Tesla, Fed, big tech, COVID: Things fall apart

Plus terror attacks Belt & Road, Peru inaugurates change, Ransomware fades

It’s Monday, time for another round of Contention -- here with about nine minutes of dissident business news. This week we cover:

  1. Bad policy, rising prices can’t stop big money 

  2. The Tesla dream fades again 

  3. Rapid Round: Terrorists target Belt & Road, Peru’s left pres. steps in, ransoms start to slip

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Bad policy, rising prices can’t stop big money 

All the major stock indexes fell last week on thin volume, summer vacations sapping market momentum -- the Dow and the S&P 500 each lost 0.4% and the Nasdaq dropped 1.1%. 

Despite the sleepy trading, it was a busy business news week with a clear theme: major uncertainty that’s still making big money for the most powerful.

The most important factor in the economy: the COVID-19 epidemic. U.S. daily infection rates have now more than doubled in the last half of July, with the CDC reversing earlier guidance this week and recommending masks for vaccinated people. Leaked data behind the recommendation point to a variant more infectious than the common cold, effectively a novel virus on top of the novel coronavirus. The official pandemic control strategy and narrative have completely unraveled. 

The impact on business has already begun. Restaurant traffic data from OpenTable shows significant declines in Sun Belt cities where the new wave has hit hardest, and anecdotal reports from restaurant owners raise the specter of a new round of business failures. This also means fewer tips and less job security -- as well as increased health risks in a sector hammered by COVID deaths -- adding to talent attraction woes in the industry at the front lines of the current labor shortage.

Shortages across the economy prompted the second factor making news last week: inflation. Friday saw the latest edition of personal consumption expenditure (PCE) data, the Fed’s preferred measure for price stability.

Year-over-year, PCE inflation rose 4.0%, with core inflation -- stripping out volatile food and fuel prices -- up 3.5%, the most since 1991. On a three-month, annualized basis, core PCE inflation is now 6.7%, the highest since 1982. At this rate, inflation has wiped out all recent income and consumer spending increases and Q2’s lackluster GDP growth announced on Wednesday -- economists expected 9.1% and got 6.5% -- likewise disappears. The only thing really growing in this economy are the prices.  

Inflation like this indicates the biggest economic regime change in a generation. The author of that change also made news last week: the Federal Reserve. The lords of the global economy announced no new plans to pare back any of their extraordinary market supports following the Federal Open Market Committee meeting on Tuesday and Wednesday. In fact, Chairman Jerome Powell and company removed any reference to specific amounts they would spend on asset purchases, promising to proceed at “at least the current pace.” 

Powell did acknowledge that inflation was now “higher and more persistent than we expect,” but also redefined the committee’s goal of “substantial further progress” to focus only on the Fed’s employment mandate, not price stability. This means that as long as pricing chaos and supply chain shortages leave labor misallocated, the bank can keep propping up markets. 

The markets approved the dovish tone: inflation raises their stock prices too. 

The biggest beneficiaries of that largesse also made news last week, as the tech megacaps Facebook, Amazon, Apple, Google, and Microsoft all reported quarterly earnings. 

These five companies have become behemoths by monopolizing key elements of the digital economy and collecting rents between the value-producing producers and value-realizing merchants that make the world of money go round. Their fat margins come largely off the balance sheets of more productive firms facing the squeeze of an economic order that’s up in the air. 

Last week was a good week for them, suggesting that the system may have shifted from “too big to fail” to “too big to care.”

The Tesla dream fades again 

Tesla Motors released its latest quarterly earnings report on Monday, with the world’s leading electric vehicle-maker celebrating its eighth consecutive quarter of profits.

But a deeper dive into the company’s controversial balance sheet raises familiar questions, namely: is Wall Street’s great green hope a great big fraud?

First, the basics. Tesla beat both top-line (revenue) and bottom-line (earnings) expectations, profiting $1.45 per share vs. $0.98 estimated on $11.96 billion dollars in revenue. The business cleared over $1 billion in profit for the first time ever in a quarter -- a year ago, it was making 10% of that.

And in another first, the company actually -- allegedly -- made profits as an automaker. Only $354 million of the $1.14 billion net income came from regulatory credits, previously a patch for its money-losing car-making business. As for last quarter’s other balance sheet boost, Tesla’s investment in bitcoin, the company wrote down a $23 million impairment of its cryptocurrency assets. Small potatoes in context, but its stake gained and lost more than a billion dollars in value over the quarter. 

Aside from those new accomplishments, Tesla’s report featured many of the same, long-standing red flags that the company has never really addressed. Most famous: its extraordinary levels of accounts receivable (AR). Businesses count the IOUs they hold from customers as assets, but this usually doesn’t matter much to auto companies -- you can’t leave the lot without paying.

Tesla, on the other hand, reports billions of dollars in AR every year, with a 12% increase in this quarter alone. At $2.13 billion, AR accounts for 18% of the company’s total revenue, meaning they delivered a fifth of their products without taking payment. This seems unbelievable, and critics believe the company is making up the numbers to pad its profit claims. For its part, Tesla keeps changing its story about the anomaly.  

Another known problem: warranty under-provisioning. A warranty is a liability, and car companies are supposed to set aside funds to cover future warranty costs. Businesses can overestimate this amount and sock away cash to patch up losses later, or underestimate it to reduce liabilities and increase profits now. 

Tesla appears to have done both at different times, but this quarter they likely under-provisioned. The company reported $125 million in warranty expenses this quarter -- high for such a young fleet -- by one estimate about 44% too little. This saved the company hundreds of millions of dollars, reported instead as profits. 

