Coyote Blog

Nobody really liked Jeff Skilling of Enron and he sits in jail for 20 years.  We think Elizabeth Holmes is attractive and cool so that despite the fact that she committed serial fraud in lying about her company's technology and financials (far more baldly and egregiously than Skilling) and actually put people at risk through faulty medical testing, she got only a slap on the wrist.

And then there is Elon Musk.

The Economist used to be boring, but smart with a wicked dry wit. Now it’s just boring (sigh). Tesla will be profitable & cash flow+ in Q3 & Q4, so obv no need to raise money.

— Elon Musk (@elonmusk) April 13, 2018

I am not sure how I got in the role of fact-checking Elon Musk, but given the company's stated results to date and announced operating plans and strategies, there is simply no way for the Tesla to be profitable and cash flow positive in Q3, barring some deus ex machina like a massive energy credit or California subsidy windfall.  It's possible I could go in there and shut down R&D and model 3 production and milk the Model S and X for cash and might make this be true, but that is certainly not their announced business plan.  On their current path Tesla has to continue to burn cash through the rest of this year.  I am not even sure that if you stated their gross margin the same way that other automakers state their numbers that even it would be positive right now -- there is an argument to be made they are still losing money at the margin on every car they produce**.  I would add that in this point of their ramp, if you want to see Tesla the huge success that is baked into its current stock valuation, you don't want Tesla to be cash flow positive in the third quarter, you want it continuing to invest.   Amazon rules the world because it deferred profitability for years in favor of growth.

Tesla pretty much never ever lives up to Musk's promises, at least for the dates he promises them.  That is probably OK with things like deliveries of new products -- people understand he is pushing technology and new products can be delayed and they forgive entrepreneurs for being -- shall we say -- overly enthusiastic about such things.   But on financial stuff like this his statements are bordering on fraud.  But he'll never get called on it, because we like him in a way we didn't like Skilling.

I will add that if Musk wants to get snippy about the media's guesses about his company's prospects, and thinks we are all getting it wrong, he could sure be a lot more transparent about Tesla's financials and plans.  Go watch an Exxon-Mobil analyst presentation and compare it to Musk's quarterly arm-waving.  Also, one final memo to Musk:  responding to your critics on Twitter emulating Trump's style is not recommended.  Though it might be interesting to compare the irrational populist wave behind Trump with the populist wave behind Tesla.  Though the two Venn diagrams of supporters probably do not overlap much, the whole relationship feels similar to me.

Disclosure:  I have been short TSLA in the past but right now have no position.  To be honest, I am going to let Musk urge his fanboys to pump the stock a bit further before I short again.  The fanboy effect makes TSLA a dangerous short, as TSLA stock holders will defy reality for far longer than will holders of say GE or XOM.

** gross margin at TSLA is interesting because TSLA has no dealer network, something I like them for.  GM discounts its cars to their dealers (10% or so?) but in turn they offload a bunch of selling and support costs to the dealers.  In their gross margin, TSLA banks in their gross margin the extra 10% from not having to discount their cars but in turn does not charge gross margin for a lot of the extra sales and support costs they have to take on -- instead they drop these costs into SG&A overhead. The situation with gross margin is even more complicated because Tesla not only has to build out and operate its own warranty service, sales, and delivery network to replace traditional dealers, it is also building out its own fueling service to replace gas stations.  Here is one guy who thinks Tesla gross margin is really negative.  I have zero idea who he is but for the last year his predictions about Tesla have been a lot more reliable than Musk's statements.

From the WSJ:

The European Central Bank’s corporate-bond-buying program has stirred so much action in credit markets that some investment banks and companies are creating new debt especially for the central bank to buy.

In two instances, the ECB has bought bonds directly from European companies through so-called private placements, in which debt is sold to a tight circle of buyers without the formality of a wider auction.

