Tuesday, December 27, 2022

How Elon Musk Could Go Bankrupt - Part II

2023 could be an interesting year.

From richest man in the world to homeless?  Could it happen?  Well, maybe not that far, but one thing is clear, Musk is no longer the richest man in the world - if he ever was - and never will be again.

Getting one thing out of the way - Market Cap.  I have written about this before and how it is bullshit and only plebes bite on this nonsense.  Market cap is a simple equation - the number of shares of a company multiplied by the last share price paid by some sucker.   It really doesn't represent the "value" of a company, only a theoretical value if somehow you could sell every single share for that price.

This does happen, on occasion, when someone buys an entire company - for example, when someone pays a $10B premium over "market cap" to buy Twitter (Genius!).  But for the most part, Market Cap is never realized.  Once the large shareholders of a company start cashing out, everyone else gets nervous (and there are not enough suckers to buy the shares) and the share price - and market cap - plummets.  Oddly enough, we see this side of Market Cap also with Musk - as he sells blocks of shares of Tesla to try to bail out his shitty Twitter deal.  There aren't enough people to buy the shares, so the price plummets - by 70%!   Clearly Tesla was never worth more than all the other car companies combined - and clearly the share price is still well above where it should be, particularly since it pays no dividends.

It gets worse.  Musk famously didn't pay income taxes for a few years (he's paying now, though!) as instead of selling shares in Tesla to make payments on his lifestyle, he borrowed against his shares.  Loans are not taxable income, and the theory is, you can pay back the loans with the shares later on, and a tax deferred is a tax denied.  Say you borrow $1B and pay it back ten years later, pledging your shares in as collateral in the interim.  Ten years later, your shares are worth $2B and you pay back the loan by selling half the shares (plus some more to pay the interest).  Sure, you have to pay capital gains tax on the shares you sold, but in the meantime, you made a pile of money on the share price increase!

That's the theory, anyway.  The reality is, of course, Tesla shares were dramatically over-valued and if pledged as collateral on a loan, the Bank may "call" the loan and force sale of the shares, if they feel the loan is in risk of default.  Elon Musk could lose most of his stake in Tesla this way - perhaps all of it.  Because when those shares are sold by the bank, that's another realization event, and it comes with a hefty capital gains tax bill, which in turn requires selling more shares to pay that (and then selling more shares to pay the tax on that sale).  The whole thing can collapse like a house of cards.  According to some sources, Musk has pledged half his shares in Tesla for such loans.  This was before the Twitter takeover.

What's worse is that Tesla is facing its own share of troubles.  The "autopilot" and "full self driving" modes are being faulted for causing accidents. These driving aids were marketed as self-driving features (hence the names) when in fact, they were merely driver's aids.  Worse yet, there are reports that Teslas are slamming on the brakes while on the Interstate, causing a 9-car pileup in one incident, recently.  "Move fast and break things" might work in Silicon Valley, but in the car business, the "things" you break are real people.   Expect class-actions suits to dog Tesla in 2023.

But wait, it gets worse.  Teslas have acquired a poor reputation for quality and service.  Cars fresh from the factory have poor door panel fit and trim pieces that fall off.  Maybe you could get away with this for a $35,000 car, but not a $100,000 one.  As more and more mainstream automakers offer electric vehicles, the impetus for owning a Tesla will diminish, and according to some sources, orders are already being cancelled.

But wait it gets even worse.  Musk embracing ultra-right-wing "free speech" and GOP values has alienated the very people who buy EVs.  So expect to see that "backlog" of orders diminish down to nothing.  Already, Tesla is offering discounts on some models - this is not a good sign.  As I noted recently, I met a fellow who ordered a Tesla and a Mach-E and Ford delivered first, so he canceled his Tesla order. "I'm glad it worked out that way," he said, "as when I ordered the Tesla, Musk hadn't come out as a right-wing Republican!"  Driving a Tesla, as a liberal is seen as hypocritical.   I wonder how many will hit the used-car market in California in the coming months.

But wait, it gets worse than that.  The Texas and German "giga-factories" (really?  Did a child come up with that name, like "cybertruck?" Oh, right, nevermind), which Musk called "money furnaces" are struggling to go online.  Germany in particular will be problematic for Tesla, as the powerful unions and local governmental regulatory agencies have as much a say in running a factory as management does.  GM bailed on Europe in part because even closing a factory required approval from the union, local governments, and even the customer base.  The Tesla/Musk model of trying to get people to work 60-hour weeks with no overtime simply won't fly in Europe - and maybe not in America for much longer.  Eventually, the people working themselves to death have to ask, "What's in this for me?  Why am I sacrificing my life for a Billionaire?"