Tesla doubles down on this trick by classifying many warranty repairs as “goodwill” repairs to make their liabilities look even smaller. A new federal lawsuit filed in California contains evidence of such warranty fraud, and the company makes some of its warranty customers sign non-disclosure agreements to keep the practice under wraps. 

Other tricks and manipulations helped prop up Tesla’s balance sheet, like an unexplained $500 million jump in “accrued purchases” -- delivered goods that haven’t sent Tesla the bill yet. More shocking, Musk admitted on Monday’s earnings call that the main justification for Tesla’s tech company-style valuation -- its Full Self-Driving (FSD) software package -- is worth less than the company has previously claimed. 

Investors price software companies at a high multiple to earnings because they have high operational leverage

  • The variable costs for each new product sold are low -- Google can add tens of thousands of new customers for $0.

  • Gross margins are high -- Facebook’s are 80%, meaning that providing their basic service costs them only 20 cents on the dollar. 

  • Operating income -- the money left after all the bills are paid -- grows faster and faster the more revenue comes in. 

Automakers do not meet any of these definitions. Each new car costs tens of thousands of dollars to make and margins are modest. Credulous investors, on the other hand, have valued Tesla like a tech company in part because FSD promises to be a low-cost, high-margin product all of its customers will want. 

But on Monday’s call Musk admitted that the package -- which is so far from “self-driving” the company is getting sued for false advertising -- doesn’t really work. “Like right now, does it make sense for someone to do an FSD subscription? It's debatable,” Musk said. 

In the same release, Tesla said it had slashed research and development by 13% despite plummeting electric vehicle market share, tapped out legacy markets, and major new delays on its most important promised product lines -- semi and pickup trucks. The company’s headlines celebrate growing profits, while all of its fine print details growing problems. 

Maybe the problems are all illusory, but there is no way a business like this should have the most highly-valued stock price on Wall Street. Tesla has done its part with its suspicious accounting, but the market has met it more than halfway, bidding up a company that promises to solve the carbon crisis without making us change in any uncomfortable way. Musk has played into the Great Man ideology and capital’s hope that climate change is just another business opportunity we can innovate our way out of.

It isn’t, it’s an accelerating catastrophe, and much like its shoddy cars, Tesla appears to be one too. 

Rapid Round

Pakistan militants target Belt and Road

A gunman fired into a car carrying two Chinese engineers on their way to a factory in Karachi, Pakistan last week, wounding one, the latest in a string of attacks on Chinese nationals. Earlier in July, a bomb killed nine Chinese construction workers traveling in a bus to a hydroelectric dam under construction.

Pakistan is a centerpiece of the Belt and Road Initiative linking up trade across Eurasia -- bringing $60 billion in Chinese investment into the country’s infrastructure and industries from car assembly plants to textiles.

The source of some of the attacks appear to come from the Balochistan Liberation Front, a seperatist group operating in Pakistan’s southwest. The BLF claimed responsibility for the attack on the engineers last week, and has boasted of other attacks on Chinese nationals. Last November, Pakistan’s Foreign Ministry accused Indian intelligence of supplying $191 million to the BLF and other insurgent groups in Pakistan over the past three years. The money was allegedly used to fund attacks on Chinese-Pakistan projects.

BLF’s leader Allah Nazar Baloch has asked for that kind of help. In 2016, Baloch vowed in a video recording to attack Chinese construction crews and asked India for financial assistance.

Peru’s new president swears in

Peru’s new socialist Pres. Pedro Castillo took office on Wednesday and kicked off his term with several noteworthy appointments. 

  • Guido Bellido -- a Marxist economist and member of Castillo’s Free Peru party -- as prime minister

  • Hector Bejar Rivera -- a sociologist and former guerrilla -- as foreign minister

  • Pedro Francke -- who formerly worked for the country’s central bank -- as finance minister.

Francke has laid out a roadmap for a “popular market economy” that has ruled out nationalizations but seeks to target inflation and raise taxes on multinational mining corporations’ profits to fund public expenditures. At the same time, Castillo and Bellido want to rewrite the constitution which currently enshrines private property as the highest social good, even above national sovereignty. 

“We urgently need to recover employment while respecting private property, ensuring the proper functioning of markets, and promoting private and public investment,” Francke said. “Private companies will continue to be private companies. Our economy will be market-oriented but with pro-poor policies.”

A tax on mining windfalls and currently-high copper prices would theoretically benefit Peru. Those prices could get higher -- workers at the world’s biggest copper mine, Escondida in Chile, voted to strike over the weekend after negotiations for a bigger share of the windfall broke down. Copper futures are up 5% in the past two weeks.

Ransomwarers get greedy

Ransomware attacks on business and government agencies reached a historic high in July, after rising more than 400% in 2020, according to new data from cybersecurity company SonicWall. But the higher tempo of attacks is creating downward pressure on ransoms, with the average amount hackers demanded falling to an average of $136,576 compared to more than $200,000 earlier this year.

The insurers are not paying out as much as they used to, either. “The ransomware groups got way too greedy too quickly,” one specialist at cybersecurity firm Emsisoft said last month. “The cost-benefit equation the insurers initially used to figure out whether or not they should pay a ransom -- it’s just not there anymore.”

So, hackers are more and more threatening to leak data to get their targets to pay up, and preferring cryptocurrencies to cash -- a potentially profitable venture when crypto prices rise. One such attack in April by hacker group Evil Corp. paralyzed the Illinois attorney general’s office which spent more than $2.5 million in crisis management, another booming industry. The FBI is calling for mandatory reporting rules as most attacks go unreported, a move that could likely land on insurers.


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