The history of industry leading consumer tech products has not been kind to investors who overstay their welcome. You need look no further than all the hundreds of notable recent failures, to realize that these companies almost always flame out. The list below (in no particular order) is a nice trip down memory lane of former favorites, that are now either bankrupt or shells of their former selves—often consumed by some other entity that fortunately put them out of their misery. Of course, the list below, is just from the past decade or two;
Palm, Gateway, Research In Motion, GoPro, FitBit, Heelys, Handspring, Compaq, BlueRay, Garmin, Delorean, Casio, Sega, Tamaguchi, TiVo, Betamax, AOL, Walkman (Sony), Set Top Boxes (Scientific American), Kodak, Atari, Napster, Netscape, Polaroid, etc.
Let’s just say, it’s hard at the top. You must guess each change in technology, each generation of improvement and design it for fickle consumers, while constantly outlaying capital for research and development that may never go anywhere. All the time, others are constantly trying to overtake you.
If you look at the lifecycles of these companies, they often follow a similar trajectory from ingenious creation with huge margins, to a few generations of new products with smaller margins, to massive competition as deep pocketed competitors and venture capitalists try and emulate your product, to missing a product cycle, to becoming obsolete. These consumer product companies rarely last more than a decade; often just a few years. In the end, consumer focused tech is vicious and Darwinian, with very few long-term competitive advantages.
Of course, Tesla (TSLA – USA) is something of an anomaly here. While the companies in the above list, all produced prodigious cash while they were industry leaders, Tesla seems to incinerate cash while in the lead—using repeated equity and now debt offerings to plug the hole. While other companies had a huge stash of cash to fall back on when others overtook them, Tesla’s cash balance leaves it only a few quarters from insolvency. Add in a host of questionable related party transactions, convoluted financial statements (what the hell is pro-forma revenue?), the inability to ever hit company guidance, deceptive disclosures and a business that seems to lose more money with each vehicle it produces, is it any wonder that Tesla is one of the most shorted large-cap stocks today? If I had to choose the most obvious pending bankruptcy of a large-cap stock, it is clearly Tesla.
At the same time, I have to give Elon Musk credit. He has created a company that is a rather successful cult, even if it is still a failing auto company. Every time that skeptics ask real questions, he deflects them with futuristic sci-fi pronouncements. What other automobile CEO is obsessed with Mars while his assembly line fumbles along? What other CEO talks of hyperloops, while his main product on auto-pilot will kill you if used as currently designed. This “visionary “status has deferred timelines and made all logical financial metrics meaningless to investors—which may be the point of all his hubristic talk in the first place. Extend, pretend, blatantly mislead investors, raise more capital. It’s the junior mining model—applied to auto production—on a scale that would make anyone in Vancouver blush.
Automobile production is a decidedly unsexy industry, with massive capital outlays, high fixed costs, huge cyclicality and low returns on invested capital throughout the cycle—the technical definition of an awful business. The leading players produce millions of vehicles a year, yet trade at mid-single digit cash flow multiples, due to how awful the industry is. Why is Tesla valued like a high-tech growth stock, where investors ignore accelerating operating losses; if the best-case outcome is that it becomes a cyclical auto manufacturer with depressing returns on capital? A new technology like electronic vehicles (EV) sounds cutting edge, but so was automatic transmission, air conditioning, power steering, fuel injection, etc. All the other auto makers copied these technologies and caught up within a few years—much like what is now happening in EV. So, how has Tesla become such an epic bubble, if it is competing (poorly) in an industry that is notorious for destroying capital? It is clearly the promotional genius of Elon Musk. Naturally, he won’t be the first or last “visionary” to have a comeuppance.
So, going back to my question, which is the genesis of this article; when will the Tesla stock promote finally implode?
Long-time readers of this site know that I no longer short companies. This was a hard-learned lesson from when I was short Research in Motion, about two years too soon and watched as it went up 3-fold on me—before ultimately collapsing as I had predicted. Unfortunately, I was not short much by the time of the collapse as a small position had mushroomed into something pretty large and I was forced to keep covering at accelerating losses—lest I be forced to sell good longs to fund the repeated margin requirements of the short. While my thesis had been right, my timing was wrong. As long as investors believed in Blackberry, it didn’t matter that Apple and Samsung were building competing products that were likely to be better. It didn’t matter that Chinese players were producing low-end models that were likely to be almost as good, but at a fraction of the cost. It didn’t matter that competition from cash rich competitors grabbing for market share would crush margins. No one on Wall Street cared—until the iPhone finally showed up and people realized it was better. Then the Research in Motion collapse began.
For the past year, Tesla was a bet on pending mass production of affordable EV cars. Earlier this summer, we saw the first of the Tesla Model 3s to be produced. Even the normally ebullient journalists struggled to hide their disappointment with the product. This is understandable, dozens of competing EV models are coming, starting as soon as 2018. Will they be better than the Model 3? Based on what we know thus far, they’re unlikely to be worse. As they continue to advance EV technology, auto companies with far greater resources than Tesla, will eventually surpass it—much like with Blackberry. Then again, Research in Motion was coining money while at the top of its game—Tesla consumes money, while racking up debt. This won’t be a game of margins and profits—all the incumbents need to do is show that they can break even producing a comparable vehicle. At that point, the funding for Tesla will subside and its debt will bury it.
I was too early with RIMM and I don’t want to be too early with TSLA. So, I’ve been patient. I’ve been waiting for the competitors to show up. They’re now coming. The Tesla Model 3 is a dud—competing products will begin showing up in 2018 and they look much better. However, I’m not going to short TSLA. I’m going to use long-dated puts—much like I’ve played all subsequent dead-man-walking companies with an uncertain mortality date.
The problem with puts, is that long-dated puts are expensive. Fortunately, there’s a way to offset this cost, the bear put spread. This is the purchase of a put and the sale of a put at a lower price. By doing this, your gains are capped by the price of the put you’ve sold, but since your cost is much lower, you get to play with many more of them. Besides, you don’t need Tesla at zero to win with these, you just need Tesla’s share price to drop materially from here. If my timing is wrong, my losses are small and I can reload when they expire. Besides, I don’t expect TSLA to be a zero immediately. It is much more likely to limp towards zero, as opposed to imploding towards zero—making the bear put spread even more attractive than straight puts. Let’s just say that for the past few months, I’ve been adding to this position. The net cost of the spread is cheap and the timing now seems increasingly pregnant.
When will Tesla’s stock promote finally implode? When people realize that it’s a cash incinerating vanity project for Elon Musk, at a time when new, better products are coming to the market. That point is coming soon. Very soon.
Disclosure: Long 2019 TSLA Bear Put Spread (250/175)