Tesla, the "short burn" of the century?

Tesla shorts are down more than $25 billion since the start of the year as the stock is up almost 400% year-to-date. But despite this massive short squeeze, Tesla remains the biggest short in the U.S. market. There are always two sides to every story. Below we break down the bulls and bears arguments.


 

Traders betting against Tesla are down a collective $25.4 billion in mark-to-market losses so far this year, according to data from S3 partners and Business Insider. The short-seller losses come amid an outstanding rally which has sent Tesla shares above $2,000, up nearly 400% on a year-to-date basis. The company now has a fully diluted market cap approaching $400 billion. It is now the most valuable car company in the world and the stock is worth more than triple the combined value of US automakers General Motors and Ford (while these two automakers generated 10 times more sales than Tesla last year).

Short sellers are down about $7 billion in August alone and added over $1 billion to their loss tally last Thursday as the stock eclipsed the $2,000 mark for the first time.

As shown on the chart below, many short sellers have been forced to throw the towel and Tesla short interest as a percentage of Equity float has been dropping as Tesla stock price has been going parabolic. Meanwhile, Tesla is poised for S&P 500 inclusion and just announced a 5-1 stock split.

Chart: Tesla short interest (in white) vs. Tesla stock price (in yellow) – source: Bloomberg


tesla short interest stock price

 

But despite this massive short squeeze, Tesla remains the biggest short in the U.S. market, with $21.31 billion in short interest and 10.65 million shares still shorted. This is about around 8% of the company’s float, according to S3 data.

In July, Tesla became the first company to have $20 billion in short interest bet against it. For perspective, Apple, the second most shorted stock in America, has $13 billion worth of its shares shorted (while the market cap of Apple is 14 times bigger than Tesla).

The sheer magnitude of short sellers put Tesla at risk of being caught in another short squeeze. Still, well-known shorts such as David Einhorn of Greenlight Capital and Jim Chanos of Kynikos Associates are clinging to their bets against Tesla.

Will short sellers continue to get burned? Or will they ultimately be vindicated? Below we review the main arguments of the bears and the bulls.


Tesla: the bear (short) case

1. Massive Overvaluation
While a good portion of Tesla bears think the equity is worth zero and that bankruptcy is imminent, the majority of Tesla short investment thesis simply come down to valuation: they believe that Tesla’s stock is massively overvalued.

When using a comparable-based valuation model, it’s easy to understand where the bears are coming from. Indeed, Tesla bears believe that the biggest market mistake is to value Tesla as a software company. To their opinion, the market should value Tesla as an auto OEM (Original equipment manufacturer), i.e valuation multiples should be roughly in line with that of GM or Ford, with a premium multiple for the growth and brand value.

Indeed, while they acknowledge that technological innovation and software are undeniably a part of Tesla’s business, they are pointing out that Tesla remains first and foremost a company that produces cars. And that typically means lots of debt, economic cyclicality, and low margins.

When looking at the market caps of the largest automakers, Tesla is in a league of its own. Its market capitalization is getting close to $400 billion, nearly twice the size of Toyota (the 2nd largest), while only capturing a fraction of the revenue (see chart below).

Chart: Tesla quarterly sales vs. Toyota and GM – source: Techcrunch

tech crunch


As of Monday, Tesla trades on a 1,061x trailing P/E and on a 15x EV/Sales valuation.

As highlighted by a Kynikos Associates, “Tesla is one-half of 1% of global new car sales but one-half of all FinTV programming”.

2. Regulatory credits have been artificially boosting their Q2 numbers
For the first time ever, Tesla was able to post a GAAP profit in the second quarter – a necessary condition to be included in the S&P 500 index.

But for the bears, Tesla is still not making any money by actually selling cars as regulatory credit sales were above EBIT in the second quarter.


3. Growing competition
One of the key arguments from the bears is that competition is right around the corner for Tesla. As the demand for fully electric vehicles (EVs) keeps growing and is eating into ICE (Internal combustion engines) market share, the largest automakers are now producing their own electric cars. With its Model 3 being priced at around $38,000, Tesla is clearly positioned in the luxury car buyer segment, a segment into which the competition is rapidly growing with the likes of Audi’s E-Tron, BMW’s iX3, Porsche’s Taycan, Jaguar’s I-Pace, etc.

To the shorts, Tesla has benefited greatly from being a first mover in mass-market EVs but their competitive advantage is likely to erode going forward as consumers are given more choices of EVs, making Tesla more of a niche player for affluent brand enthusiasts.