Speaking of unions, though, Tesla will eventually have to deal with the UAW, who, over time, will get their foot in the door at Tesla, particularly as stories of worker abuse continue.  It may be a matter not of "if" but "when."

Speaking of factories, some analysts have noted that while Musk called these empty factories "money furnaces" at the time, Tesla's profits seemed strangely level.  Some are claiming that there may be some accounting irregularities - for example, claiming warranty claims as "goodwill repairs" instead of expensing them.  Building three new factories simultaneously would seem to take up a good portion of the company's cash-flow, but it isn't showing up on the books.  Maybe it is just an accounting record-keeping method.  But given Musk's irrational and bizarre behavior, anything is possible.

But the worst is yet to comeCarbon credits is one way Tesla makes more money per car than Mercedes or BMW.  Or made, anyway.  Other automakers buy these carbon credits to offset their sales of gas-hungry SUVs and pickup trucks. Automakers are getting tired of putting cash in Tesla's pockets, though, and bidding against each other for a tiny pool of carbon credits.  So they are making EVs of their own - which are more attractively priced (particularly since they still qualify for tax credits) and better built.

So you can see a death spiral here with Tesla. The share price will continue to drop as Musk (and others) sell their shares.  The reputation of Tesla, now besmirched by quality issues and political ones, will result in slower sales, aggravated by the plethora of newer EV models from competing manufacturers.  Carbon sales will slow as they become more plentiful from other makers.  Profit per car will diminish, and the rush to build and expand with new factories in Europe, China, and Texas, will start to look like a bad move.  China could be particularly problematic as nationalism there takes hold and Chinese buyers look to domestic brands over foreign ones - that could be a problem for all Western car companies (and companies in general) particularly General Motors, who made 50% of its profits in China.

The good news?  Well, Tesla might finally have a rational P/E ratio as its share price falls (but not if earnings fall just as fast).  If Musk's interest in Tesla shrinks to nearly nothing, perhaps his political legacy will no longer dog the brand (the dirty halo effect) and he will be forced out of leadership positions and more rational and experienced people can take over.  And in fact, the share price might drop to the point where some other manufacturer decides to bid to buy the place.  That could be a good move for a company that is late to the EV game and wants to buy their way in - and buy the carbon credits as well.

Or, Tesla could go the way of Studebaker and Packard.   The carmaking business historically is littered with the carcasses of old-time and wanna-be makers.  It is a cutthroat business of tiny margins, and as soon as one maker discovers a new vein of ore, the other makers dig in and mine it as well.  Studebaker and Rambler made a go of the small car market during the recession of 1960.  But within a few years, both were history as the "Big 3" introduced small cars of their own.   You can't expect other automakers to sit on their hands.

OK, well, that's Tesla.  What about SpaceX and other ventures?  SpaceX is having success with its Falcon rockets, but since it is privately held, we have no idea whether it is making money or not, and if so, how much.   The other half of the endeavor is the "Starship" rocket which many have noted makes no sense whatsoever.   While it is an interesting technical feat to launch a rocket straight up and then have it land vertically on its launch pad, it is a horrendous waste of fuel and payload capacity.  This might work for a Falcon-9 booster (which is not in orbital flight).

The "Starship" looks like the "spaceship" from the 1930's to 1950's pulp-fiction sci-fi magazines, which posited that such craft could be used for suborbital flights - Los Angeles to Tokyo in two hours!  But landing a huge craft on its tail is kind of risky, particularly with people inside.  There is a reason Falcon-9 boosters land on a barge in the Atlantic.  And more than one has flubbed the landing.

And for orbital flight, the "Starship" will require a booster larger than the Saturn V rocket.  It is the stuff of science fiction and we'd all like to see it as science fact.   But is it a realistic space transportation system or just a one-off technical gimmick like the Virgin Galactic?  I think the point is, space is a risky investment, and it might pay off, or might go broke.  We'll have to wait and see.

The more traditional approach of using aerobraking to slow a space vehicle to suborbital speeds makes far more sense. Whether the "Starship" can do this with a thin body made of stainless steel, remains to be seen.  For every dollar SpaceX is making with a Falcon-9 launch, they are throwing away on the "Starship" wet dream, or so it would seem.  If they can pull it off, it would be a miracle.

