Thursday, December 6, 2018

Ten Problems With Tesla

This are in order of how serious I think they are.

  1. Indictment of the accounts payable guy. A month ago the government charged Salil Parulekar with "embezzling" $9.3 million. Since then, nothing has happened in the case. The indictment alleges that Parulekar impersonated employees of one Tesla vendor (Hota Industrial Manufacturing of Taiwan) in order to substitute their payment information with the payment information of a different vendor, Schwabische Huttenwerke Automotive GmbH (SHW), the German company that makes oil pumps for the Model 3. The indictment says that Tesla paid $9.3 million to SHW but these were marked as satisfying Hota invoices. Nowhere does the indictment allege that Parulekar received any benefit from doing this - the account was not a disguised account of his, nor does it say that SHW gave him a kickback. While these actions may indeed be "fraudulent", they do not sound like embezzlement. [Matt Levine can't figure this out either, and the WSJ said "it couldn't be immediately determined how or whether Mr. Parulekar benefited from the alleged scheme".] If he were embezzling via a kickback, you'd think it would be an Indian company and not a German mittelstand company. Elon loves to pick Twitter fights with people - when his former employee Martin Tripp blew the whistle on Tesla, Elon tweeted about him by name and Tesla sued him. (The whistleblowing was regarding "extremely unsafe batteries/modules, unsafe production methods, and inconsistencies in numbers of cars produced".) But he has not said anything about Parulekar. My theory is that the fraud here was not embezzlement, but that it was a higher level fraud directed by Parulekar's superiors for the purpose of making payables and cost of goods sold look lower, and hence Tesla more profitable and more solvent. It is possible that the government is pressuring Parulekar to roll over on the masterminds of a fraudulent accounting scheme.By the way, the general counsel is being replaced with a "seasoned trial lawyer".
  2. Quality problems. Here is a buyer who took delivery of a Model 3 which immediately went into the shop for two weeks for a "deep scratch on bumper, weather stripping problems, no insulation on floor/backseat, glass roof not aligned". They've managed to sell a small number of Model 3s to diehard fanboys - these guys often seem to go from total beaters to a $50k+ vehicle and don't know what they should expect or demand. The quality is going to appall most German, Japanese, or even American luxury car buyers. Straight from the assembly line into the repair shop is just not going to be a viable model to compete with the high quality incumbent manufacturers. The Model 3 build includes zip ties (see 1,2,3). Water leaks. (More.) There is even a pre-delivery "water repair checklist" for "known water leak sources". This guy went ahead and drilled holes so that the water that leaked into his bumper would drain. Or: "rain draining into trunk... causing both mildew and electrical issues." Damaged by puddles (more 1,2,3). Doors that won't open in cold weather. ("Terrible winter car.") Poor battery life in cold weather. Here's a Model S lemon. A Model 3 that needed its batteries replaced after six days. This one needed new battery AND drive units two days after delivery. The fundamental problem the Tesla fanboy rubes have is that they don't get this heuristic: if the cosmetic / paint / panel fit stuff is as bad as it is, how bad is the engineering and the stuff that you can't see? This is why companies normally need to produce goods with quality fit and finish to survive in a competitive marketplace.
  3. Shortage of working capital yet not raising money. A lot of problems for Elon would disappear if he could raise $6 billion (with a mere 10% dilution) at the current valuation. Many shortsellers would give up and go away. He would have the working capital needed to run the business, so that customers could get things like their titles and registrations or repair parts on time. He could invest in expanding the service and supercharger network, which are both badly strained. He could invest (and make a big show of investing) in future products and model upgrades. Even just hiring more call center reps to help people so the waiting times on the phone are not so long. Why doesn't he raise the money? I have two guesses: either he knows he could not survive the due diligence (buyers taking a hard look at the reservation list, warranty claims, COGS, etc.) or he has gotten bids but they are for realistic valuations that are below the point where his stock would get sold by his margin lenders. He may also just be crazy; I've seen people who could have raised a lot of money when a bull market was running fail to do so and end up going bankrupt.
  4. Market capitalization compared to real car companies. Tesla's market cap is bigger than General Motors (trades at 1/3 revenue while TSLA trades more like 3x), Honda (also 1/3), Ford (only 0.22x sales), Fiat Chrysler (0.19x sales). They simply have not earned a $60 billion dollar valuation. Toyota is the biggest and it is only 3x larger market capitalization while having vastly larger sales and profit. 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.
  5. Price to book compared to real car companies. Real car companies trade at 1x book. A naive comparison of the Toyota and Tesla valuations would say that Tesla shares could perhaps triple 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 14 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.
  6. Erratic founder who we know did a buyout hoax and the abusive Solar City bailout. People who are grandiose narcissists don't change their stripes. This guy has come within days of blowing up before. His destiny is to blow up. He was the perfect man for the startup bubble, when you could make a name for yourself selling a dollar for fifty cents. (Rockets, solar panels, cars - who cares?)
  7. Competition coming and tax credit runoff at the end of the year. With the tax credit partially rolling off on Jan 1, what fanboy that wanted to buy this isn't buying it right now? Really the best competition if you care about cost effectiveness is a VW TDI. The hybrid electric vehicles are also more practical and economical.
  8. Failing to register vehicles and payoff trade-ins. Look at people Tweeting or otherwise commenting about buying a Tesla and not receiving their plates/registration after weeks or months. This is something that existing automotive retailers are able to handle as a matter of course. It is so unpleasant for customers to risk getting tickets or not be able to drive their cars because they are not registered. One person called this the "expired temp tag club". [By the way, if cars aren't registered or titled to the customers than they are still registered to... the manufacturer/dealer. Which can still use them as collateral and gets to sit on the cash that the customer paid for title/registration fees - substantial on $50k-$100k cars. This is what the movie Fargo was about.] Failing to payoff trade-ins is a much bigger cash grab. (See: 1,2,3.) Also refusing to refund deposits, what Plain Site calls "deposit theft".
  9. Executives quitting. Again, the best example is 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.
  10. Lack of any disruptive technology. The test of whether you are an electric vehicle “disrupter” is: how many manufacturers are licensing your battery? If you’d actually invented a better electric battery or other EV technology (battery is the only technology that matters though), you could license them and have a 10x book business. 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.


