Saturday, November 26, 2022

Struck By Lightning! - Revisited

Being lucky isn't the same as being brilliant.

I wrote over a decade ago about people who confuse luck with skill.  Over the years, I have read, again and again, about people who seem to fall from grace.  And pundits and prognosticators make sage comments as to where the former superstar went wrong.  How did they screw up such a good thing?  The answer is, not knowing when to stop.

On Wall Street, the pattern is familiar.  A young hot-shot hedge fund manager or trader makes a lot of money by making the right stock picks.  It seems he can do no wrong!  The guy is brilliant and people ask for stock tips and advice from him.  But then one day, he makes the wrong pick and the scribes wonder whether he has "lost his touch" when in fact, he was just on a lucky streak and it eventually broke.

Now, in some instances, this sort of hubris amplifies itself.  The "golden boy" who can do no wrong, makes some "bad" decisions, which is to say, the law of probability finally caught up with him.  So rather than call it a day and walk away from the table with his remaining chips (which is still a fortune) he "doubles down" his bet to try to win it all back - and loses spectacularly.

From his perspective, it was a "smart move" - after all, he was the "golden boy" and surely his stock-picking skills would turn things around, right?  Of course, we always have a surplus of "golden boys" when there is a bull market.  You can pick almost any stock then, and it goes up in value.  Genius!

I recounted before reading in the Virginia Bar Journal (disciplinary committee section) about a young hot-shot attorney who had a real estate practice.  It was the 1980's and real estate just went up and up and up.  So he invested in a number of commercial properties and they increased in value.  Genius!   Actually not, of course, it was just another real estate bubble and everyone who bought real estate was a "Genius!" for a while - until the bubble burst.

The problem for a lot of these geniuses was that they had to keep rolling over properties into new properties, to avoid capital gains tax.  So they went out and bid against other people to buy another property, and that, in part, drove up prices.   When the bubble burst, this attorney fellow decided that he couldn't just walk away - after all, he was a golden boy, right?

So he decided to "borrow" some money to "tide him over" until "things got better."  It is the same song told by hapless fools who borrow from loan sharks.  Or the kind of people who whine about banks not giving them unsecured loans to "tide them over" until "things get better" - you can't borrow your way to wealth!

Problem is, he "borrowed" from his clients without them knowing.  He was doing real estate closings in his law practice.  So when someone bought a house, he would handle all the money at closing.  The bank would wire him $500,000 to his escrow account to pay for the house his client was buying.  The client now owed the bank a half-million dollars.  Meanwhile, the seller of the house had a mortgage of $400,000 to pay off.  The attorney would wire $100,000 to the seller (their profit in the sale) and then not pay off the $400,000 mortgage.

The house was now mortgaged for $900,000.  Ouch.  The attorney in question kept up this ruse by making payments on the old mortgage - using some of the "borrowed" money.  The rest he used to prop up his failing commercial real estate empire - which had a staggering negative cash-flow.  Of course, in order to do this, he had to "borrow" yet more money from the next real estate closing.  And so on and so forth, until he was tens of millions in debt.   Or more precisely, his clients were.

The whole thing came unraveled when he missed some mortgage payments on those old mortgages which were supposed to be paid off.  People started asking questions, the District Attorney got involved, as well as the State Bar. The "errors and omissions" insurance of the attorney covered some of the damage - title insurance covered some more.  Some banks took a hit.  The attorney was sued.  He lost his license to practice law - revoked forever.

He went from "golden boy" real estate investor to bankrupt and out of a job - and a career - in a very short period of time.

It is a tale as old as time.  And you've heard about the big players that fall from grace - Enron and Madoff, for example.  They started out, perhaps, thinking they were golden boys and offered  obscene rates of return.  When that didn't pan out, they resorted to fraud, hoping maybe to turn things around.  When things didn't turn around, maybe they figured no one would notice the fraud until after they were long dead.  They lived in denial, but eventually the golden boys were brought back to Earth.  I think drugs may have been involved, particularly cocaine - which makes people do weird shit like this.

The most recent example of this is, of course, Elon Musk, who has taken Twitter from 0 to insolvent in less than four weeks - faster than even a Tesla Model S.  But if you look at his history and the pattern I outlined above, you can see his downfall is inevitable.  He was struck by lightning at birth - being born to a fairly wealthy family.  He invested in a company that would eventually become PayPal and was forced out before it did.  When PayPal went ballistic, he made a fortune, not from his own hard work, but because he still owned shares in the company.  That, and the stock was way overpriced.

He repeated the same pattern with Tesla.  Only this time around, the stock price was hyped by Musk himself.  He was able to use bots and trolls to groom his image - and that of Tesla - to the point where the share price  was ridiculous.  Tesla is "the most profitable car company on the planet" (on a profit per car basis) exceeding Mercedes and BMW for the first time - but in terms of P/E ratio, the stock was wildly overpriced, particularly in what is a commodity business, manufacturing.

So lightning strikes twice - helped along by a little stock manipulation.  Surely, he can do the same thing with money-losing Twitter!  Fire all the employees, make the rest work a staggering 80 hours a week (why would anyone go along with that?) and charge $8 a month for the service - more than some streaming services are asking for real content.   Oh, and his shenanigans have caused advertisers to flee the site at a time when many advertisers are starting to realize that online advertising is over-rated.