The big "if" for SpaceX is that one accident could cripple the company for years.  Space exploration is a highly dangerous endeavor. The Soviets only crowed of their accomplishments when Cosmonauts returned to earth.  The rumor is, there were many others who died in space when their vehicles could not re-enter, or they burned up on re-entry or blew up on the pad.  In America, we blew up quite a few rockets in the 1950s to the point where we felt we would never win the "space race." 

But even then, three men died in Apollo 1 on the pad during testing.  Apollo 11 landed on the moon, but came within seconds of running out of fuel and crashing to the surface - it was a close call and not talked about much at the time.  Apollo 13 illustrated how one tiny undetected flaw in manufacturing could blow up a spacecraft and nearly kill its compliment.  And the Space Shuttles reinforced this lesson - tiny defects or unanticipated events could cause an entire spacecraft to explode - killing all aboard.   Space travel is and always will be, risky.

SpaceX has had its share of blowups, mostly on the ground or with unmanned missions.  The "Starship" in particular has made some impressive balls of fire when it failed to stick the landing.

The point is, SpaceX is one blow-up from financial ruin.  When Apollo 1 burned on the pad, it took a crash course of months - years even - to figure out what went wrong, not only with the technology, but the manufacturing process and the corporate culture.  Again, "move fast and break things" is a bad idea when human lives are involved.  After Apollo 13, NASA realized they were living on borrowed time and curtailed the whole moon landing program early. When the shuttles blew up, they were grounded again, for years, until safety measures could be improved.  After Columbia, the end of the shuttle program was announced.

So if SpaceX does have an accident, it could shut down that program for years, which would mean spending millions - if not billions - fixing problems, while at the same time, having no income. In the meantime, competing space vehicles are coming online and may steal some of SpaceX's thunder.  That in turn points out another problem - with so many getting into the space launch business, can SpaceX compete?  So far they have been the low-cost provider, but are they doing so at a profit or loss?  Again, we have no idea as the company is privately held.

Granted, this is a "what if" scenario, but a very real one.  Given how Musk pushes his employees to work long hours and rush things through, I think there is at least a 50/50 chance of some sort of SpaceX disaster in the next 1-5 years.  That could create a huge financial blowout as a result.

So what does that leave? Twitter? Twitter was losing $1B a year before Musk over-paid for it on a whim, using a price based on a marijuana pun.  He saddled the company with $1B more per year in interest payments on its debt, and then lost another $1B a year in advertising revenue.  That's $3B a year in the hole - and he's asking other shareholders to throw good money after bad in this deal.

Meanwhile, he's stopped paying the rent on office space and refusing to pay severance to the numerous employees he's fired.  Why anyone would want to keep working there is anyone's guess - their stock options are probably worthless at this point.  When you stop paying rent and stop paying your suppliers, it is a tacit admission that bankruptcy is around the corner.

When that happens, shareholders are generally wiped out and debtors take possession of the company as the new shareholders.  So Saudi Arabia and Bank of America will become the new owners of Twitter?  Stay tuned.

The point is, using "Market Cap" to say that such-and-such a person or company is the biggest or richest in the world is pointless.  And sadly, sometimes even the people and companies involved start to believe this.  Tesla is worth more than Toyota?  When Toyota makes more cars in a month that Tesla does in a year?  That simply makes no sense whatsoever.

And like clockwork, some clueless "stonk" buyer will go on Reddit and "ELI5" as to "where did all the money go?" never realizing that it never existed in the first place.  Market cap is bullshit - and dangerous bullshit at that.  It's only real use is in generating click-bait headlines for "Finance Journalists" to sell ad space.

Sadly, it seems that even Musk got caught up in this hoopla and that is what is leading to his downfall with Twitter.  It is one thing to make a strategic purchase of a distressed company and then turn it around, shed unprofitable divisions, and return it to profitability.  That is the Warren Buffet way.  It is another to pay a hefty premium over market value for a company that has never made a profit in its short history and has no path to profitability and then instead of cutting costs and making it profitable, increase annual losses by a factor of three.  This is not financial genius at work.

What is it, then?  Drug use?  Mental illness?  Narcissism?   All of the above?   Would you invest with a guy who names his kid Mercur Scorpio XR4Ti?   I certainly wouldn't.  Yet there are still today, legions of fanboys who worship at the altar of Space Jesus.

They all want to get in on "The Next Big Thing!"  I think 2023 will be the year we realize that "The Next Big Thing!" wasn't even a thing.  "Technology" such as delivering food or driving taxicabs or renting out your house, simply isn't that profitable.  In fact, it isn't profitable at all, when Silicon Valley takes a huge cut of the cake.

Maybe 2023 will be the year we wake up from this dream - with one heck of a hangover!