Wednesday, November 21, 2018

High Plateau Drifter: "Old Trend - New Trend"

The latest from our old friend High Plateau Drifter:

Last night I watched (once again) the movie The Big Short with Christian Bale as Michael Lewis. It is a history lesson on the crisis of falling housing prices in mid 2007 through 2008 and the mortgage default crisis which accompanied that collapse.

The key point of the movie is the psychology which makes a few people see the obvious in years 2006 and 2007 while most others ignored it. And when I say "obvious" I mean the weakening and exhaustion of a trend in which mortgage finance outpaced incomes thus making a collapse in housing prices inevitable just as night inevitably follows day.

Moving now to present day matters we have the matador moving ever closer to the raging bull of deficit spending armed with only a pocket knife instead of a sword.

The future for financial instruments is baked into the cake.

Federal "Deficit" Federal Debt Increase
For year 2018 $833b $1,271b

Note that the "Debt Increase" includes the interest cost of nearly $400 billion on $15.9 trillion of public debt outstanding, or 2.5% interest (not counting interest on, or principal amount of inter-governmental debt holdings). As you can see, there is an awful lot of rate risk north of 2.5% on outstanding Treasury debt. And given that the President is something of an expert on default and restructuring, I wouldn’t put it past him to try an executive order "cram down."

As of now, only the first 7 years of the post WW-2 baby boom generation (1947 through 1964) had reached age 65 and thus became eligible for social security benefits pictured below. There are another 10 years of baby boomers to go! And in year 2018 Social Security is already costing us one trillion dollars per year meaning that another 10 years of Boomers along with cost of living increases will send it North to 3 trillion. And the big advances in medicine mean we keep more people alive for longer periods of time.

Add to the above the increasing automation of manufacturing and even service industries, and the Red State rebellion that Trump provoked will be much worse and likely turn violent.

Of course those of us who were econ majors in college will wonder how demand is to be maintained when vast numbers of former middle class voters are thrown out of work due to automation. The solution will be a guaranteed income for all – as championed by Bernie Sanders and Ocasio-Cortez. The problem is that as unemployment climbs up the skill and intelligence ladder, at some point the system will be paying money to many capable, aggressive and very angry males. Make them unemployed, and they will have time for face to face communication and the mobility to organize into an irresistible force in ways the system cannot track.
Previously on CBS regarding the bond bear market.
  • Trump will be remembered for inaugurating a bond bear market, and not much else. It is shocking how little discussion there is of the November 2016 "Trump bond crash," and bonds have continued to set new low after new low since then. [March 2018]
  • The financial system wouldn't be so unstable if the Fed hadn't tried so hard to stabilize it. The Fed's response to the bubbles it has created is to blow even harder and hope for the best. The Fed has got itself into a corner and has no credible strategy to get itself out. We know that the latest bubbles must burst at some point and when they do interest rates are likely to rise sharply as bond market investors attempt to dump their holdings. When that happens the financial system will collapse, again. The temptation will then be to prop up bond prices by monetizing what could well be the entire government debt... [November 2017]
  • "[T]he US has a very short maturity structure, so higher interest rates turn into higher debt service quickly. We live on the edge of a run on sovereign debt. The US has a shorter maturity structure than most other countries, and a greater problem of unresolved entitlements. Despite our 'reserve currency' status, we may actually be more vulnerable than the rest of the high-debt, large entitlement western world." [April 2017]
  • Ultimately, debt implies a future transfer of purchasing power, and provides only a few choices. Either you raise adequate tax revenue, or you denominate the debt in long-term bonds and devalue them through inflation, or you default, or you violate the social contract made with those who don't hold paper claims (e.g. Social Security beneficiaries) in preference for those who do. Had the borrowing resulted in productive investment, future output would be easily available to meet those claims. Instead, what’s going on is a quiet dilution of future living standards. [December 2016]
  • [Y]ou're looking at the endgame of a Ponzi scheme that ended when it caused the total fertility rate, and thus - eventually - the worker retiree ratio, to drop too much. To put in a different perspective, the total equity value of the S&P 500 companies is less than $20 trillion. Imagine the federal government exhausting that much capital in ten years. I don't know when it will happen, but I think the bond market will choke. Occasional spikes in bond yields will be the signal that no more can be borrowed. [December 2016]
  • The next crisis is going to come in the investment that is currently perceived as riskless enough for highly leveraged institutions like banks to buy. Right now, government bonds are accorded zero risk in calculating bank capital ratios. The idea that government bonds are riskless when governments are planning to flood the market and when the expenditures are consumed (building no collateral) may prove to be the latest extraordinary popular delusion. This week has illustrated my point. The election of Trump led to an immediate 25 bp increase in the 10 year bond yield, which means an instant 2.3% loss in value. More than a year's worth of interest. [November 2016]
  • There could be a period when stocks and bonds go down together. For example, instead of stock declines -> people wanting the security of bonds, people might decide that stock declines lead to bailouts which are really stealth currency devaluations, and decide they want no part of the long end of the yield curve. It is very, very nonlinear, because once bonds lose momentum, who will want to own them? Professional asset management and retail investor sentiment are both all about momentum. And every credit - government or corporate - looks much worse with rising interest expense. I think we will come to realize that a lot of stuff in the economy (junk bonds, private equity) was part of a virtuous interest rate cycle. If you synthesize the best parts of Falkenstein and Redleaf, you predict that the next crisis is going to come in the investment that is currently perceived as riskless enough for highly leveraged institutions like banks to buy. [May 2016]
  • We can see with Trump's tax plan (implausible tax cuts and no specific expenditure cuts) that the personalities no longer really matter to the ultimate outcome: sovereign debt crisis, inability to debt finance expenditure, followed by loss of legitimacy of government. [September 2015]
  • Having $3 trillion of assets under management puts you in the top handful of asset management firms. Owning $1 trillion of treasury debt (like China or Japan) makes you one of the largest holders. Who, then, is going to be buying the $3 trillion a year that federal, state, and municipal governments are planning to borrow to cover their operational and pension shortfalls? [June 2015]
  • For the counterargument that the Fed will just buy bonds to "keep rates low", you have to face the fact that QE invariably caused rates to rise, and you could (and we did) make money buying bonds every time the Fed stopped buying them. As I kept trying to explain, the QE bond purchases may have been respectably large in relation to the flow of debt issuance, but they were puny in relation to the stock of $60T of dollar denominated debt. It freaked creditors out about inflation more than it helped. [May 2015]
  • The legitimate purpose of public debt is to borrow money to build infrastructure improvements that have a positive net present value. However, a vast portion of federal expenditure now leaves nothing tangible, leaves no collateral. A treasury bond is a certificate that money has successfully been expended on section 8 housing, or on make-work military "jobs". The lack of collateral makes these treasuries creatures of social mood. In a way, they are as valuable as tulip bulbs or south sea shares. What is a treasury going to yield when mood darkens, and a distressed investor who looks over the enterprise for scrap value is the marginal buyer? [February 2015]
Baby boomers will never be able to accept this psychologically. Baby boomers are accustomed to some asset always going up. If not stocks, then bonds. Hence their 60/40 "diversification" strategy.

Tuesday, November 20, 2018

Oddball Stocks Newsletter

Credit Bubble Stocks is known for a number of things: short ideas (DSL, WLT, XCO, BCEI), capital structure arbitrage ideas (CPE, RMIX, GMXR, KV-A, SHLD), micro cap value ideas (CNRD, TVOC, OPST, SFBK, LINSA), thoughts on interest rates, and our book reviews and links.

Some of our readers may also be familiar with Nate Tobik and his blog Oddball Stocks, which he turned into the Oddball Stocks Newsletter in 2014.

Nate also runs a software company called Complete Bank Data which tapped a market need at smaller banks and is now growing rapidly. It is taking up so much of his time that he asked me to help out with the Oddball Stocks Newsletter.

So from now on my writing about the micro cap stocks is mostly going to be in the Oddball Newsletter. We just published a new one, issue number 22. If you liked reading my ideas on these over the years and want to keep seeing them, you should subscribe.

The link to subscribe is here:


In addition to the micro cap ideas, the Newsletter also has general commentary from us. I hope Credit Bubble Stocks readers will subscribe so they can continue to be part of that conversation. (The newsletter also has a members-only forum.)

