Tesla Motors Inc (NASDAQ:TSLA) is one of the most heavily shorted firms on Wall Street, but the firm’s impassioned supporters outnumber its detractors by a wide margin. At the end of May 25,034,930 shares in the firm were held short, almost one in four of the total number out there. That leaves three quarters of investors banking on the firm to succeed.
With most of Wall Street’s research houses behind Tesla Motors, it can be hard for those betting on the firm’s success to get a good overview on the bear case. Here’s a look at why so many people are against Tesla Motors, and why they think the firm is going to fail and send shares crashing.
Tesla Motors is expensive
Benzinga recently released a report on why the bears are against the firm. The most important item on the list was valuation. Most of the standard valuation metrics show that Tesla Motors is a real outlier. The firm trades at 38.35 times book value and 9.01 times sales. On top of that it has negative profit margins, and operating and leveraged free cash flow is negative every year.
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Book value is the value of Tesla Motors as a whole on its balance sheet. The firm’s price to book value is the multiple by which the market values a firm over its book value. Apple Inc. (NASDAQ:AAPL) trades at a book value of 5.68, Tesla Motors trades at almost seven times that.
Other high-growth firms also have a high multiple for price to book. Netflix trades over 20, while Facebook trades at more than 18 times book value. Very few firms trade as high as Tesla Motors, however, and many big firms that expect high growth, like Google and Apple, have much lower price to book ratios.
The first pillar of the bear thesis is that Tesla Motors is overvalued beyond possible redemption. Jim Cramer said recently that he couldn’t find a single metric along which the firm was inexpensive and so could not advise anyone to buy into Elon Musk’s company.
Looking at cash and debt
In a report released after the firm’s latest earnings numbers, well known Tesla Motors bull Adam Jonas of Morgan Stanley said that the firm’s cash burn was “eye-watering.”
Tesla Motors has a 320.32 debt-to-equity ratio, and the company’s total of $2.65 billion in debt is met with just $1.5 billion in cash on the other side of the balance sheet.
That means that if Tesla were to close today it could not pay its bills. With negative cash flow, the firm will not be able to generate any cash to pay off bills either. The firm has just, effectively, used a credit card to make sure it can pay its bank loan.
The poor cash to debt position at Tesla Motors is the second pillar of the bear thesis. Bond holders have a much stronger claim that shareholders in the case of a cash shortage, and any problems with debt in the coming years could send shares crashing.
Elon Musk said in January that Tesla Motors won’t make a profit until 2020. That means accumulating a lot of debt until then, while keeping a negative cash position for much of that time.
Tesla Motors needs strong demand
Tesla Motors has survived and thrived as strong demand for its cars convinced Wall Street that there is a big future in EVs. John Lovallo, one of the few card-carrying bears on Wall Street, looks at the firm for Bank of America, and he doesn’t like what he sees.
In a February report Mr. Lovallo said that “bulls consistently argue that the company can stimulate demand at will and that the true issue is capacity and supply,” but said that that idea simply wasn’t true. Mr. Lovallo said that Tesla Motors was “pulling back on production, which we believe could create the appearance of rising demand.”
Tesla Motors has kept its unit target for 2015 stable at 55,000 cars, and the firm’s coming Model X EV SUV has about 20,000 booking on tap. Anyone can book a Tesla Motors Model X with a $5000 down-payment, but shipping won’t start until the third quarter and the backlog won’t be gotten rid of until the second quarter of 2016 at the earliest.
Mr. Lovallo says that Tesla Motors deserves a price target of $65. The rest of Wall Street doesn’t agree, however. Of 23 looking at Tesla Motors, just 4 rate it at Underperform. 6 advise clients to Hold the stock, and the remaining nine are positive on the firm’s future. The average price target from that group is $290. Mr. Lovallo is a real outlier at $65.
The third and most important pillar of the bear case is that Tesla Motors isn’t as good at selling its cars as everyone assumes. This idea has come to a head in China this year, as demand fell below expected levels and bears screamed that the lack of Tesla Model S demand was proven.
That outcry has ceased for the time being, but the idea that Tesla Motors may see a shortfall in demand is one of the strongest legs that the bears have to stand on.
Bundling up the bear case
Tesla Motors bears see the firm as what Jim Cramer calls a “story stock.” Elon Musk appears as some sort of EV messiah, and those looking for a change in the world follow him. He has the charisma, the background and the achievements to make people believe in him and his version of the future.
He’s gotten this far on that belief with a healthy dose of help from the state. Tesla Motors could never pay its own way, so it relied on grants and tax breaks along with low rates and strong market support to give it what it needed.
If the story breaks down Tesla Motors is a house of cards that could collapse completely. Without the support of the market, Tesla Motors won’t be able to release a car this year. A high stock price and a strong bull thesis got it good terms from the Wall Street on its new credit facility.
Tesla Motors is incredibly highly valued by almost every single metric. Its cash debt position is very worrying, and its future relies on massive demand growth every year until 2020 and beyond. If Tesla Motors gets a shock from the demand side or the balance sheet side that high valuation could crash very quickly.
Mr. Lovallo of Bank of America reckons that shock will come in an earnings report in the near future. If Tesla Motors demand falls, as was thought in the first quarter of the year, there will be a shock to the firm’s stock and things could move very quickly from there.
The 25,034,930 shorts could, in that case, suddenly become incredibly valuable, and the Tesla Motors story will unravel. Tesla is only able to fund itself through the belief of the market. The bears are betting that the story will come apart, and their shorts will be there to collect when that happens.