All the Tesla scams a newsletter can fit
Accounting games, outright fraud, and China overshadow inflated stock
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When we wrote about Tesla’s questionable financials on Monday, we had to leave a lot out -- enough for an entire column, in fact. With the stock down roughly 10% since the company reported earnings last week, now is the perfect time for sharpened scrutiny on one of our era’s most hyped brands.
Let’s start with more balance sheet shenanigans. Headlines last Monday reported that Tesla beat analyst expectations with $0.93 earnings per share. But this is not accurate: the company only beat projections by ignoring generally accepted accounting principles (GAAP). Specifically, they exclude stock-based compensation from their earnings calculation, meaning that a huge chunk of Elon Musk’s pay disappears from the balance sheet altogether.
The upshot: Tesla only earned $0.39 a share, far below expectations. In fact, without this accounting trick, Tesla has zero profit over the last three years.
This stock-based compensation isn’t just large, it’s the largest ever -- a $56 billion package if Musk hits market cap and unit delivery targets. On Monday, a Delaware judge ordered Tesla to turn over communications between Musk and the company’s general counsel to shareholders suing the company for what they allege is excessive pay resulting from improper decision-making by Tesla’s board.
This is not the only shareholder lawsuit arising from the board’s decisions. Musk still faces an earlier suit over the company’s acquisition of solar panel company SolarCity in 2016. Tesla purchased the company for $2.6 billion in stock despite the fact that SolarCity was insolvent at the time, according to Ernst & Young auditors.
SolarCity’s biggest debtor: SpaceX, Musk’s other company. Its biggest shareholder: Elon Musk. Its founders: Lyndon and Peter Rive, Musk’s cousins. The lawsuit alleges what anyone can see: Musk used Tesla shareholder money to enrich himself and his family and to cover ill-advised debts from his other enterprise.
Now the solar business Tesla acquired from SolarCity has retroactively hiked prices as much as 114% on its customers, admitting last week that it has “made significant mistakes” estimating installation costs. The hikes pad Tesla’s revenue numbers.
Tesla is guilty of another, even more subtle accounting trick. The company counts expenses other companies consider costs of goods and services (COGS) as operating expenses, i.e. overhead costs. For example, it sells cars directly to consumers, but considers 100% of its dealership costs as overhead. Other automakers count at least a portion of their dealership expenses as COGS.
Why does Tesla do this? Because revenue minus COGS is a company’s gross profit, and gross profit minus overhead gives you its operating profit. The ratio between gross profit and operating profit is called “operating leverage,” and investors like companies with high levels of operating leverage. High fixed costs and low variable costs -- characteristic of tech companies in particular -- mean that cash flow grows at an accelerating rate with each new sale.
But try as it might, Tesla is not a tech company, it’s an automaker, and the car industry has low profit margins. Rigging its balance sheet helps justify inflated valuation like a tech company with an automaker business model.
Or rather it would if Tesla’s multiples were anything like any other company ever. The S&P 500 average for Price-to-Earnings Ratio is 30. Tesla’s P/E ratio as of January was 1,601. Investors justify this wild valuation by claiming that autonomous vehicle (AV) tech breakthroughs will generate huge profits long into the distant future: Tesla cars will become robotaxis that generate revenue streams for their owners.
But the company warned last week in its SEC filing that these breakthroughs may never come. Musk said in 2016 that “Full Self Driving” (FSD) was months away. In 2019 the company said that “Level 5 autonomy” -- an AV that doesn’t even need a steering wheel -- was eight months away.
Now the company says FSD is coming sometime this year, but in emails with California’s DMV it admits that FSD is only Level 2 autonomous, a notch above adaptive cruise control. Tesla’s current “Autopilot” system has led to dozens of dangerous crashes, with the National Transportation Safety Board now calling for stronger regulation of its technology.
Tesla has a notoriously dismissive attitude towards these and other regulators, but now the company relies heavily on a market where business has no power over the state: the People’s Republic of China. Fully 30% of Tesla’s Q1 sales came from China, with the country accounting for half of all its incremental revenue over the last three years.
This is a precarious situation for Tesla. In April, a protestor at a Shanghai auto show jumped on top of a Model 3 and demanded compensation for a brake failure that had injured her father. Video of the incident went viral, with the Communist Party’s Central Political and Legal Affairs Commission soon after saying “Tesla has to face up to the torment of its Chinese customers.”
Now the company is going into overdrive apologizing for its actions, offering new discounts, and humbling itself before regulators it had previously dodged. Musk got the message from the Ant Group’s shuttered IPO: the party will not hesitate to hold corporations accountable in ways American officials could only dream of.
This raises the question that hangs over everything Tesla: does the company’s enormous valuation -- five times larger than Ford and GM combined -- reflect its concrete conditions? A third of its revenue is at the mercy of the Chinese government, its software is shaky at best and subject to growing regulatory threat in the United States, its balance sheet is riddled with questionable accounting, and its CEO treats his investors like a personal piggy bank.
Maybe there are good explanations for what looks like a pattern of extreme bad faith. More likely: Tesla is a parasite on global investment, with a stock price that proves that capital loves a great parasite when it sees one.
Our only investment advice: Get ready for new Kemet.
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