Monday, November 19, 2018

November 19th Links

  • Cities are fractal. You can always go a layer deeper and there's just as much complexity. Following this principle, I sometimes think it might make sense to just stay in San Francisco my whole life and explore the infinite levels of that fractal. It's cheaper than interstate or international travel anyway, and according to this framework you get the same amount of interestingness no matter how many levels deep you go. The catch is that when you stay in one place it's too easy to accidentally fall into a rut and not actual get the most out of the levels available to you. So while it may be theoretically possible to see a wide variety of things and learn things at different levels by staying within the limits of a single city, you're much less likely to surface those experiences because it's easy to build up habits, a pattern of behavior that cut off interesting discoveries. This is an obstacle rather than a theoretical limit. The other possible takeaway from viewing cities as fractals is that it doesn't matter how much time you spend in one. There'll always been an infinite amount of people, places, subcultures, foods, and more that you didn't get to experience. In other words, the one-day-per-city approach was fine for my recent trip to Asia. The limit on it is less how much you can see in a day (per its scale-free nature) and more how exhausting it can be to go from place to place. [DZ]
  • Newell and Simon's Turing award cited them for their work on "symbol systems." Newell once told me that this was just names, and then he explained his understanding of names: "They provide distal access." That is, a name is a local piece of data that stands for some other piece of data, which is presumably large and remote. You can now use that small, convenient, local datum instead of the large, remote thing for which it stands. The key act you perform with a name (that is, a symbol) is ship it to that remote location, and get back the chunk of data it named. Newell said the career-making, fundamental "aha" experience of his entire life was realising that computers were not, as was typically held in the 1960's, "number crunchers." They were symbol processors—something much more general. They processed names. [link]
  • If we think of the variables in the system as forming a space, then a concrete representation corresponds to a point in this space. (If we have interactive control over the variables, we can steer this point around.) An abstraction over a variable can be thought of as a line in this space. (Specifically, our trajectory here is the image of this line.) An abstraction over two variables spans a plane, and so on. "Stepping down" from this abstraction corresponds to choosing a line within this plane. [link]
  • Different size investors operate at different levels of abstraction. An enormous institutional investor might say "small caps seem cheap, let's give a billion to small cap value managers." While we say "Conrad is the cheapest, best small cap that we can find, let's buy that." One reason for different levels of abstraction is that if you are big you need to ignore certain smaller details in order for your work to be manageable. Someone interested in finding rare coins can get rolls of them from the bank at face value and sort them. On average, he may find enough rare pennies that are worth 1000x face value to make the activity worthwhile. But, a bank is just concerned about keeping the cash drawers stocked. To them, a penny is a penny and they don't care if they accidentally let some rare ones go. It's because the bank is operating at a different level of abstraction than the coin collector. [CBS]
  • To a newly arrived undergraduate, all university departments look much the same. The professors all seem forbiddingly intellectual and publish papers unintelligible to outsiders. But while in some fields the papers are unintelligible because they're full of hard ideas, in others they're deliberately written in an obscure way to seem as if they're saying something important. [Paul Graham]
  • We conveniently classify animals with backbones into five groups: fishes, amphibians, reptiles, birds, and mammals. This is misleading because it fails to represent the profound distinctions among fishes. The bony fishes are at least as evolutionarily distinct from the cartilaginous fishes as mammals are from birds. A tuna is actually more closely related to a human than to a shark, and the coelacanth—a "living fossil" first discovered in 1937—sprouted closer to us than to a tuna on the tree of life. [Phil G]
  • And to sail a condemned vessel east from Europe is to adjust the financials of a demolition substantially. A secondhand vessel is currently worth about $190 per tonne to a shipbreaking yard in Turkey, a price established by the local market in reclaimed steel. Sail on to China and a different market, and the same metal is worth $210 per tonne. At breakers' yards in Alang in India, Chittagong in Bangladesh and Gadani in Pakistan, they will pay around $280 per tonne. Meanwhile, at the EU-approved shipbreaking sites, which are bound to conform to continental waste laws, and where vessels are dismantled in closed-off quays or dry docks, rates are less competitive: European yards offer zero dollars per tonne, and, in fact, tend to ask a fee to take a shipowners' junk. Of the 864 vessels that were dismantled around the world last year, nine were dismantled in Europe. [Guardian]
  • Let's say you were living in the Soviet Union back in 1989-ish just before all of Russia's institutions dissolved and the economy collapsed. Would it have been a good use of people's time and energy to go to city council meetings to try and bring about structural change? [Granola Shotgun]
  • The topographic isolation of a summit is the minimum great-circle distance to a point of equal elevation, representing a radius of dominance in which the peak is the highest point. It can be calculated for small hills and islands as well as for major mountain peaks, and can even be calculated for submarine summits. [Wiki]
  • Street networks in Osaka, Kyoto, and Tokyo are highly connected. The streets are narrow, and the blocks are short, which feels more human-scale and creates more opportunity for diversity. Pedestrians feel comfortable in these dense networks, which encourages walking and biking. [DZ]
  • Bangalore's trees were my favorite part of the city. They were so lush and made the experience of walking in Bangalore quite enjoyable despite the heat and the otherwise crumbling pedestrian infrastructure. [DZ]
  • I had a general sense of "if you can't afford to arrive here by car, you’re not the kind of customer we're looking for". There were a many spots where the underlying street structure was amenable to pedestrians, but then small changes after the initial development were made to actively inconvenience pedestrians. Terrible pedestrian experience! Wandering Jakarta was the most exhausting and unwelcoming of the five cities, and that's saying quite a lot considering Beijing was in that mix. [DZ]
  • I'd read a lot about two of the cities (Beijing, Singapore), knew a bit about one (Saigon), and knew close to nothing about the others (Jakarta, Bangalore). Now, I feel quite confident that given a photo of a street from one of these places I could name the metropolitan region with a low error rate. My internalized representation of each of these places is certainly not complete, but it's much better than it was a week ago. [DZ]
  • How is having those under age 45, trying to buy a house, pay 50 percent of their income in debt service "good news?" Aren't later-born generations already disadvantaged and overburdened enough? If you are such a household, don't buy, whatever you do. Decide that no matter what it takes, Generation Greed is going to have to cut its price so low that lower mortgage payments as a percent of income make up for all the other disadvantages and burdens they are imposing. Better to rent for years, or decades, in a new apartment building – preferably one that is located in a place were you can bike things so you aren’t dependent the collapsing transit system and don't have to borrow to buy cars either. [link]
  • A figure/ground map shows much better than a typical street map the diversity of Boston's development. From the gridded row houses in the Back Bay and South End, meandering suburban streets to the south, gridded three-deckers in Cambridge and South Boston... this variety is in part a record of Boston's piecemeal land reclamation efforts. Notice how the scale of development has increased in the twentieth century — some of the largest building footprints are located on recently reclaimed land, in Fort Point Channel, Miller's Creek, and the South Bay. The high-res map also shows that Boston has its fair share of modernist housing developments scattered throughout the city. [Radical Cartography]
  • The map here shows all the streets on either side of the US—Canada border along the 49th parallel — the longest straight-line border in the world, by far. (West is up, with the U.S. to the left and Canada to the right.) Although there are still some data problems in both countries — suspicious splotches, unexpected edges, disconnected roads — there's a subtle change at the border that seems undeniable. In Canada the Great Plains are more consistently gridded, while the mountains are much less accessible. This isn't a difference in data quality; it's a difference in national priorities and public-land management practices (U.S. national forests are full of roads; Canada crown lands are not). And note that the border itself is visible as a thin white line where the local roads are all dead ends. Despite sharing such a long arbitrary border, most of which is open plains, there are only a handful of places where it can legally be crossed. [Radical Cartography]
  • Hot property markets tend to have railroads crossing them. Since railroads are entirely federally governed, no city building permits are required for adding new train cars, even live-aboard Palace Cars, onto the tracks. Federal law and federal zoning instead prevails. Local zoning is bypassed. Your train cars can have running hot/cold water, septic systems/bathrooms, electricity, heating, air conditioning, cell phone service, WiFi, satellite, desks, conference rooms, bedrooms, kitchens, metal 3D printers, etc. They can even receive postal mail and Amazon.com deliveries. [link]
  • For every point on earth, I've calculated the percent of all humans that live on the half of the globe centered on that point. (This is the same as calculating how many people live within 10,000 kilometers.*) On land, the values range from a high of 92.9% (the Human Hemisphere) to a low of 8.1% on the Antipodes Islands off the coast of New Zealand. [Radical Cartography]
  • Humans are an unmistakably low-altitude species. The basic S-curve here shouldn't be surprising, since most of the earth's land is low-lying plains and forests rather than mountains. But the human population is quite low even with this in mind. Half of all humans live below 165 meters, while only 28% of land is that low. The lowest 4% of the world's land is home to about 15% of humans. [Radical Cartography]
  • Olympus Mons is a very large shield volcano on the planet Mars. By one measure, it has a height of nearly 25 km (13.6 mi or 72,000 ft). Olympus Mons is about two and a half times Mount Everest's height above sea level. It is the largest volcano, the tallest planetary mountain, and the second tallest mountain in the Solar System compared to Rheasilvia on Vesta. [Wiki]
  • Hyperborea, Thule, and Ultima Thule are names of mythical utopian far-northern places from pre-modern geography or pseudo-geography. They have featured in a wide range of mythology and nonsense, from the ancient Greeks to recent esotericists and mystics, including theosophists such as Helena Blavatsky. Lately they have been adopted by the far-right as part of esoteric Nazism, a philosophy which considers some northern land to be the secret place of origin for the Aryan race. [link]