It is a startling example of how banks and companies are quickly adapting to the extremes of monetary policy in what is an already unconventional age. In the past decade, wide-scale purchases of government bonds—a bid to lower the cost of borrowing in the economy and persuade investors to take more risk—have become commonplace. Central banks more recently have moved to negative interest rates, flipping on their head the ancient customs of money lending. Now, they are all but inviting private actors to concoct specific things for them to buy so they can continue pumping money into the financial system.

The ECB doesn’t directly instruct companies to create specific bonds. But it makes plain that it is an eager purchaser, and it lays out the specifics of its wish list. And the ECB isn’t alone: The Bank of Japan said late last year it would buy exchange-traded funds comprising shares of companies that spend a growing amount on “physical and human capital,” essentially steering fund managers to make such ETFs available to buy.

Note that none of the criteria for the debt purchases is anything like, "the company has sensible plans for investing the money."  It is merely buying debt for debt's sake.  In the US, private companies are using most of their debt issues to buy back stock, a nearly pointless exercise that channels money from central banks to propping up equity valuations.  I wouldn't be surprised if European companies do the same.

Folks, it may not feel like it, but we are at the top of the economic cycle.   We have negative interest rates and central banks buying up every available debt issues in relatively good times, when these were formerly considered tools for the deepest point in a recession.  I am not a big believer in government stimulus, but these folks are.  What are they counting on in the bad times, when nothing will be left in the tank?

But now, we see central banks going one step further, encouraging private companies to lever up at the top of the business cycle.   Historically, this has been a formula for disaster.  The oil industry has been a preview of this.  Take ExxonMobil (XOM).  XOM, given its size, has never been very good at developing certain sorts of plays (e.g. the shale boom).  What it has done historically is use its size and balance sheet to swoop in during inevitable periods of low oil prices and producer losses to buy up developed fields at good prices.  But this time around, XOM has only had limited ability to do this, because it spent the boom years levering up its balance sheet and buying back stock.  Other large oil companies are in even more dire straights, facing real cash flow crises because, again, they levered up to repurchase stock when they should have been cleaning up their balance sheet.

We have all heard that artists make very little money from their songs, and get "ripped off"by record labels and other folks in the chain.  I have always had mixed reactions to this.  I have no doubt that, with zero power and a burning desire to "make it big", young acts sign uneven deals with record labels.  However, I find it hard to believe that Beyonce is getting hosed in that negotiation.

I saw this chart in TechDirt about where the money consumers spend on music goes (I think this is for a CD sale):

So the performers themselves get about 9% of the retail price after everyone in the chain is paid.  That certainly seems paltry -- after all, they are the owners and creators of the music.  Everyone else is just in the service chain to make sure the music reaches the customers, all the accounting is done, the legal documents are correct, etc.

But it turns out that they may not be doing that badly.  I am a shareholder of ExxonMobil (XOM).  I own a piece of all the oil that XOM owns and controls, along with all the other shareholders.  Think of us as the band, though a really big band with lots of players.   That oil we own, like the band's music, has a ton of value.  When sold as raw crude, it goes for $40-$60 a barrel nowadays.  When sold in pieces (such as gasoline, or asphalt, or lubrication oil) it can sell for hundreds of dollars a barrel.

But out of those proceeds, we have to pay people to help us.  We have to pay managers, and lawyers.  We have to pay oilfield services companies and equipment companies and transportation companies.  We have to pay retailers.  When all those payments are made, before taxes, in 2014 we were left with just under 8% of every dollar we sell.  We own all this oil and we are not even getting as much as a musician!

And XOM shareholders do pretty well.  Owners of Wal-Mart only get about 3% of every dollar they sell.   In my company, I get about 5% of every dollar I sell.   And those evil health insurers?  Their shareholders get just over 2% of every dollar sold (all based on 2014 full-year financials).

Does that mean that Exxon shareholders are getting "ripped off" by Haliburton and Burlington Northern?  Is Wal-Mart getting ripped off by Proctor and Gamble?  Is Humana getting ripped off by GE imaging?  No?