What do I mean by that?  Well, it is not by accident that when you go on any site these days, particularly on your phone, you try to close out the many pop-ups asking you to subscribe, or close that pesky auto-playing video (who the fuck actually watches those?) that when you just are about to hit that "X" the entire page shifts and suddenly an ad appears and you just clicked on it.  Of course, you quickly close out of the ad using he back-button or whatever, but the site owner just got click-though credit and now the Internet thinks you are keen on women's pantyhose or whatever the fuck the ad was for.

Advertisers are figuring out that these bogus clicks are not real, and that their ads are far less effective than they thought they were - or what the site owners were telling them they were.  And odious content?  That was what sank Glenn Beck.  He had good ratings, but his fan base was broke and wasn't in the market for anything but guns and survival food.  Kind of hard to sell $50,000 pickup trucks to that crowd.  By embracing the "basket of deplorables" Twitter risks going down that same road.  Racists generally are not wealthy people - or at least the type that go online and type the N-word over and over again for a reaction.  In fact, most of those folks are teenagers.  I guess you could sell them zit cream.

The other problem with Twitter is hardly anyone uses it - relatively speaking. There is a core group of people who are literally addicted to it and cannot stop tweeting all day long.  Politicians, celebrities, and media types - they all love Twitter as it gives them a megaphone to shout out to the masses.  But most ordinary people read "Tweets" that are republished on other platforms - on Facebook, Reddit, or on news sites.  Everyone has heard about Trump's Tweets, not from Twitter itself, but because every news outlet felt that "covfefe" was worthy of ten minutes of airtime.

So now, Twitter is saddled with debt, including a billion dollars a year in interest payments, in addition to the billion dollars a year they were losing before Musk bought it.  And people wonder, has he lost the golden touch?  Or maybe it never existed - he was just getting lucky on a massive scale.  Eventually, luck runs out.

The above chart illustrates Tesla share price, earnings per share (EPS), and Price-to-Earnings (P/E) ratio.  A you can see, the stock price got way ahead of itself at one point, when the P/E ratio went over 1,000.   Even in the hundreds, it was wildly overvalued.  GM has a P/E ratio of 25 or so, Ford, a bargain-basement 9. Most car companies have ratios in the low double-digits and they pay dividends which Tesla doesn't do and has pledged never to do.  Which stock is a better investment?  Which car companies are making millions of cars a year and paying dividends - and introducing new models yearly?  It ain't Tesla, that's for sure.

The chart is interesting, as at the beginning, Tesla was making a small amount of money.  Then Musk plowed money into expansion - in China and Germany - and then bought-out his cousins in their Solar City venture, using Tesla sharehoders' money.  So for a long time, the profit was negative and the P/E ratio undefined.  It is only since the pandemic (and the so-called car shortage) that Tesla has made any money.

But at the same time, the P/E ratio has declined from its dizzying heights to a somewhat more rational 60 or so - which would imply Tesla is still overpriced by a factor of three (at the time of this writing - in recent days, the stock has taken a further hit).  What has changed is that Musk has had to sell off a lot of his stock to cover the loans he took out, pledging half of his shares. And no doubt the rest are pledged to other loans he took out to buy Twitter - as well as money he needed to make that transaction.  When the major shareholder of a company starts selling huge chunks of it, the share price plummets.

This is a real-world, real-time illustration of why Market Cap is Bullshit.  If Bill Gates sold all his Microsoft stock, the result would be the same - or Bezos his Amazon shares or Zuckerberg his "Meta" - or whatever.   First, you are dumping a lot of stock into a market than can't absorb it - the law of supply and demand.  A lot of shares for sale, and not enough instantaneous buyers.  Second, buyers would be nervous that the insiders are cashing out - do they know something the rest of us don't?

For example, that maybe Tesla's aging products are going to get creamed in the marketplace by lower-cost competitors?  For EVs to succeed, the prices have to come way down.  I noted before that doing the math on even a hybrid, it often makes no sense.  The thousands extra you pay for an EV or a Hybrid would buy a lifetime's supply of gasoline.  Sure, I could buy a $100,000 EV and "save on gas."  Then again, the $60,000 I would pay for the vehicle would buy 115,000 gallons of gasoline at $4 a gallon. That's well over 200,000 miles of travel, even towing a trailer.

And let's face it, people who buy $100,000 cars aren't worried about the price of gas.  Or if they are, they are being penny-wise and pound-foolish.

Musk is making noises about building a "more affordable" Tesla, which means they have to plow more money into R&D to design such a vehicle - and update their already dated designs.  Speaking of which, where is the "Cybertruck?" anyway?  Ford and GM have beat Tesla to market here.  And they (and others) are beating Tesla to market in the low-price field.  Low-price cars mean low-margins.  No more making $9000 per car!  You'd be lucky to make a grand apiece!  GM and Ford actually lost money on their low-price cars, which is why they stopped making them in favor of high-margin SUVs.

But maybe Musk is trying to get out of that game, entirely.  A new CEO of Tesla has been appointed, and Musk is selling off shares and taking less of a role in Tesla due to his obsession with Twitter.

Besides, I am sure that now he is part of the GOP and the "Club for Growth" his new peeps are not happy that he is selling electric cars - an anathema to the far-right.  "Welcome to the Club for Growth, Elon!  We're happy to have you as a member!  But hey, that whole electric car thing?  Not cool, dude!"

So maybe he is throwing Tesla under the bus, so to speak, to appease his new friends, who are giving him a love-bomb for making Twitter a "free speech" (read: hate speech) platform.

The golden boy has really lost his touch, hasn't he?  Of course, he never really had it in the first place.