Monday, November 12, 2018

November 12th Links

  • However, there is one factor above that should be highlighted now, because many inventors and patent owners are unfamiliar with the concept. Continuity and continuations are of the utmost importance; they are a powerful tool for fixing problems, increasing claim coverage, and minimizing risk. If there are no pending continuations, it is unlikely that a lawyer will accept a patent portfolio on a contingent fee representation unless the other factors are extraordinary. Continuations allow the patent claims to be refined over time to improve validity and infringement positions as issues surface or the law changes. If the opportunity to file a continuation has passed, the patent owner cannot continue to obtain issuance of new patents and claims with the same effective filing date. [JDBIP]
  • If you wanted to communicate as much as possible to someone about your worldview by asking them to read just five books, which five books would you choose? [Luke Muehlhauser]
  • Risk cannot be avoided, only managed. The risk-free asset is an illusion. Someday your natural life will end, you need to invest taking that into account, and taking into account that this is true of everything else on this earth that you can put your trust in. If you allocate too much of your portfolio to "safe" assets you're leaving yourself unnecessarily exposed to the risk that this asset will become irrelevant, and failing to take the chances that are actually available to improve your position. [Ben Hoffman]
  • Relatedly, I've long wanted to research, compose, and record a many-hour continuous piece of music that recapitulates the entire history of "Western music" (which is better documented than other traditions). The piece would begin with sections composed in accordance with scholarly guesses about how prehistoric music might have sounded, eventually transition into the earliest styles from recorded history, then evolve into styles covered in e.g. Burkholder's History of Western Music, up to the present day. This is a pretty obvious idea and I'm upset that nobody has attempted it yet. [Luke Muehlhauser]
  • I was looking for clues as to how we could frustrate the Soviet versions of RAND and SAC, and do it in time to avert a nuclear Pearl Harbor. Or postpone it. From the Air Force intelligence estimates I was newly privy to, and the dark view of the Soviets, which my colleagues shared with the whole national security community, I couldn't believe that the world would long escape nuclear holocaust. Alain Enthoven and I were the youngest members of the department. Neither of us joined the extremely generous retirement plan RAND offered. Neither of us believed, in our late twenties, we had a chance of collecting on it. [Luke Muehlhauser]
  • With the outbreak of World War II in late summer, White returned to the United States. He later enrolled at Yale Law School in 1939. In a 2000 interview, White said that he was supposed to enroll at Harvard Law School, but got sick on the train ride there, so he got off the train in New Haven, Connecticut and went to Yale. [Wiki]
  • Economists love Uber like a mother loves her child. They love it like the internet loves cats. They love it like tech bros love Elon Musk. Economists love Uber because it's the closest you can get to taking the pure economic theory of textbooks and summoning it to life. Uber created a massive open market, governed first and foremost by the forces of supply and demand. Along the way it broke up the taxi monopoly, taught people to accept "surge" pricing, and ushered concepts long confined to econ 101 into the popular discourse. [link]
  • Bressloff's model does not only provide insight into the mechanisms that drive visual hallucinations, but also gives clues about brain architecture in a wider sense. In collaboration with his wife, an experimental neuroscientist, Bressloff has looked at the connection circuits between hypercolumns in normal vision, to see how visual images are processed. "People used to think that neurons in V1 just detect local edges, and that you have to go to higher levels in the brain to put these edges together to detect more complicated features like contours and surfaces. But the work I have done with my wife shows that these structures in V1 actually allow the earlier visual cortex to detect contours and do more global processing. It used to be thought that you process more and more complex aspects of an image as you go higher up in the brain. But now it's realised that there is a huge amount of feedback between higher and lower cortical areas. It's not a simple hierarchical process, but an incredibly complicated and active system it will take many years to understand." [link]
  • The intermittent and incompletely predictable solar cycles periodically stress the genomes of all life producing genetic changes which may be harmful or adaptive. The evidence presented in this study indicates that solar cycles, particularly the most irradiant which have occurred over the past 65 years, are fundamental engines of evolution, even underlying natural selection, and we bear their marks even to the end of our lives. [link]
  • Folate, a key periconceptional nutrient, is ultraviolet light (UV-R) sensitive. We therefore hypothesise that a relationship exists between sunspot activity, a proxy for total solar irradiance (particularly UV-R) reaching Earth, and the occurrence of folate-sensitive, epigenomic-related neonatal genotypes during the first trimester of pregnancy. Limited data is provided to support the hypothesis that the solar cycle predicts folate-related human embryo loss. [link]
  • Strange new respect for judicial minimalism. As Harvard Law professor Adrian Vermeule remarked, "Law review editors: brace for a tidal wave of legal academic theories supporting judicial minimalism, Thayerianism, and strong — very strong — theories of precedent. Above all: the Court must do nothing without bipartisan agreement, otherwise it is illegitimate." The past half-century's enthusiasm for judicial activism will vanish, as legal academia turns on a dime to promote theories that will constrain the court until a left-leaning majority returns, at which point they'll turn on a dime again. [link]
  • My friend Satvik recently told me about an important project management intuition he'd acquired: it's a very bad sign to have a lot of projects that are "90% complete". This is bad for a few reasons, including: Inventory: For any process that makes things, it's a substantial savings to have a smaller inventory. A manufacturer buys raw inputs, does work on them, and ships them to a customer. Every moment between the purchase of inputs and the delivery of finished goods is a cost to the manufacturer, because of the time value of money. Smaller inventories are what it looks like to have a faster turnaround. If a lot of your projects are 90% complete, that means you're spending a lot of time having invested a lot of work into them, but realizing none of the value of the finished product. [Ben Hoffman]
  • A key heuristic for confidence seems to be "cards in your back pocket." For example, it's much easier to negotiate salary when you know you have other job offers. It's much easier to confidently give a talk if you've done it before and know you can recover even if you get derailed. It's much easier to be confident in social situations when you're comfortable with your existing relationships, and aren't desperate for new ones. [Satvik Beri]
  • Implicit in this is that good taste helps you eventually become a good artist: by recognizing what good work looks like, you're able to practice and gradually improve your work until it meets your own standards. On the other hand, if your taste is poor then you're subject to a much slower feedback loop: at best, you can ask others to look at your work, which is still useful but introduces a substantial amount of delay. And the gap between practice and feedback has an enormous impact on how fast you learn. So poor taste = slow feedback loop = slow learning, while good taste = tight feedback loop = fast learning. This suggests that one of the most important things you can do is continuously cultivate better taste. [Satvik Beri]
  • If you spend an hour beautifully perfecting the wording of an essay only to throw out the whole paragraph afterwards, then all the time you spent polishing was wasted. It would have been much better to nail down the layout, then focus on getting it to the point where you'd be willing to show it to others. The broader lesson here is to figure out the piece of a project that has the highest uncertainty, and start iterating there, and do this sequentially until the project is done. [Satvik Beri]
  • Another important factor is that the tree of decisive considerations reduces what can seem like very complex values problems to relatively objective questions which can be answered with information. This makes it very easy to narrow in on the actions you need to take. [Satvik Beri]
  • Those of you who know me might know that I tend to get obsessed about things sometimes. And by sometimes I mean I almost always have one obsession that lasts about 1-6 weeks where I spend most of my waking hours thinking about, studying, or working on some topic. These obsessions have included statistics, video games, the history of monogamy, Kaggle contests, project euler problems, Coursera courses, work projects, and more. [Satvik Beri]
  • A simple, but important factor is that I started to take Tyrosine last year, and seriously upped my dosage whenever I felt depressed and unable to act. This didn't have much effect on my mood, but it made me noticeably more able to get things done. I would estimate that I was about 70% as productive in a "down" state as I was in a normal state, which is a huge improvement for me–previously, that looked more like 10%. [Satvik Beri]
  • On behalf of property owners everywhere, I want to thank Jeff for installing 1/4 turn ball valves on his plumbing shut-offs. I've replaced so many seized gate valves over the years (roughly all of the ones I own!) that hearing someone else with a practical bent to real estate makes me very happy. Plumbers love gate valves for reasons that make no sense to me, and I've had them installed in properties I own after I explicitly specified 1/4 turn ball valve (by plumbers that no longer do work for me). That type of attention to detail is key for small scale real estate investment. It costs an extra couple bucks, but it is basically guaranteed to save a $100 service call within the next 10 years. And once in awhile it will save a $10,000 flood issue when something is leaking and the crappy gate valve can't be closed. I doubt that level of attention to detail is available from an outsourced property management firm, but I sincerely wish this company the best. [CoBF]
  • The law surrounding subject matter eligibility under 35 USC 101 used to be clear-cut and well established compared to the law as it stands today. In 1980, the Supreme Court confirmed the historical intent of the law that "anything under the sun that is made by man" met the requirements for subject matter under 35 USC 101. Diamond v. Chakrabarty, 447 U.S. 303 (1980). Thirty-four years later, the Supreme Court changed its mind. [JDBIP]
  • How can a claim be novel enough to pass 102 and nonobvious enough to pass 103, yet lack an "inventive concept" and therefore fail 101? Or, how can a claim be concrete enough so that one of skill in the art can make it without undue experimentation, and pass 112, yet abstract enough to fail 101? How can something concrete be abstract? These problems confound the most sophisticated practitioners in our patent system. People simply don't know how to draw these distinctions. If something is not inventive, then invalidate it under 102 or 103. If something is indefinite, or too broad to be fully enabled or described, then invalidate it under 112. [PatentlyO]