I will reveal the ugly secret:  There is one person who is "ripping off" all of these folks, from Exxon to Rihanna to me.  That person is.... the consumer.  Yep, there are certainly many examples of people signing bad contracts in all these businesses, but the only entity systematically and consistently ripping all these folks off is us.  Because in a capitalist economy, we have the ultimate power.  We drive down the street to get the gas that is 10 cents cheaper, we now shop for our books and TVs at Wal-Mart and Amazon rather than at Borders and Best Buy, and we buy 99-cent individual songs on iTunes instead of buying a whole CD of songs we don't want for $14.99.

Because they are too freaking low!  ExxonMobil (XOM) is a cyclical company that is following on 20 years of middling prices for their commodity and finally have a price spike, and they only manage to make 8.5% return on sales  ($11.68 billion profit on $138 billion of revenues).  At the top of their cycle they are barely making the same profit margin as the average industrial company.  This is not good.   Sure, the absolute dollars are large, but it is a large company, and the absolute dollars of revenues, expenses, and taxes are also large.

While this outcome may be confusing to many  (since the press and politicians insist on calling these mediocre profits "windfall"), they are in effect the reflection of a new reality for western oil companies.  Less and less do companies like XOM operate their own oil fields.  They are increasingly concession operators or really glorified service companies and middle men to state producers. 

Disclosure:  I am an XOM stockholder, and I am not happy.

Postscript:  This from Mark Perry is kind of interesting:

Exxon has already paid $19.828 billion in income taxes for 2008 (data here),
and will probably pay almost $40 billion in income taxes this year (see
graph above, income tax data for 1999-2007 taken from Exxon's annual
reports).

To
put $40 billion of income taxes in perspective, it can be reasonably
estimated that Exxon will pay more in income taxes this year (both here
and outside the U.S.) than the entire bottom 50% of American individual
taxpayers (about 67 million) will pay in income taxes this year.

Perry has a number of notes and updates in response to questions about how he got these figures at the bottom of his post.

Update:  Yahoo Finance data and ranking on profitability by industry.  Integrated oil companies come in around #60.

Today, Microsoft came under fire from a number of activists:

Activists today accused Microsoft of spending all of its time focusing on software.  "All they want to do is write code for operating systems and applications".  Activists were complaining that Microsoft does not invest any of its huge profits into alternatives to software and operating systems.  "They have not invested one dime in trying to come up with computing technologies that don't require operating systems or business applications."  Activists also accused Microsoft of not investing in any alternative computational approaches, such as abacus research or mechanical calculators.

Makes no sense, right?  Well, that's because I made it up.  But I did not make this up, which is essentially the exact same charge, just against a different target:

Unlike
other major oil companies that essentially acknowledge the very real
threat of global warming and the need to transition to renewable energy
and off of a finite, non-renewable resource such as oil, ExxonMobil is
using its profits and its power to continue to keep this country
addicted to oil, as President Bush has noted," Hoover said.

ExxonMobil cares only about drilling for more oil, Hoover alleged

You hear this stuff all the time.  But why are the major oil companies responsible for investing to obsolete their own business?  Why are they obligated to invest in things like wind farms or whatever that they know nothing about?   Did we demand that railroads invest in aircraft research?  Do we require cable companies to invest in DirectTV?  For all of its size, ExxonMobil represents a tiny fraction of World GDP -- if all these alternative energy ideas are such great opportunities, let the other 99.99% of the world economy take it on.  Besides, do these guys who think that XOM is evil incarnate really want them controlling the next generation of energy production?

By the way, I thought this was hilarious:

"We
believe that ExxonMobil -- primarily through its former president and
CEO, Lee Raymond -- has been involved in conceiving of and then
promoting the invasion and occupation of Iraq," Reed said. "When the
Iraq war was being cooked up, we think ExxonMobil was in the kitchen."

