followed by a dull-as-dirt water meter company.  But it turned out that the water meter company minted money, with little technology change and huge moats against competition, while the electronics company was having to invest billions every few years just to stay in the game and never really earned a return on capital.

Another factor that shapes a lot of my thinking was that in-source / out-source decisions were very much in the spotlight at HBS at the time.  It was a time when the very nature of the industrial conglomerate was in question, and we were constantly made to ask whether a company really had to own function X to be profitable and successful.  Over and over and over, in company after company, we were asked to think about what were the critical success factor for a business, as well as what the most profitable elements of the vertical value-delivery chain were, and to think about structuring companies solely around these key elements, and outsource everything else.

To a large extent, this has been a key to Apple's success.  As I observed in comparing Tesla to Apple:

But as far as the iPhone is concerned, Apple is a design and software house.  It does not build the phones, it has a partner do it for them.  It does not write most of the applications, third parties do that.  And (at least in the early days) it did not [sell] through its own stores, it sold through 3rd parties.  An Apple-like Tesla would NOT be trying to build its own manufacturing, service, and fueling capacity -- it would leverage its designs as its unique value-add and seek others to do these other lower-margin, capital-intensive tasks.

Yes, we have Apple stores now, but this was NOT part of the initial strategy and success.  The initial Apple iPod and iPhone strategy basically had Apple outsourcing everything from manufacturing to sales as non-strategic, and keeping in-house the design and software functions.   As it turned out, they were right, because they certainly made much better margins than anyone else in the vertical value chain.

But for all Tesla compares itself to Apple, it has take a totally different approach.  Like most manufacturers, it designs its products (which it is pretty good at).  It also manufactures them (which it is not so good at).  But unlike other auto makers it also owns its own sales and service network (instead of third party dealers) and it is not very good at this and this activity consumes a lot of capital.  Also unlike other auto makers, it also is building out its own fueling network, something GM and Ford can rely on Exxon for. AND, Elon Musk at various times has said we would in-source building of car carrier trailers, car transportation trucking firms, and body shops.  I have argued for years that one of the things that Tesla fanboys love about Tesla -- that it is so integrated vertically -- is an Achilles heel because it greatly increases the capital it needs to grow, takes it into low-margin business segments, and forces it to do highly-technical functions like auto manufacturing it does not have the skills for.  If Tesla really were like Apple, it would have developed a 3rd party dealer network, it would have partnered with someone else to do the charging stations (as VW has) and it would have farmed out the actual manufacturing to an auto-equivalent of Apple's Foxcon (maybe Kia?)

I wish I had the guys name but the person in this blog said it far better than I have been able to say it to date.  From "Credit Bubble Stocks"

The test of whether you are an electric vehicle “disrupter” is: how many manufacturers are licensing your battery? If you’d actually invented a better electric battery or other EV technology (battery is the only technology that matters though), you could license them and have a 10x book business. Tesla not only did not do a battery licensing model, but they effectively did the opposite. Consider the parts of the vehicle industry that they have decided to in-source versus the ones they have decided to outsource. As we know, they decided to in-source and compete head-to-head on manufacturing. The results have shown that they are worse than their more experienced competition. They decided to in-source the automotive retail, which had not been done before and was not legal in most states. (And still is not legal in eight states). This had been a huge distraction from the manufacturing side and has resulted in abysmal customer service. But of all things to outsource, they outsourced the battery production to a joint venture with Panasonic. What should be the entire premise of an electric vehicle company is not even enough of a competitive advantage to do in house.

I am not totally sure I agree -- I think Tesla would argue the key is in design and software, just like Apple.  But even if that is true, why are they doing all this other stuff that they don't do very well and is a total distraction and sucks up needed capital?