Monday, November 5, 2018

November 5th Links

  • All government, in its essence, is a conspiracy against the superior man: its one permanent object is to oppress him and cripple him. If it be aristocratic in organization, then it seeks to protect the man who is superior only in law against the man who is superior in fact; if it be democratic, then it seeks to protect the man who is inferior in every way against both. One of its primary functions is to regiment men by force, to make them as much alike as possible and as dependent upon one another as possible, to search out and combat originality among them. All it can see in an original idea is potential change, and hence an invasion of its prerogatives. The most dangerous man to any government is the man who is able to think things out for himself, without regard to the prevailing superstitions and taboos. Almost inevitably he comes to the conclusion that the government he lives under is dishonest, insane, and intolerable. [H.L. Mencken]
  • In 2016, TSLA thought its Fremont plant could make 5,000, 10,000 and 20,000 vehicles a week in late 2017, 2018 and 2020, respectively. This can't happen at people speed. Consequently, the cost structure of the Model 3 is much higher than Elon Musk expected when he took deposits from hundreds of thousands of people for a $35,000 car. It's a promise he can't keep. 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. In May, Elon Musk tweeted that the $35,000 version would be launched 3-6 months after the company achieved 5,000 cars a week. That milestone was hit with great fanfare in June. However, investor relations has leaked that the company now expects the $35,000 version in the second quarter of next year. Tellingly, TSLA has stopped taking orders for the $35,000 version, as it may already know that it won't be releasing a $35,000 version anytime soon or ever. The company has changed its policy on refunding deposits so that customers who are tired of hoping TSLA makes a car that doesn't exist and want their money back have to wait 45 days. It reminds us of Jane and Michael Banks in Mary Poppins. We think this may explain Mr. Musk's erratic behavior. He can't make the car without losing too much money and he can't bring himself to cancel the program and refund everyone's deposits. His conduct suggests that he is doing his best to be relieved of his position as CEO to avoid accountability. Quitting isn't an option because it prevents Mr. Musk from claiming he could have fixed the problem had he stayed. [ZH]
  • Several mechanisms can explain the association between visceral fat accumulation and increased risk of prostate cancer. Adipose tissue is a source of specific substances, including adiponectin, resistin, leptin, and adipsin, and secretes a variety of other cytokines, such as tumor necrosis factor‐α and interleukin‐6. There is ample evidence that VF and SF cells differ metabolically. The metabolic products of VF, namely free fatty acids, are delivered directly into the portal circulation to the liver, inducing a significant metabolic disturbance. It is well established that VF accumulation is associated with insulin resistance, resulting in hyperinsulinemia. Insulin can promote the growth of several different cell lines, including prostate tumors, and high plasma insulin levels have been related to prostate cancer risk and stage. In a case‐control study, men in the highest tertiles of waist/hip ratio and serum insulin levels had an 8.55‐fold increased risk of prostate cancer compared with men in the lowest turtles. [link]
  • I reached Sunbury, where the West Branch of the Susquehanna joins the main. About here, I judged, was the limit of Colonial era settlement. Thereafter the infrastructure and artifacts appeared to be Jacksonian era or later. The West Branch arcs northwesterly. The population of the state is concentrated in the east, along the Delaware River valley, and in the west around Pittsburgh, the Ohio River and Lake Erie areas. The central, which is hills or mountains, is less populated, especially north of the West Branch. Here the Alleghenies run southwest-northeast, up from West Virginia and into New York. Mountains are as powerful a metaphor and symbol as they are a physical obstacle. [link]
  • Could the next Senate confirmation hearing of a Supreme Court nominee be worse than the Kavanaugh-Ford hearing? Who would have thought that a hearing could be worse than Chappaquiddick Teddy Kennedy's attack on Judge Bork, or the "high tech lynching" of Clarence Thomas? [Federalist]
  • In 20 years of covering New Hampshire primaries, I crossed paths with candidates who almost immediately revealed their fallibilities. Call it intuition, but when Ernest "Fritz" Hollings, a silver-haired South Carolina senator with a stentorian voice and Dixie accent, strolled into the newsroom at the Monadnock Ledger in Peterborough and requested directions to the restroom by inquiring with all the authority of a world statesman, "Where's your little boys' room?," I sensed his quest for the 1984 Democratic nomination was doomed. [Boston Globe]
  • Norwegian Karl Ove Knausgaard, author of six volumes of autobiographical musings entitled My Struggle, is likely the most celebrated literary writer of the current decade. He's a leading light of the Hapless White Guy literary genre perhaps founded by the late David Foster Wallace. [Sailer]
  • Even with a new year, the pattern of en route delays to the airport at SeaTac [KSEA] continues. A particularly galling aspect of this is that both FAA and the management at this airport have expended a huge effort promoting these so-called 'NextGen improvements', even going so far as to over-use a 'Greener Skies' eco-moniker. To help reveal this propaganda, an analysis was recently done, looking closely at 25 arrivals during a half-hour-long push on the late evening of Thursday, January 14, 2016. [link]
  • This urgent pulling forward of buying has happened before on a large scale in the U.S. in 1999.  The year 2000 fear that software would not be able to handle the switch from 1999 to 2000 due to program limitations triggered both corporate buyers and consumers to purchase new hardware and software that would fix the bug. Sales were pulled forward into 1998 and 1999 then in 2000, sales dropped fast 'like the lights were turned out' the CEO of HP, Carly Fiorina said. [link]
  • Wallace Stegner has published thirteen novels, three short-story collections, sixteen nonfiction titles, and has edited eighteen works in the fifty-three years he has been publishing books. His first novella, Remembering Laughter, won a Little, Brown Prize in 1937, and in 1990 Random House published Stegner’s collected stories. [Paris Review]
  • "Oplan Fracture Jaw has been approved by me," General Westmoreland wrote to Adm. Ulysses S. Grant Sharp Jr., the American commander in the Pacific, on Feb. 10, 1968. (The admiral was named for the Civil War general and president, who was married to an ancestor.) [NY Times]
  • In one of the celebrated scenes of the 1997 movie  Good Will Hunting, Matt Damon's title character gets into a battle of wits with a student from Harvard University, whom he accuses of uncritically parroting the views of the authors on his reading list as a first-year graduate student. He goes on to predict that a little later in his curriculum, he would simply be "regurgitating Gordon Wood." The student begins to respond with a critique of Wood, which Hunting interrupts, completes, and notes is plagiarized from Daniel Vickers' Farmers and Fishermen: Two Centuries of Work in Essex County. [Wiki]
  • The text covers four years of the Kulturkampf - 1936, 1937, 1938 and 1939. Like modern bloggers, the authors wrote more newsletters in the early years,than the later, perhaps because of losing interest, perhaps because everything had already been said, perhaps because of life interfering, or perhaps because of the Gestapo. [Amazon]
  • The civil war has been talked about quite a bit. Some foolishly believe it will follow the template of the previous two, which was largely geographically based because both side fundamentally had the same culture. This won't happen. I live in a so-called "deep blue" state. Does anyone think that if the balloon goes up, I'm going to run out with my AR-15 and join the "Washington State Progressive Stormtrooper Brigade" just because I live here? No, what is going to happen is much more complex and simple at the same time. [American Digest]