I love the "we believe" part.  I am sure that half these folks also "believe" that aliens are alive and well in Area 51 and that George Bush was behind the 9/11 attacks.  Would it be too much to ask to bring some facts to the table?  Or how about even a motive?  I could maybe come up with a motive if the US invaded Nigeria, since Exxon has assets at risk there that are threatened by rebels and general chaos, but Iraq?  Since Iraq's output was limited before the invasion, invading Iraq only served to put more oil on world markets, which would depress rather than raise prices and profits.  In fact, if there was really an evil genius oil company pulling the strings of government to maximize their own profits, UN-sanctioned Iraq would be just about the last oil producing country in the world you would want your government puppets to invade.

Today XOM has its annual shareholder meeting, and if you ever want to see a great parade of barking moonbats, buy yourself a share of XOM and attend.  Lee Raymond caught a lot of grief for his compensation package, and it did seem overly generous to me, but I am not an XOM shareholder right now so its not my concern.  I will say that having seen one of the XOM shareholder meetings and the ridiculous grief the CEO must endure for a day, my guess is that the XOM CEO would likely knock several million dollars off his comp. package if he could call in sick today.

The feeding frenzy that the media has been salivating over for days can begin, now that Exxon-Mobil (XOM) as announced quarterly profits.  They reported net income of $8.4 billion on $88.98 billion in sales, for a net income margin of 9.4%.  Previously I observed that 9.4% for a peak profit in a cyclical industry is pretty average, and that over the last decade oil company profits have been below average for the whole of US industry.

In fact, most investors found these profits to be disappointing.  You know you have a fun CEO job when half the country is pounding on you for profits being too high and the other half are pounding on you for profits being too low.  The fact is that XOM and other large US oil companies don't get the benefit of rising oil prices that they did, say, 40 years ago.  US oil companies no longer own most of their overseas reserves since many of their foreign operations were nationalized by countries in the 1960s  (with the US government refusing to lift a finger to protect these US assets, one of the early instances of the no-blood-for-Exxon argument).  Today, XOM must pay near market rate for much of this crude, either in arms-length purchases or through royalty agreements stacked in the favor of local governments.

So what can you folks who are screaming about high gas prices and obscene oil company profits do?  Well, you could tax all these "windfall" profits away, like Ford and Carter did in the late 1970s.  Of course, you would still be paying $3 for gas, but the profits would go to the US Congress to spend, who I am sure will do an excellent job.  Probably could pay for another bridge in Alaska.  Or, you could somehow ban oil companies from making a profit, and drop gas prices by that 9.4%, or about 28 cents.  This would get you $2.72 gas instead of $3.00 gas.  Feel better?  Of course, in either scenario, oil companies would stop making any investments in refining or oil exploration.  Supplies would quickly begin to fall (I won't go into it now, but take my word for it that refineries and oil wells require constant reinvestment just to keep running at current capacity) and I would bet it would take less than a year for that 28 cents to be right back in gas prices due to shrinking supply.

OK, what else could we do?  Well, we could cap gas prices.  Which is a fabulous idea, as long as no one who drives a car has anything better to do than sit in lines all day.  Or, we could regulate oil like we do telephones and electric utilities.  Highly regulated electric utilities make a net income margin of 7.1%.  If we regulated oil companies down to 7.1%, then this would reduce gas prices from $3.00 to $2.93.  So a huge and inflexible and costly national regulatory structure would save about 7 cents a gallon.  Oh, and since for most of 10 years oil company profits have been less than 7.1%, then, a utility type regulatory environment would likely raise gas prices and profits in most years. And of course you would get all the business flexibility, creativity, and customer service currently demonstrated by your local electric and phone company.

So what government action should a irate gasoline customer demand?  Well, I know this answer goes against years of education that the role of government is to step in and take over when any little aspect of life is not quite what citizens want it to be, but the correct answer is "none".  Its like the line from Wargames:  "A strange game. The only winning move is not to play."

More on why gas prices are still well below their historic peaks here.