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Bram de Haas
Bram de Haas
Articles (318)  | Author's Website |

Einhorn Argues Tesla Could Be in Lehman-Like Trouble

Guru sees similarities between pre-crisis Lehman Brothers and Tesla today

October 10, 2018 | About:

David Einhorn (Trades,Portfolio)'s third-quarter letter is making the rounds and, as usual, it is very interesting. I confess to being an Einhorn fan, so Greenlight's year-to-date loss of 25.7% isn't causing me question whether he has lost it. He makes concentrated bets and he's been wrong on the short and long side. It hurts, but it happens.

I want to specifically talk about Einhorn's lenghty breakdown of Tesla (NASDAQ:TSLA). The guru has been short the stock for a long time, but this is the first time he has shared so many original reasons for the bet.

I think he may have likened it to Lehman Brothers not just because of the similarities he observes, but also because it makes for great headlines as the media is spending a lot of time on the 10-year anniversary of the credit crisis. Here are some of the similarities he sees:

"Lehman threatened short sellers, refused to raise capital (it even bought back stock), and management publicly suggested it would go private. Months later, shareholders, creditors,employees and the global economy paid a big price when management’s reckless behavior led to bankruptcy."

Elon Musk is definitely after short sellers. He refused to raise capital earlier in the year and recently made an infamous faux pas by tweeting about taking Tesla private.

Einhorn said in the letter Musk desperately tried to sell Tesla to Alphabet (GOOG) (GOOGL) when the company's cash reserves fell critically low in 2013. Ultimately, though, Tesla got through that crisis and Musk got props for navigating the company along the edge. Einhorn believes this a dangerous instead of valuable experience:

"In our opinion, this has emboldened the TSLA CEO to embark on ever more aggressive deceptions. In 2016, Mr. Musk bluffed his way through the TSLA bailout of SolarCity by demonstrating a very exciting but fake product called Solar Roof. The company started taking $1,000 deposits in May 2017 and launched the product in August 2017, but as of May 31, 2018, reports indicate that only 12 Solar Roofs have been fully installed – 11 of which are owned by Tesla employees."

Einhorn then gets into some of the production problems Musk is facing. The company announced a $35,000 Model 3, to which a $7,000 tax credit could be applied. Tesla predicted it could make this car with a 25% margin.

Tesla figured it could execute on this ambitious car by building a factory that surpassed those of competitors in efficiency. It would robotize a robotized industry to a much higher degree, thereby cutting production costs.

Einhorn raises the interesting point that Tesla just demonstrated this thesis is faulty. It doesn't seem to be able to ramp up production through robots and is instead bringing in more humans:

"In July 2017, TSLA turned on the machine that was to build the machine… and it didn’t work. Instead of producing TSLA’s forecast of 5,000 Model 3s a week in the month of December, TSLA produced only 2,425 for the entire quarter. Elon Musk realized that full automation is impractical. Humans replaced some robots. Adding humans into the production process means that TSLA can’t improve the factory speed to achieve its vision of improving manufacturing by an order of magnitude."

Einhorn goes on to argue that if the increased robotization isn't possible, the cost structure of the Model 3 will not match Musk's expectations:

"UBS did a teardown analysis and estimated that the cost to make a stripped down version of the Model 3 is $41,000. That’s a long way from $35,000, let alone $26,250 – the level needed for TSLA to make a 25% margin."

Tesla can still sell more expensive Model 3s, but these lack the same draw as the very affordable $35,000 version. According to Einhorn, the addressable market at $60,000 (where Tesla can probably turn a profit) is no more than one-third the size of the market.

Short sellers were unconvinced Tesla could actually make 5,000 cars per week, but Einhorn now has a new and much more threatening concern (because it can't be solved by throwing manpower at it):

"To date, TSLA has made about 95,000 Model 3s, and given that some versions are now available for immediate sale to people who weren’t on the wait list and that TSLA is offering promotional discounts like free supercharging, it seems clear that the backlog for premium versions is nearly exhausted. TSLA is expected to make and deliver more than 65,000 Model 3s in the December quarter. It might be able to make them, but without an order backlog there is very little chance that there is enough demand to sell them. We expect a large revenue and earnings disappointment in Q4. The exposed demand shortfall should ruin a key pillar of the bull case."

If Tesla is able to make Model 3s but is not be able to sell them, that would be a huge blow to the bull case. If the company were to do that, it would also suggest it is, in fact, unable to lower production costs (for now). But it gets worse. I'll cite a number of concerns Einhorn raises on a stand-alone basis, each potentially problematic:

"...Next year, TSLA loses the government Zero Emission Vehicle subsidy, which will make it even harder to attract demand...."

"....There have been lots of reports of delivery snafus and poor quality cars...."

"...There are anecdotes about TSLA accepting full payment for cars and then not delivering them..."

"...There are many stories of cars (even Model S and Model X) in service shops for months for lack of spare parts..."

"...The Model 3 is the least reliable car on the market..."

"...in August TSLA hired a well-respected finance executive to be its new Chief Accounting Officer. He was to receive $10 million worth of stock over four years. Suffice it to say, that is not the going rate for accountants. He lasted a month and quit before ever being associated with a reported financial statement. TSLA may be in accounting hell."

I happen to have a modest short position in Tesla myself based on high turnover among executives, multiple competing electric vehicles coming to market and Tesla's need to raise capital soon. Needless to say, I read Einhorn's letter very carefully. As always, I found it both funny and insightful.

Disclosure: Author is short Tesla. 

About the author:

Bram de Haas
Bram de Haas is the managing editor of The Black Swan Portfolio.

Visit Bram de Haas's Website

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