Stanphyl Capital June 2018 letter to investors on Tesla Inc. (Nasdaq:TSLA)

The fund was absolutely massacred this month, and it was primarily due to our large short position in Tesla, to which I added on each new piece of negative news, much of which was indicative of the kind of outright fraud (see below) that would immediately send a “normal stock” into a death spiral, and yet for most of the month Tesla’s stock kept levitating. So here’s what I’ve done about it: I slashed our common stock short position to approximately 15% of the fund from a much larger size and then put approximately 12% of the fund into far less volatile January 2020 put options (as nearly all the luxury EV competitors will be in showrooms by 2019) with a strike price of $210. Then in light of recent whistleblower stories (see below for more detail) and the potential for a fast Tesla death spiral as it may be under a Wells Notice (also see below), I put another 0.30% (30 basis points) of the fund into an array of near-term (out one to three months) put options that will pay off hugely if a TSLA stock crash is imminent.

As noted above, we remain short shares of (and long put options in) Tesla, Inc. (TSLA), which I consider to be the biggest single stock bubble in this whole bubble market—a company so landmine-filled that I think it can implode at any moment regardless of what the broad market does. To reiterate the three core points of our Tesla short position:

1) Tesla has no “moat” of any kind; i.e., nothing meaningfully or sustainably proprietary.

2) Tesla loses a huge (and increasing) amount of money despite relatively light competition but will soon be confronted with massive competition in every aspect of its business.

3) Elon Musk is extremely untrustworthy.

Despite its recent rally TSLA remains 12% off its all-time high and once again appears to be downtrending, and it’s worth noting that although this has been a rough road for us, it’s not a unique one:

I wrote earlier that Tesla may be under an undisclosed Wells Notice, and if that’s the case (and this is completely speculative) it may explain why the company hasn’t been able to take advantage of its $300+ stock price to raise fresh equity. Courtesy of Twitter user @ElonBachman, here’s a terrific representation as to why this is a plausible (but admittedly unproven) theory:

(Click on image to enlarge)

Also “headlining” this month in Tesla news is an astonishing new report from Twitter user @eriz35 (an environmental engineer) pointing out that Tesla’s paint facility only has physical capacity for a total of approximately 5000 cars a week including, presumably, 2000 Models S/X, meaning (if the report is accurate) that Tesla and Elon Musk have been committing blatant securities fraud in claiming to have capacity to build 5-6000 Model 3s a week plus 2000 Models S and X. However, as this story just broke today (June 30^th), it’s important to emphasize that we don’t yet have a definitive answer as to its accuracy.

Speaking of paint, early in June came an astounding story about Tesla failing to report multiple fires in its paint shop while simultaneously conducting hugely unsafe practices there (for both employees and customers), followed by another astounding story about the vast amount of scrappage occurring in its manufacturing process accompanied by hugely unsafe practices in how those manufactured parts are labeled and tracked, followed by another astounding story full of well-documented instances of Tesla safety and securities fraud violations. Later in the month Tesla sued the employee whistleblowing source of some of that information, undoubtedly hoping to squelch others in the future. But based on the massive number of recent executive departures (including, in June, the CIO), I strongly suspect that many more whistleblowers will soon appear.

Also in early June came a series of fabulous reviews of the new Jaguar I-Pace electric SUV, which is in European showrooms now and will be available in the U.S. in August. As a reminder, the I-Pace starts at a price $10,000 lower than the Tesla Model X, and that gap will eventually widen to $17,500 as Tesla’s tax credits gradually phase-out beginning late this year or early 2019. Next on tap in luxury EVs are the Audi E-Tron Quattro (to be formally unveiled in September and available in Europe this winter and the U.S. next spring) and the Mercedes EQC (also to be unveiled in September and available next spring), followed by the Porsche Taycan (previously called the Mission E, and available some time in 2019). And all those cars (except the Porsche) will be priced significantly less expensively than the comparable Tesla even before their U.S. buyers enjoy the $7500 tax credit that will soon expire for Tesla. (The Porsche’s base price will be similar to that of the base Tesla Model S and come with the tax credit. Hmmm, Tesla or Porsche… tough choice!)

Next in June came the preliminary NTSB report regarding a fatal Tesla “Autopilot” accident in March, in which it was determined that the car accelerated (where was the Automatic Emergency Braking?) straight into a construction barrier, and that Tesla’s claim that the driver had been warned to keep his hands on the wheel was highly deceptive as the last warning came 15 minutes before the accident. (Also remember that in May Tesla was besieged with multiple tragic accidents—two teenagers were killed in Florida when trapped in a burning Tesla after a high speed crash, as was a German businessman traveling in Switzerland, and a man in California was killed when his Tesla left the road [perhaps due to either Autopilot or a widely- documented but not yet recalled Tesla suspension failure] and deposited him in a pond. And a woman in Utah slammed straight into a parked vehicle while on Autopilot as it accelerated into the impact, similar to what happened in the aforementioned crash in March [although fortunately this lady survived with only a leg fracture], while another Tesla on Autopilot ran into and totaled a police car.) Now where would all those Tesla buyers get that idea that something named “Autopilot” was designed to be used in such a reckless manner?