4. Growth is Stagnating
Anytime a company’s valuation is unusually high for its industry, that can usually be explained by the current growth trajectory being projected into the future. While it was indeed the case for Tesla prior to 2019, Tesla’s revenue growth has been stagnating over the last few quarters, which raises questions about the company’s high multiples.

For some analysts, growing earnings without growing sales is a red flag for a growth stock. Without accompanying sales growth, it usually signals increased operational efficiency (finite), rather than acquiring more customers and market share.

Below is Tesla’s revenue over the last five years. As shown on this chart, revenue growth is not accelerating any more.

Chart: Tesla quarterly sales vs. Toyota and GM – source: CNBC

tesla revenues
5. Elon Musk personality
Elon Musk is one of the most outspoken leaders in tech. The CEO of Tesla and SpaceX has inspired intense devotion and attracted controversy as a result of his public statements.

But he's also landed himself in hot water, like when he called a British cave diver a "pedo guy" or said he had the funding secured to take Tesla private at $420 per share. Musk hasn't shied away from sharing his more off-the-wall ideas, like the concept that humans are living in a simulation or the theory that we should nuke Mars to warm the planet. Most recently, he tweeted that the pyramids in Egypt were built by aliens.


Tesla: the bull (long) case

1. Dominant position in the Electric Vehicle (EV) Market

Tesla currently has roughly 60% US EV market share, a market they’re helping expand by altering consumer preferences. While China, a growth market Tesla is aiming for with the production of a new Chinese factory, has several competitors in the EV space, analysts seem confident that Tesla can quickly outshine them. According to Acumen Research projections, the EV market is projected to grow at a 25% compounded annual growth rate until 2026. At this point, they expect the industry to be worth roughly $567 billion. If Tesla were to continue to own 60% of the market, its share would be $300 billion a year. By 2040, it is estimated that Electric vehicles would account for 35% of all new vehicle sales (see chart below).

Chart: The rise of Electric Cars – source: Bloomberg

tesla ev projections



2. Top-Selling Midsize Luxury Car in 2019
While Tesla has been producing niche vehicles for only a handful of years, it dominated the midsize luxury car market in 2019. Indeed, Tesla sold 161,100 Model 3s in 2019, with the Lexus ES being the next runner-up, selling just 51,336 units. Indeed, automotive industry incumbents have not been able to compete until now. Looking at the first half 2020 numbers (for the US market), Tesla remains far ahead of competition (see chart below).

Chart: US EV cars ranking in H1 2020 – source: Statista, Forbes

americas best selling EV cars

When confronted with the mounting competition, Tesla bulls typically compare Tesla’s reputational and consumer preference power to that of the iPhone. Sure, Samsung, OnePlus, Google, and dozens of others manufacture phones, but most iPhone buyers don’t weigh these competitors against each other. To their opinion, similar behavior will be observed with Tesla over time. However, the car buying cycle is slower, which means that more time is needed to show that Tesla owners will repeat their purchases.

It is also worth mentioning that Tesla’s enormous investments in new plants might have created an economic moat versus the established premium manufacturers. As mentioned by Forbes recently, its development compared with BMW, Audi and Mercedes is astonishing.

3. A leader in Autonomous Driving Miles
According to the bulls, Tesla has a competitive advantage versus competition and its early mover advantage creates a positive feedback loop.

By way of comparison, Tesla has about 3 billion cumulative autonomous miles, compared to Waymo’s 20 million, and GM’s 1.4 million. Self-driving technology is mainly based on machine learning, so the more data you feed the algorithm, the better it gets at driving. Being so early in such a new industry, it’s difficult to quantify the value of Tesla’s mileage advantage, but it’s one of the few hard numbers we can put on the self-driving industry right now.

4. A very promising future
Like most growth stocks, Tesla bulls base their valuation on the Tesla of tomorrow. Among the factors driving their thesis are a potential Tesla robot taxi network, a radical change in consumer preferences for EVs over ICEs, and Tesla leading the self-driving vehicle industry.

By including high growth rate projections in financial models, some analysts are able to justify current valuation ratios. We must also keep in mind that the EV automotive industry is very capital intensive which means that the stock price appreciation becomes self-fulfilling. i.e high stock prices means access to cheap capital which will ultimately help Tesla to widen its economic moat, etc.

5. A change in status
Tesla is becoming a must-own stock. After the S&P 500 inclusion, the stock will benefit from being included in other indices.


Final words
There is no doubt that Tesla is one of the most controversial stock in history with a major split of arguments between the longs and the shorts. The bulls call Elon Musk the new “Thomas Edison” while the bears see him as an over-rated Silicon Valley Executive. History will tell which side would ultimately be right.

 

(source image front page: Opportunités Techno)

 

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