  • Given that the brain consists in a mass of connections, whose power depends on the number and complexity of those connections, why is it divided? Or is that just random, and we should give up trying to find a pattern which make sense in terms of evolutionary advantage? [Kenan Malik]
  • Split-brain structure (with the different hemispheres having very distinct structures and morphologies) is common to all higher organisms (as far as I know). Is this structure just an accident of evolution? Or does the (putative) split between a systematizing core and a big-picture intuitive core play an important role in higher cognition? AGI optimists sometimes claim that deep learning and existing neural net structures are capable of taking us all the way to AGI (human-like cognition and beyond). I think there is a significant chance that neural-architectural structures necessary for, e.g., recurrent memory, meta-reasoning, theory of mind, creative generation of ideas, integration of inferences developed from observation into more general hypotheses/models, etc. still need to be developed. Any step requiring development of novel neural architecture could easily take researchers a decade to accomplish. So a timescale greater than 30-50 years for AGI, even in highly optimistic scenarios, seems quite possible to me. [Steve Hsu]
  • Cannabis use is a heritable trait that has been associated with adverse mental health outcomes. In the largest genome-wide association study (GWAS) for lifetime cannabis use to date (N = 184,765), we identified eight genome-wide significant independent single nucleotide polymorphisms in six regions. All measured genetic variants combined explained 11% of the variance. Gene-based tests revealed 35 significant genes in 16 regions, and S-PrediXcan analyses showed that 21 genes had different expression levels for cannabis users versus nonusers. The strongest finding across the different analyses was CADM2, which has been associated with substance use and risk-taking. Significant genetic correlations were found with 14 of 25 tested substance use and mental health–related traits, including smoking, alcohol use, schizophrenia and risk-taking. [Nature]
  • The seven main bearing straight six. The straight axles. The locking diffs. The Biggie interior. Not that Toyota didn’t also build these with cloth interiors, stripped down to the bare necessities of what one would need to drive, say, from here to Uzbekistan. This is the last bridge between the Unkillable Warlord SUV Era and the Maximum Cup Holder Comfy SUV Era. [Jalopnik]
  • Global logistics sites depend on what Jake called "just in time," where ideally the goods don't spend any time sitting around. Ultimately that's the source of this competitive advantage. Time is what potentially gives workers in this industry a lot of power. If you're able to disrupt an industry that is absolutely dependent on moving things quickly there are huge potential losses for the employers. [Jacobin]
  • A lot of commonly-accepted social norms (especially among Blue Tribe, but also in religious Red Tribe settings) have to do with safeguarding against flagrant assholes and sociopaths, but catch overthinking nerd types in the net. [SSC]
  • Short answer: no. It doesn't matter what embryo selection does, it's weak and even what I call "massive embryo selection" (using stem cells for generating hundreds of embryos) will be obsoleted within a generation by iterated embryo selection/genome synthesis/some sort of super-CRISPR. Goodhart's Law in all its forms is irrelevant because so little can be done. More in-depth answer: human traits turn out to be very convenient, and the usual animal breeding solution (selecting on an index of trait PGSes weighted by value) will probably work fine and is already what GenPred would like to do. Doing embryo selection on a single trait would be dumb and inefficient and unnecessary anyway. [Gwern]
  • The Consumer Price Index for Rent in this town is up 30% since I moved here 4 years ago. Nice. In all transparency, my rent only went up 8% this year, which doesn't sound quite so bad. Until I do the math on another 4 years of 8% rent increases (100 * 1.08^4 = 136%) — and realize that I need a 36% increase in income over that same period just to stay flat on nominal take-home savings. Per my first point on Cost Disease, real median household income in the US has only just clawed its way back to what it was in 1999. Certainly it hasn't grown 36% in the last 4 years. But maybe there's some way I can get ahead of the median? Maybe there's some way I can keep my income going up more than 36% every 4 years and actually build wealth too? How much was that MBA, again? [link]
  • Eventually, the US is going to break apart in much the same way as the Soviet Union. I have no doubt of that, although I may not live to see it. But the idea of the 50 individual States being independent nations makes little sense practically or politically. I'm guessing there will be from four to six or seven nations formed out of the current Continental US, with lines sometimes but not always following the current state lines, and some present states being broken into two or more parts. California and Texas are unlikely to stay whole, several New England states unlikely to stay separate, and many arbitrary or geographically odd boundries will be eliminated, such as Michigan's Upper Peninsula. Chunks of Western Canada and Baja California may be part of the new nations as well. Mexico's military is utterly impotent and would not last a week against the California National Guard alone. Canada's is more serious, but even a semiserious revolt against rule by Ottawa and Frogs would succeed in the long run. Big question is: Who gets the nukes and why? [Sailer]
  • What they have in common is that they aren't 19th century river cities. The old-line river cities boomed and became very wealthy hubs for industry. When river/water transport became less labor intensive, they couldn't retool b/c their local economies were built around the rivers. St. Louis, Cincinnati, Cleveland, Pittsburgh, Buffalo, New Orleans, Louisville, Evansville -- all of these saw population declines. In some cases, populations were cut in half. Memphis is one of the few big river cities that never saw meaningful population decline. Its business leaders actually deserve some credit for reinventing the city as a logistics hub. Air cargo, trucking, rail -- Memphis escaped the river city curse by adapting. [link]
  • If you're manufacturing car parts or providing landscaping services or running a restaurant, how is it useful to hear from the CEO of a company that has had, essentially, a monopoly for 5-15 years? The regulated Bell System monopoly had its drawbacks, but at least Americans were spared from having to purchase and read books by its managers offering purported secrets of their success. Nobody who ran a business exposed to competition was forced to watch a Bell System executive being interviewed on TV with fawning questions about how he or she had made the company so profitable. [Phil G]
  • Anyone who is on the West Coast can basically attest Asian women are displacing White women as partners for upwardly mobile White guys. The guys like the low drama, femininity, and intelligence. [Sailer]

Thursday, November 1, 2018

Updated - Thoughts On Tesla

[This is an update to our July 7th post on Tesla.]

Tesla is just one of the many overvalued companies – mistakenly considered "tech" companies and to which normal rules do not apply – that have been in business for a decade or more but have shown no ability to generate and return cash to shareholders. Yet Tesla seems to be closest to the precipice of failure than any of the others, and perhaps it will be the first domino to fall in a series of long overdue revaluations.

Tesla is not profitable and so it has been (and will be) dependent on continually raising capital in order to survive. It sells an expensive product that will sell poorly in a downturn. The Tesla customer base consists to an unusually high degree of engineers at overvalued NASDAQ companies - hence the San Francisco Bay area is the premier market for Tesla vehicles. In this way, Tesla is something of a "derivative of itself." That property seems to be a hallmark of manic entrepreneurship - so you also have Musk's ownership of Tesla augmented by margin loans against his stock, which is a pattern with company managers whose businesses tend toward the unsustainable: Michael Pearson, Aubrey McClendon.