Now watch the short (a bit over a minute) video embedded in this Autopilot story from the BBC and you’ll be shocked at how dangerous this system is! (As an aside, as of now there are at least 40 worldwide Tesla- related deaths, a huge number relative to the number of Teslas on the road and its luxury car peer group.)

In response to the Autopilot demolition derby, in mid-June Tesla remotely limited the hands-free capability of the system to just 15-20 seconds, a significant safety improvement from its previous status and yet hugely disappointing to Tesla owners who were enjoying (at least those still alive) the previous system’s “flexibility.” As Autopilot’s capabilities were oversold by Tesla and Musk from Day 1, it will be interesting to see who now sues for a chunk of his money back, as well as how much lower the uptake of that option will be going forward. (My prediction: much lower.) Remember, that $5000 option is pure margin for Tesla, as every car comes equipped with the hardware regardless of whether or not the buyer pays to activate it. In fact in a blatant attempt to keep his Autopilot fish on the hook, Musk tweeted that in August Tesla would begin implementing full self-driving. Was anybody stupid enough to actually believe that? Well perhaps they were, as the stock closed up over $14/share that day! Here’s a great overview of what—if anything—Tesla will really implement in that regard.

Next in June came an announcement from Electrify America that within the next 12 months it will have built or under development 2000 ultra-fast (150-350 kw, vs. Tesla’s 120 kw) chargers... So much for that Tesla “charging moat”! (See lots of links below showing how many more of these ultra-fast chargers are being built.)

Next in June, just five days after an annual meeting during which “everything was great,” Musk announced layoffs of 9% of Tesla’s work force, which he essentially said was necessary to avoid bankruptcy. (I suspect it won’t work.) Among those fired were reportedly a significant number of engineers—very impressive for an automobile manufacturer with a massive vaporware pipeline and serious aging & reliability problems with its existing products. On the day of that layoff announcement and the day after, Musk bought $25 million of Tesla stock, much (and possibly all) of which was done in the illiquid pre-market in order to jam up the price up as much as possible. The effect of this was to cause algorithmic computers to bid the stock up from there, further squeezing shorts and thereby forcing the stock up still higher. Clearly the sole purpose of Musk’s timing (after all, his buy was insignificant relative to his holdings) was to punish short sellers, possibly figuring that if he’s going down, he’ll take as many shorts down with him as he can. Sorry Elon, but we’ll still be here, and we won’t be visiting you where you’re going.

Next in June came an analysis by Gordon Johnson, an analyst at Vertical Group, estimating that the Model 3 cancellation rate is as high as 66%. No wonder Tesla—which never fails to report a favorable data point (even if it has to fabricate it)—refuses to update the current net Model 3 reservation number (and by net I mean net of requested refunds too, as numerous Twitter posts indicate that the cash-strapped company is delaying those requests for weeks or even months). And watch those reservations really vanish when Tesla’s $7500 tax credits expire later this year while over 100 competing new EV models entering the market over the next few years will still enjoy them, and potential buyers realize that the $35,000 Model 3 will never appear in any significant quantity. In fact, in May Musk admitted that a $35,000 Model 3 is a long way off because “building one now would cause Tesla to lose money and die.” I have news for you,

Elon: whether you build them or not, Tesla is going to “lose money and die.”

Next in June—courtesy of Twitter user @TeslaCharts—came the most concise summary yet of how Elon Musk committed securities fraud by using Tesla to bail out his (and his family’s) failing stakes in SolarCity. Zero Hedge included the entire thread in this follow-up story about SolarCity’s latest retrenchment, which will undoubtedly help fuel the fraud case currently working its way through a Delaware court, as will this later story describing how Tesla sales people have no idea when the solar tiles or PowerWalls used to justify that merger will ever be available. (Remember that when Musk was promoting that merger he used fake solar tiles on a fake house at a movie studio… How appropriate!)

