Stories from Shortville – Trimming my Texas Hedge $TSLA $TSLAQ
Elon Musk demonstrated a neat turn of phrase when he said “Stormy weather in Shortville”, back in April 2017.
The share price at the time? $298.50.
Now, more than two years later, the share price sits at $252. The unusually volatile and controversial stock continues to frustrate both bulls and bears.
Bears can point to the gulf betwen the current share price and the faked $420 go-private deal. They can rightly argue that the Tesla share price has achieved very little during a period in which stock market indexes have carved out fresh all-time highs.
Tesla’s share price reached $290 as long ago as 2014, so buyers even from five years ago might currently be underwater.
Longs, meanwhile, can take comfort from a fantastic rally over the past six weeks. From a low around $180, the share price has rallied 40% in a remarkably consistent bull run.
The 2019 Q1 update letter showed record production and deliveries by Tesla:
As is customary, there is a delay between the update letter and the detailed quarterly financials, which are scheduled for next Wednesday, July 24th.
As is also customary, bulls prefer to think about Tesla’s top-line growth and delivery numbers rather than the ongoing losses. Bulls use the “Amazon argument” (that top-line growth and market share matters more than profitability), so the delivery numbers matter the most to them. Bears, meanwhile, look forward to the updated financial statements.
As a bear, it has been amazing for me to see how the Tesla narrative has shifted. Yes it’s true that Elon Musk’s promises have always been far-fetched. But even ignoring the zany promises, it’s amazing to me how accepting the Tesla shareholders are in relation to broken financial and operational projections.
For example, on January 30th, 2019, Musk said “I am optimistic about being profitable in Q1 and all quarters going forward.” The company went on to post a $700 million loss in Q1.
In April, Musk radically reduced financial guidance for the company until it deploys autonomous vehicles:
Well, we’re aiming to be approximately cash flow neutral during the fleet pullout phase. And there, I expect to be extremely cash flow positive once the robotaxis are enabled..
In the space of three months, therefore, guidance shifted from “profitable in Q1 and all quarters going forward” to “aiming to be approximately cash flow neutral” until autonomy is achieved.
And in May, Tesla’s stretched balance sheet forced it to raise cash yet again (despite Musk’s implausible claims that it didn’t only needed the cash as a “buffer” to shield it against a possible recession).
With the share price now back around the levels it traded at on Autonomy Day, I take this as further confirmation that Tesla shareholders simply don’t care about the company’s financials.
Trimming my Texas Hedge
My own position on Tesla has shifted in recent weeks.
Until recently, my Tesla stance amounted to a bearish “Texas hedge” (i.e. completely unhedged), with an outright short position and some very far out of the money put options.
The put options were at the”ludicrous” strike price of $10, expiring in January 2021.
As the share price dived to $180, these options showed healthy mark-to-market gains, but their value subsequently began to fade.
Eventually, after the Q1 delivery numbers, I decided to give up on them, for now, and sold them for a small loss.
The delivery numbers weren’t the most important factor in my decision to exit the puts. The more important fundamental reason to sell these puts was actually the $2.7 billion fundraise in May. The puts were a way of betting on disorderly collapse, and the most likely trigger of this collapse was the company being legally prevented from raising fresh funds (e.g. because of ongoing investigations by various authorities and investor lawsuits).
Since nobody wants to stand in the way of Tesla raising more money from investors, the chance of a disorderly collapse has become that much less likely, at least in the short and medium term. So I abandoned the $10 puts for the time being.
And what of my short position? That too, has been trimmed – last month, I halved it.
Running scared of the short storm?
There were practical and fundamental reasons for trimming this position. On a practical level, I wanted to release some cash from the portfolio, due to some large personal expenses this month. It seems far more sensible to trim a spread bet and release the collateral, rather than sell physical shares, so the Tesla short was an obvious candidate for reduction.
On a fundamental level, we have entered the “dead zone” between deliveries and financial results. During this period, bulls are free to focus on the top-line growth story without facing any difficult questions about average selling prices, margins and cash burn.
Another factor to consider is the Q2 push in the United States in relation to the federal income tax credit. This was worth $3,750 on every purchase, but has now reduced to $1,875. We saw in Q4 last year that demand was pulled forward to get the tax credit when it was still at $7,500. Something similar, albeit on a smaller scale, may have happened in Q2.
Q3 and Q4 will have to get by on a tax credit of just $1,875, and then this subsidy will completely disappear. Meanwhile, nearly all other manufacturers will continue to enjoy the €7,500 subsidy for the next few years, putting even more pressure on Tesla’s ability to generate acceptable margins.
Needless to say, I remain extremely sceptical of Tesla’s ability to generate sustainable profits. Its efforts to design full self-driving software have not yet resulted in any real-life testing. Waymo (a subsidiary of Alphabet (GOOGL), in which I have a long position) continues to make excellent progress, and has cars on the road right now.
If Tesla’s dream of autonomy does not materialise, then all we are left with is a car company with limited resources (and arguably cash-strapped, despite the May fundraise), whose CEO is “aiming to be approximately cash flow neutral”.
I continue to believe that Tesla is one of the best shorting opportunities of my lifetime, and look forward to increasing my position size again.
At the time of publication, the author has a long position in GOOGL and a short position in TSLA.