If a bear market, recession, or NASDAQ revaluation occurs, we would expect to see Tesla shares significantly decline in value and therefore the trade makes a nice hedge against long ideas. But it is not clear that Tesla will survive even if the current boom or bubble continues. Since our previous writing about Tesla, the Chairman and CEO Elon Musk announced – on Twitter – that he would be taking Tesla private at $420 per share.

After taking some time to think about it, we decided that we would not be bullied out of our bearish view by his announcement. The normal pattern with a management buyout is that an insider or founder decides that the public market is undervaluing the (normally profitable and cash-generating) company in question, and so essentially swaps the public investors out of the capital structure and replaces them with debt financing. Obviously management wants to get a good price on the purchase, so in addition to the normal considerations of honesty and legal compliance it is intelligent to disclose any problems in the business to the market, so that the market price (which the takeover offer is compared to) will discount them.

Even the biggest Tesla believers would have to admit that with dusty Tesla inventory piling up in lots all over the country, very short wait times after relatively few Model 3s from the big reservation list have been delivered, quality problems, signs of working capital shortages such as mechanic's liens on the factory and unpaid state taxes... the operation is not running as smoothly as a nice gasoline engine.

So why paint a rosy picture and inflate the purchase price for the business? Why complain so bitterly about short sellers driving down the price of something that you want to buy? It looked like the buyout price of $420 that Musk floated was chosen as the highest price that he thought anyone would find plausible, not as an attractive price to actually pay for the business. And it did turn out that the buyout was a hoax, and in the short period of time since we last wrote about Tesla, Musk not only conducted this hoax but was also sued by the Securities and Exchange Commission and then settled the claims against him pertaining to the fake buyout, though not the other investigations which appear to be ongoing. [Worth reading the fake buyout SEC complaints against Musk and Tesla.]

The best way for Musk to "burn the shorts," which seemed to be his purpose in conducting the buyout hoax, would be to demonstrate high demand for his cars combined with an ability to earn a profit. Resorting to fraud to try to burn the shorts suggests to us that good operating results will not be forthcoming, and that Tesla may be closer to collapse than anyone realizes.

You might ask, would not Musk and Tesla disclose any impending financial difficulties or restructuring if things had gotten that dire? There are two episodes from his business career that suggest he would not. According to the Ashlee Vance biography of Musk, Tesla came close to failing in 2013.

Excerpt from Elon Musk: Tesla, SpaceX, and the Quest for a Fantastic Future

By the middle of February 2013, Tesla had fallen into a crisis state. If it could not convert its reservations to purchases quickly, its factory would sit idle, costing the company vast amounts of money. And if anyone caught wind of the factory slowdown, Tesla's shares would likely plummet, prospective owners would become even more cautious, and the short sellers would win. The severity of this problem had been hidden from Musk, but once he learned about it, he acted in his signature all-or-nothing fashion. Musk pulled people from recruiting, the design studio, engineering, finance, and wherever else he could find them and ordered them to get on the phone, call people with reservations, and close deals. "If we don't deliver these cars, we are fucked," Musk told the employees. "So, I don't care what job you were doing. Your new job is delivering cars." He placed Jerome Guillen, a former Daimler executive, in charge of fixing the service issues. Musk fired senior leaders whom he deemed subpar performers and promoted a flood of junior people who had been doing above-average work. He also made an announcement personally guaranteeing the resale price of the Model S. Customers would be able to resell their cars for the average going rate of similar luxury sedans with Musk putting his billions behind this pledge. And then Musk tried to orchestrate the ultimate fail-safe for Tesla just in case his maneuvers did not work.

During the first week of April, Musk reached out to his friend Larry Page at Google. According to people familiar with their discussion, Musk voiced his concerns about Tesla's ability to survive the next few weeks. Not only were customers failing to convert their reservations to orders at the rate Musk hoped, but existing customers had also started to defer their orders as they heard about upcoming features and new color choices. The situation got so bad that Tesla had to shut down its factory. Publicly, Tesla said it needed to conduct maintenance on the factory, which was technically true, although the company would have soldiered on had the orders been closing as expected. Musk explained all of this to Page and then struck a handshake deal for Google to acquire Tesla.

While Musk did not want to sell, the deal seemed like the only viable course for Tesla's future. Musk's biggest fear about an acquisition was that the new owner would not see Tesla's goals through to their conclusion. He wanted to make sure that the company would end up producing a mass-market electric vehicle. Musk proposed terms under which he would remain in control of Tesla for eight years or until it started pumping out a mass-market car. Musk also asked for access to $5 billion in capital for factory expansions. Some of Google's lawyers were put off by these demands, but Musk and Page continued to talk about the deal. Given Tesla's value at the time, it was thought that Google would need to pay about $6 billion for the company.

As Musk, Page, and Google's lawyers debated the parameters of an acquisition, a miracle happened. The five hundred or so people whom Musk had turned into car salesmen quickly sold a huge volume of cars. Tesla, which only had a couple weeks of cash left in the bank, moved enough cars in the span of about fourteen days to end up with a blowout first fiscal quarter. Tesla stunned Wall Street on May 8, 2013, by posting its first-ever profit as a public company—$11 million—on $562 million in sales. It delivered 4,900 Model S sedans during the period. This announcement sent Tesla's shares soaring from about $30 a share to $130 per share in July. Just a couple of weeks after revealing the first-quarter results, Tesla paid off its $465 million loan from the government early and with interest. Tesla suddenly appeared to have vast cash reserves at its disposal, and the short sellers were forced to take massive losses. The solid performance of the stock increased consumers' confidence, creating a virtuous circle for Tesla. With cars selling and Tesla's value rising, the deal with Google was no longer necessary, and Tesla had become too expensive to buy. The talks with Google ended.
So we know that at least once before when Tesla was close to failing, Musk did not disclose that to investors and in fact lied about shutting down the factory to save cash. Musk gave a speech in 2011 where he commented on the failure of Solyndra, a photovoltaic solar company which had been given loans by Obama's Department of Energy:

"The most you could say is that Solyndra executives were too optimistic. They presented a better face to the situation than should have been presented in the final few months, but then, if they didn't do that, it would have become a self-fulfilling prophecy of - as soon as a CEO says I'm not sure if we'll survive, you're dead."

Musk believes that it is appropriate to lie about a company's condition if it is dependent on accessing capital markets to survive, and if being honest would result in loss of access.

Tesla is being sued by shareholders in Northern District of California federal court in a case called Wochos v Tesla, and the allegations there are telling as well:
"[T]here is a difference between knowing that any product-in-development may run into a few snags, and knowing that a particular product has already developed problems so significant as to require months of delay." In re Apple Computer Sec. Litig., 886 F.2d 1109, 1115 (9th Cir. 1989). As 2017 started Tesla faced an existential crisis. It had burned through more than a billion dollars in 2016 developing the Model 3, diverting profits from its existing luxury cars to satisfy the cash demand for the Model 3. By the beginning of the Class Period, Defendants disclosed that they would mass produce the Model 3 by the end of 2017 despite contemporaneous facts and warnings from executives, suppliers, and vendors that Tesla's timeline was impossible to meet. Tesla had to build and operate automated production lines for the Model 3 body in its Fremont, California facility, and mass produce 5,000 batteries per week in its "Gigafactory" in Reno, Nevada.

First, the Complaint adequately pleads material falsity. In May and August, 2017, in SEC filings and in earnings calls with analysts, Defendants reported on their progress in first building, and then operating, automated production lines in Fremont and at the Gigafactory. Defendants leveraged these statements of present progress, claiming to be on track to meet Tesla's mass production goal by late 2017. These statements of present progress were materially false. Tesla was building small numbers of Model 3s by hand in its beta shop, where prototypes were constructed. In May, 2017, the automated line, itself, was in the very early stages of construction. Tesla continued to build Model 3s by hand as neither the automated production line, nor the body in white line, would produce a single Model 3 in Fremont until at least October, 2017. As with the Fremont facility, it was only in October, 2017 that the first car-ready battery came off an automated line at the Gigafactory. Similarly, supply issues abounded, and workers constructing the automated production line were regularly idle, lacking parts and instructions.