Next in June, Elon Musk finally accomplished full convergence with P.T. Barnum, his circus-owning spiritual ancestor (except Barnum’s circuses made money while Musk’s just incinerates it). Let’s start with this Elon Musk Twitter-quote as headlined (amazingly!) not by The Onion but by Ars Technica in this article:

Yes, that’s right: unable to build 5000 Model 3s a week in factory for which Musk said capacity was well over 10,000, Tesla has resorted to pitching a tent in its parking lot and setting up some sort of half-assed partial assembly line. And oh, he introduced it in one of the most blatantly fraudulent manners I’ve ever seen, using a prop (or perhaps photoshopped) car obviously built elsewhere while claiming it was built there. Why do I say “obviously”? Because on the same day he tweeted this…

…Twitter user @skabooshka had staked the place out with a telephoto lens and snapped this, including an appropriately headlined newspaper to prove it was taken that same day:

Then a few days later, Twitter user @iSpyTSLA posted a number of videos (linked in this Zero Hedge article) demonstrating that this Tesla “assembly line tent show” makes a 1970s Yugo factory look state- of-the-art, while almost concurrently Musk bizarrely tried to blame his production problems on “an internal saboteur.” Tesla then proceeded to cover the fence through which those images were taken and strategically parked semi-trailers to further block the view. But that’s okay, because a week or so later @skaboaaaoshka sent up a drone to once again prove Musk was lying! Yes, I know… If you tried to write a “corporate thriller” with a plot like this, your publisher would laugh you out of his office!

Also in June Business Insider published a scoop featuring leaked internal Tesla documents indicating that the month-to-date Model 3 production rate was averaging just 2200 cars a week, far below the 3500 a week Elon Musk deceptively implied at the June annual meeting. Yes, more securities fraud.

Also in June Bernstein Research published a note finally pointing out something we’ve been talking about for the better part of a year: Tesla is committing accounting fraud by artificially inflating its automotive gross margin by under-reserving for warranty repairs, then putting extra repair costs on the “Services and Other” line (which has a hugely negative gross margin).

Late in June Tesla announced that all remaining North American Model 3 reservationists can now configure their cars. Although this theoretically could be indicative of the weak Model 3 conversion rate noted above, it could also just be a desperate cash grab for the $2500 additional deposits that must accompany those configurations. However, this announcement came simultaneously with price cuts for the all-wheel-drive and “performance” versions of the Model 3, which *is* indicative of a demand problem.

Meanwhile, Tesla is now in such bad financial shape that all sorts of liens are piling up against it in its home county of Alameda. Here’s a snapshot I happened to take on June 21^st of just those filed since March:

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And on top of that, Tesla now has state and federal tax liens against it.

Remember that in May Tesla released a disastrous Q1 earnings report, with a record GAAP loss of $710 million ($760 million excluding the sale of ZEV credits-- an average of over $25,000 per car sold!), negative free cash flow of $1.1 billion, Model S&X combined deliveries down a double-digit percentage both sequentially and year-over-year (even before the arrival of all the luxury EV competition mentioned earlier in this letter), and Model 3 production falling far short of (already drastically reduced) previous guidance.

Here’s a terrific series of charts from Twitter user @TeslaCharts clearly explaining just how horrible the financial trends for this company are; in fact Tesla’s situation is so dire that it’s slashing capex (and thus killing the growth story) by apparently putting development of its much-hyped (but economically unviable) semi-truck on hold, as well as delaying its “Model Y” crossover. In fact even Tesla battery supplier Panasonic now has serious doubts about the viability of the company. And for those who continue to insist that as Tesla grows revenue, profits will “scale” proportionately… How’s this for “scale”?

Following the release of that atrocious earnings report, Tesla hosted what may be the most hilarious conference call in American corporate history. (I know I’ve said that about previous calls but let’s face it: Musk is a conference call superstar who somehow manages to “top” his previous performance with each new one!) Here are just a few of the “highlights” as he tried to duck, shuck and jive his way out of having to explain away Tesla’s looming destiny with bankruptcy, which is where its > $30 billion in combined long-term debt and battery purchase & other obligations—accompanied by its negative cash flow and massive encroaching competition—will eventually place it.

And no, the savior of Tesla won’t be the Model 3. Regardless of whether Tesla hits the 5000 per week production goal it has managed to make as the media’s primary focus, the car will be a financial disaster. Additionally, extensive forum posts and reviews indicate that over time the Model 3 is revealing itself to be a complete lemon, while even green car-loving Consumer Reports rated it just a 77 on a scale of 100, tied (among electric cars) with the $14,000 cheaper Chevrolet Bolt and $25,000 cheaper Toyota Prius. (Unlike Edmunds, CR has yet to rate the Model 3’s reliability.) And remember, almost nothing can be done in the Model 3 without a multi-step process on the touchscreen—not even changing the windshield-wiper speed, adjusting the air vents or opening the glovebox. Thus, operating a Tesla Model 3 may potentially be as dangerous as texting while driving.

Meanwhile, Tesla is increasingly besieged by a wide variety of lawsuits for securities fraud, labor discrimination, worker safety, union-busting, sudden acceleration, lemon law violations and, undoubtedly, many others of which I’m not yet aware.