CP said...

"Here's the latest: 441 (and counting) $TSLA/SolarCity/Elon Musk legal actions in Excel TSV format."

tjameson52 said...

Can you expand on your Parulekar theory more?

If both Hota and SHW invoices were booked (credit A/P), then so was the cost (debit side). The subsequent payment wouldn't change anything at the financial statement level (credit cash, debit A/P), it would just be an issue that the wrong vendor's A/P was cleared on the underlying books. Don't see how this transaction (in isolation at least) understates A/P or cost.

I caveat all this with the fact I am a TSLA bear and I agree with 90%+ of everything else you write in this post.

Anonymous said...

Hi tjameson52, I have thought about this as well.

The strangest part of all of this is that SHW makes electric oil pumps, which is important but not particularly critical or interesting (think lug nuts holding tires onto the car). Also, the dollar amount seems pretty small to send poor Salil to jail for 10 years (!) (Jesus, Michael Cohen got three).

I have two theories:

1) FBI wants Salil's co-operation/information for a totally unrelated matter in Tesla. Parelukar got a little cute in the negotiations, so, the FBI stumbles across this by accident and rattles his cage with it. Apparently if you're charged with something like this, you appear in court wearing the orange jumpsuit, shackled at hands and foot; if I were him I'd sing like a bird.

2) What struck me was the routine manner in which Salil executed his fraud, and Tesla AP failing to flag this transaction as obviously suspicious. This was not elaborate stuff. Perhaps what Salil did was routine, perhaps systematized (?) within Tesla. I imagine a crock where Tesla routinely pays the wrong vendor (net 90 terms), tells the new vendor "ops we'll have to wait to reverse the transaction, old vendor isn't cooperating!" (another 60 days), finally re-queues the payment. Good for cash. Also, in GAAP terms in the above situation, Tesla has i) legitimate cancellation obligations to SHW & ii) new payments due to Hota for materials already received. It has made one payment (to the wrong party). Tesla has recognized expenses probably once, will in theory get a refund from SHW, will pay Hota at some point. ^All these manual adjustments and payments open opportunities to move expenses between reporting periods, especially ahead of large capital raises essential to keeping the company solvent.

All of this is conjecture. But there's SOMETHING going on behind the scenes, and it's unlikely to be innocuous.

Unknown said...

You don't think the WHOMPY WHEELS are a major concern?


Oh well.........

CP said...

Here's how a fraud like this could have worked:

In order to keep COGS low, there are certain components and/or certain vendors that never enter the accounting system. (Hypothetically, Hota Industrial Manufacturing.) You order widgets on credit, they ship, you use them, but you never enter the invoice / accrue the liability.

The only problem with this - how do you pay them? The auditors will notice funds being disbursed to vendors that aren't in the books. And you have to pay them eventually.

Maybe you pay them by making it look like you are paying a different vendor that is in the books (Hypothetically, SHW).

Three problems with that:

*You'll never be able to get current on all of the different vendor (SHW's) invoices, or it will look like you have a credit balance with them. (Which would be a red flag.) But if you are always months behind in paying your vendors, this will not be a problem.
*It will be hard to match up payment amounts to the secret supplier with the different vendor's invoices. This is where a constant practice of disputing invoices, asking for retroactive discounts, etc. muddies the waters.
*When auditors send A/P balance confirms to the different vendor, it will not match what you have in the fake set of official books. Again, blame billing disputes, disorganization, and so forth. Maybe your auditors are lazy or overwhelmed and don't check this area very carefully. Maybe you scream at the vendor about delaying your audits and they just stop responding to the balance confirms. Maybe you are careful to do this with Asian suppliers: "sorry we don't have phones at the factory," or "no one here speaks English".

It's messy but it fits the facts at least as well as an "embezzlement" where the embezzler is not actually getting paid.

Unknown said...
This comment has been removed by a blog administrator.
CP said...

More thoughts regarding low on cash:

- unpaid vendors / lawsuits / tax liens
- interest / cash balance (compare over time, adjusted for T-bill yields)
- not registering vehicles

Anonymous said...

Uh oh, look what happens when luxury OEMs actually decide to compete with $TSLA...