Defendants' statements that they were "on track" to meet mass production goals are actionable representations of present or historical fact. See Mulligan v. Impax Labs., Inc., 36 F. Supp. 3d 942, 946, 964 (N.D. Cal. 2014); Westley v. Oclaro, Inc., 897 F. Supp. 2d 902, 918–19 (N.D. Cal. 2012); In In re MGM Mirage Sec. Litig. , No. 2:09-CV-01558-GMN, 2013 WL 5435832, at *8 (D. Nev. Sept. 26, 2013). Further, Defendants are liable for expressions of opinion when they know facts undermining the positive statements. See In re Atossa Genetics Inc Sec. Litig., 868 F.3d 784, 802–03 (9th Cir. 2017) dismissal of opinion because it did not fairly align with facts in possession at the time).

By August, 2017, Tesla was, by its own timeline, supposed to have been in the second month of automated production at both facilities. Again, Tesla told investors about progress they claimed had already occurred in Fremont and at the Gigafactory that supported its readiness to mass produce the Model 3 in 2017. And, again, Tesla repeatedly lied. About automated production, Tesla told investors that a "gigantic machine" meant to produce 5,000 vehicles weekly was—at that time—"producing a few hundred vehicles a week." Directly contrary to that statement, not a single complete Model 3 had been produced on the still-incomplete production line in Fremont, necessary robots were not even on site, and all Model 3s continued to be built by hand. Similarly, at the Gigafactory, no automated production occurred until September, 2017, and as late as October, 2017, only two batteries per day were completed. There had been no "great progress." Defendants' warnings of risk to their mass production goals were meaningless in the context of the facts they knew to be true no later than May 3, 2017. Their statements were provably false, and therefore, not forward-looking. Oclaro, 897 F. Supp.2d at 918-19 ("a statement about a past or present fact can demonstrably be proven false" and is not forward-looking). Warnings about possible problems is insufficient to rebut falsity allegations when the risks are no longer theoretical, but have materialized. Nor do Defendants' remaining arguments undermine the falsity allegations. The cases they cite in support of their claim that Plaintiffs must produce Tesla's specific timelines for specific tasks offer no support for this assertion. The "on track" cases they cite are distinguishable; almost all concern financial projections, and not statements of existing fact, on the ground.
So we must look to our own clues about how the company is doing, like the inventory piling up in lots across the country, and the staggering number of high level executive departures from Tesla. Our favorite one recently was David Morton, who joined as a new Chief Accounting Officer on August 6th, only to quit a month later. He had worked at his previous employer Seagate Technologies for 23 years. The previous Chief Accounting Officer Eric Branderiz had resigned this March after being in that job for a year and a half. But those are just a start. This year, the company also lost its President of Global Sales and Service, Treasurer and Vice President of Finance, Vice President of Autopilot, Chief People Officer, Senior Vice President of Engineering (Doug Field), and numerous others. The latest Chief Accounting Officer to resign walked away from a $10 million stock grant that would have vested after four years.

At the current price of $345, the market capitalization of Tesla is $59 billion, and it is trading at 15 times book value. Valuing it at one times book value (which would be a $23 share price) would give them full credit for their acquisition of Solar City (which was on the verge of insolvency when acquired and is now in shutdown mode) and for their investments in automotive assembly facilities (such as their assembly line in an open-air tent) which produce cars that require more rework than any auto manufacturer in recent memory. (Buyers of new Model 3s report long waits for service appointments. Why do brand new and ostensibly mechanically simpler electric vehicles need so much service?)

The Honda plant in Lincoln, Alabama that makes the Odyssey minivan can produce as many vehicles as Tesla on just one of its two lines, and Honda has 12 plants in the United States alone. Their market capitalization is about the same as Tesla. They sold about 2 million cars in the U.S. last year and 3.7 million worldwide, at an overall average annual profit margin of about 5 percent. Honda automotive plus their other businesses (like motorcycles and small engines) earn three to four billion dollars a year. The market capitalization of Ford is $43 billion, which is only 6 times last year's earnings. They too have a 5 percent automotive operating margin. They sold 2.6 million cars in the U.S. last year and 6.5 million worldwide.

Ford and Honda each earn about $1,000 net per car sold. For Tesla to justify a higher valuation than either company, it either needs to match that profit per car and sell more (far more cars than it does today), or else have a smaller market (but still much larger than current production and sales) and an order of magnitude higher profit per car than the established automakers.

Ferarri earns about $500 million a year selling cars at a 15% net margin. They sell under 10,000 units annually at an average of about a quarter million dollars apiece. But Musk's idea has been to move away from high price and margin, low volume, to compete head-to-head against mass market manufacturers like Toyota and Honda.

Speaking of Toyota, it produces 10 million cars per year – more than any other manufacturer. The market capitalization of Toyota is $190 billion. If Tesla could steal Toyota's crown to become the biggest manufacturer of automobiles with unparalleled reliability, the upside would not be all that high as a multiple of Tesla's current market valuation.

A naive comparison of the Toyota and Tesla valuations would say that Tesla shares could perhaps quadruple if it surmounted Toyota, but this ignores the massive amounts of capital, and therefore dilution, that would be needed in order to be able to grow production. Toyota has $94 billion invested in property, plant, and equipment, net of depreciation. Toyota trades at about book value, as do Ford and Honda. (Again, Tesla trades at 11 times book.) Whatever valuation lens through which we look at the valuation of Tesla, it always seems to be too high by an order of magnitude.

The other automotive manufacturers trade at price to sales multiples of less than one. Tesla had $3.4 billion of automotive revenue in the second quarter. If you annualized this to $13.6 billion and assumed that Tesla deserved to trade at an opulent multiple of 0.4x sales, that would value the car operations at $5.4 billion, which is not sufficient to cover Tesla's $7.7 billion of recourse debt. (There may be value to compensate from the Solar City assets, but the point is to show that on a comparable price to sales basis Tesla is worth nowhere near the current market capitalization.) By the way, we might have used the Q3 revenue figure except that the 10Q is not out more than a week after the conference call, and anyway the Q3 revenue figure will probably be a high water mark from a burst of Model 3 deliveries.

What owners of Tesla shares fundamentally do not seem to realize is what a legitimate premise of a $50 or $100 billion market cap electric vehicle company would be: a new battery chemistry. If you had invented that and obtained patent protection on it, and assuming it resulted in significantly better energy density and lower cost per kilowatt-hour of storage than current batteries, you would be able to sell a lot of vehicles at an above industry average profit margin.

But... why would you want to? If you invented this better battery, you did not disrupt automobiles. You disrupted oil. The share of oil used for ground transportation, which would be disrupted by a battery breakthrough, is a $2 trillion annual market. Inventing that battery and then building vehicles yourself would require you to raise vast amounts of outside capital to build automotive assembly plants. (Again, look at Toyota: $10,000 of property, plant, and equipment for each of the 10 million vehicles produced annually.) Honda and Toyota are fantastic at building vehicles and they do it at a 5 percent profit margin. What you would want to do is license your battery to these experienced manufacturers and collect royalty checks based on disrupting owners of oil reserves, not manufacturers of vehicles.

The Tesla battery is a modification of a cell called the 18650, which is a 20 year old laptop battery technology. Now you see why they are not doing a licensing model – there is nothing for them to license. Instead, with Tesla you are seeing the end result of the very arrogant Silicon Valley mentality best expressed by two tweets by venture capitalist Benedict Evans from September 2016.
A decision to take an electric battery innovation and go into automotive production would make even less sense when you look at the base rate of success in that industry. Check out the Wikipedia page “list of defunct automobile manufacturers of the United States,” there have been hundreds of failures; not to mention the equity-extinguishing bankruptcies of some of the brands that have survived. The licensing model would make much more sense – again, if you had something to license.

Tesla not only did not do a battery licensing model, but they effectively did the opposite. Consider the parts of the vehicle industry that they have decided to in-source versus the ones they have decided to outsource. As we know, they decided to in-source and compete head-to-head on manufacturing. The results have shown that they are worse than their more experienced competition. They decided to in-source the automotive retail, which had not been done before and was not legal in most states. (And still is not legal in eight states). This had been a huge distraction from the manufacturing side and has resulted in abysmal customer service. But of all things to outsource, they outsourced the battery production to a joint venture with Panasonic. What should be the entire premise of an electric vehicle company is not even enough of a competitive advantage to do in house.

The valuation discrepancy of Tesla versus the expert existing automotive manufacturers reminds us of the 2000s tech bubble, and maybe especially the story of eToys and Toys R Us. A firm called O'Shaughnessy Asset Management wrote an essay a couple years ago called "Stocks You Shouldn't Own" and described those two companies this way:

eToys had an initial public offering in 1999. The stock was listed at $20 but by the end of the day, the stock price had climbed to $77. Valuation peaked in late October 1999, giving it a market cap close to $9 billion - over two and a half times Toys "R" Us - making it the 64th largest company on the NASDAQ exchange. Think about how astonishing that is: eToys had revenues of $30 million versus sales at Toys "R" Us of $11 billion, yet eToys had the higher overall valuation and would have qualified for the NASDAQ 100.

This is what we are seeing now with Tesla. The fad of "disruption" and adulation for "tech" companies has reached the point where a company can have a bigger market capitalization with orders of magnitude less revenue and output than well-run competitors. (And no profits!) Nothing is more "technological" than making jet engines or drilling horizontal oil wells, yet companies in those industries do not get a free pass when it comes to making money. Even regular ICE auto manufacturing is highly technological, yet very unlike the software industry. Consider this point made by Daily Kanban:
Automakers like Ford are rightly frustrated by the public and market's readiness to believe Tesla's narrative about disrupting automotive manufacturing, but there's reason to believe that the wildly different standards to which Tesla and other automakers are held actually hurts the would-be upstart. After all, one of the main reasons that KTP [Kentucky Truck Plant] operates so efficiently and with such high quality is that it has no choice. Whereas Tesla has been able to count on investors and analysts to forgive its "production hell" fiascoes, KTP is the beating heart of Ford's business, building some of the most high-margin and in-demand vehicles Ford has ever made.

With the new Expedition and Navigator flying off lots, the vehicles made at KTP are absolutely critical to the financial performance that markets demand. Since every minute of downtime means that at least one margin-padding truck or SUV won't be delivered on time, the people of KTP know that the company's financial performance depends on their perfect execution and attention to detail. Were Ford able to raise capital from the markets whenever its financial performance fell short, it's easy to imagine a plant like KTP cutting corners or making excuses about "production hell." But because Ford isn't coddled like the self-described "disruptors," workers here at KTP know that downtime and poor quality simply aren't an option.
The indulgence of investors towards Tesla has created a hothouse flower that simply cannot compete over the long term in the competitive, for-profit automotive market. Also, amusingly, the "kanban" in Daily Kanban refers to Toyota's scheduling system for lean manufacturing and just-in-time manufacturing, but according to the recent article on Musk by Lora Kolodny, the kanban system is verboten at Tesla:
Behind his back, employees turned to a method pioneered by Toyota, known as "kanban," to solve their problems. In its simplest form, workers using "kanbans" put up workflow charts, schedules and cards around a production line to help keep track of items they have and items they need.

In this case, workers took all the parts out of the boxes around the Model X line, arranged the parts with a clear sequence and labels, and put the parts back into the boxes. If one part was out of sequence or damaged, they'd remove a card and leave it in a box or bag to let the supply team know what needed to be replenished.

The cards helped the teams reduce the clutter, keep a small stock of spares nearby, and find the right parts quickly.

But because kanbans were pioneered by Toyota, workers thought they had to hide their kanban cards from Musk during his visits to the factory. Half a dozen current and former Tesla workers say that supervisors in Fremont warned them that if Musk discovered kanban cards posted around their work areas, they were in danger of being fired.
The bullish theses for Tesla (at the current $50-$75 billion price range) involve the company growing to a $500-$1000B titan like Google, Amazon, Facebook, or Apple. That is actually one of the main expected value calculations that keeps the tech mutual funds invested. They know that Musk is a loose cannon and they could not justify holding without the possibility of 10x upside. But what trillion dollar company ever spent its first fifteen years insulated from concern about profitability?

We referred to the missing 10Q for third quarter 2018, and this is worth developing further. Last week Elon published summary results for Tesla that were the company's best ever, and bulls (and even many skeptics) embraced these unquestioningly. Yet, see the following tweetstorm by Ryan Doherty on Twitter about how Musk's behavior was so at odds with a quarter of good performance.
I want to review the last three months (as of 11/1/18) and see if “The Story” we are presently being told ($TSLA turned a corner in Q3 and is now a highly efficient, well-run, profitable car manufacturer) makes sense given what was happening at the time.

August 7: Elon tweets that he is thinking about taking Tesla private. He follows this up with a blog post explaining his thinking, citing short sellers and avoiding quarterly reporting as reasons. This is a month into Tesla's greatest quarter to date.

August 16: A NY Times article about Elon and his fateful tweets quotes Mr. Musk as saying, "But from a personal pain standpoint, the worst is yet to come." This is halfway through the greatest quarter Tesla has ever had.

September 4: CAO Dave Morton resigns, effective immediately, after less than a month on the job. At this point, Tesla is two months in to a great Q3 in spite of high numbers of employee turnover and executive departures.

September 27: Elon calls off a settlement that had been agreed upon with the SEC, and he tells the BOD that he'll quit on the spot if they don't publicly support him and "extol his integrity". The best Q3 he could have hoped for is wrapping up in 4 days.

September 30: Musk emails his employees and states, "We are very close to achieving profitability, but to be certain, we need to execute tomorrow." This is the last day of a quarter in which Tesla reported net income of $311 million dollars.

October 24: Tesla releases their Q3 numbers; they're great. They've gone from a cash-burning enterprise to one of the most efficient car manufacturers on the planet. On the earnings call, they have no prepared statements about operational adjustments and instead talk about safety.

October 26: Mr. Musk uses twitter to question the FBI's investigation into Tesla, as well as claiming that the tweet that cost both him and $TSLA $20M was "worth it". At this point, Elon is antagonizing regulators even though his company is finally performing at a high level.

October 30: Elon Musk tweets that he has relinquished the roll of Tesla CEO "just to see what would happen". $TSLA is now a profitable and growing enterprise that had the CEO remove his title and confuse the corporate governance structure for kicks.

This is obviously not an all-inclusive list and you could explain away any one of these examples. (Miscommunication, personal reasons, etc) But all of them combined paint a pretty vivid picture. (At least, to me they do) And that picture doesn't match "The Story" we're being told.

Why try to go private? Why pick fights with regulators or threaten to quit when your company is finally executing? Why are so many executives leaving the company during one of the greatest turnarounds in automotive history? Why remove your title of CEO "just to see what happens"?

Why wouldn't Elon, who promised "the short burn of the century" and called the boss of a Tesla critic in an effort to shut him up, spike the ball during the Q3 conference call? Why wasn't he bragging about the operational improvements he made that ruined the short thesis?
It is especially strange how little explanation the Q3 results and business trends got in the Q3 summary release and conference call. And now the 10Q is not materializing. It seems as though the reason the summary results were released in the first place was to get in front of the WSJ article that came out on Friday, "Tesla Faces Deepening Criminal Probe Over Whether It Misstated Production Figures":
In recent weeks, FBI agents have contacted former Tesla employees asking them for testimony in the criminal case. The former employees received subpoenas earlier in the probe, and FBI agents recently have sought to interview a number of them, the people said.
For whatever reasons, the bulls are just not bothered by this. Maybe it is because the civil penalty for his buyout hoax was so low in relation to the damage it caused - $40 million vs billions in damages is a penny on the dollar. It is probably also relevant that Silicon Valley "disruptors" have been allowed, this cycle, to break the law with impunity.

But take a look at this Tesla forum poster's "mega panel gaps" on a Model 3 that was delivered in August. This is a new car that is going immediately from the customer's hands back to the manufacturer's body shop! How "disruptive" is that? And how is that being accounted for exactly?

This is an unbelievable situation: the poor quality of these expensive cars, the executives quitting, the lying management, the bad balance sheet, the paltry sales, and yet the stunningly high valuation. When you add in the ~5:1 returns possible if this garbage pile goes to zero between now and January 2021, it is reminiscent of the opportunities that were available in the spring of 2007.