Tesla: Taking A Turn For The Worse
Featuring Jay Van Sciver
Published on: April 15th, 2019 • Duration: 17 minutes • Asset Class: Equities • Topic: Valuation, Sentiment, ResearchReal Vision continues its discussion on Tesla by speaking with Jay Van Sciver, sector head of industrials & materials at Hedgeye. Sciver examines both the bullish & bearish theses for the company, highlights the unraveling of the demand story in 2019 and reviews just how low he sees share prices falling, in this interview with Jake Merl. Filmed on April 10, 2019.
JAKE MERL: Welcome to Trade Ideas. I'm Jake Merl sitting down with Jay Van Sciver, sector head of industrials and materials at Hedgeye. Jay, it's great to have you back on the show.
JAY VAN SCIVER: Great. Thank you so much.
JAKE MERL: So today we're going to be talking about everyone's favorite subject, and that's Tesla. And you're one of the most well-known bears out there, so I'd love to pick your brain. Here at Real Vision, we actually did a mini documentary recently on Tesla. And so I'd love to get your bearish view. If you could just go over four or five of the main reasons of why you're bearish on the stock, that'd be great.
JAY VAN SCIVER: Sure. I think one thing that differentiates what we did is we spent a lot of time trying to understand the bull case. Because I think if Tesla shares are actually going to go down, we would need some of those institutional longs to finally give up and exit or sell their positions.
And what we found as we basically did that research is that what they really believe in is the unlimited demand hypothesis. That, basically, Tesla can sell more and more cars and, therefore, increase manufacturing to a point where unit costs come down and they can be profitable.
And that is basically the point I think we just saw this quarter with deliveries, where, basically, that isn't really the way it's going to work. They are going to be demand limited. There isn't that much demand at the price points at which they operate.
And when we launched on Tesla in June of 2017, we really had three thesis points. One, story stocks hate dates with reality. No matter how good the Model 3 was going to be, it wasn't going to be as good as the god machine that was being priced into Tesla shares and the expectations.
Finally, it's A to B transport, and it is. I've driven a lot of Model 3s, and I think it's a perfectly nice car, but there's a limit on how many units of a car at that price you can really sell.
The second point was that they had inferior manufacturing, which is going to, I guess, aggravate people who believe in the Alien Dreadnought. But we did a lot of fieldwork. We talked to people on the line. I've spent a career looking at manufacturing.
And what we found is they don't even have a stable design for a car. They change the car intraweek. That makes for a very difficult process of optimization of a line. They also have turnover on the line that is too high. They don't train the line, which I guess is good because the turnover on the line is really high, so you'd be training people who, subsequently, leave.
I think great car brands are made by exceptional manufacturing. Whether you look at the Model T, which was finally a triumph of manufacturing, not a triumph of branding and autonomous driving. It is also true of Toyota. And it's a reason why the US auto industry started to decline because the manufacturing just wasn't up to par.
So when you look at Tesla's process from testing to, really, service and parts on the other end, they are deficient in the best practices of manufacturing.
And then the final point we made, which was, I think, increasingly playing out this quarter as well is what we call the first loser disadvantaged. People talk about the first mover advantage.
First loser disadvantage was basically that Tesla would be the first company to lose tax credits with General Motors eventually, and it would occur just as competing vehicles, which take six years to develop, were entering the market.
So you would be in the situation where you would be able to buy a car that was being developed by Audi in, say, 2013, coming out in 2019. It will have a full $7,500 tax credit in the US, whereas Tesla's tax credits are going to be stepping down.
So not only are you going to have competitive entry, but you're going to have disproportionately subsidized competitive entry. And, basically, that combination of factors led us to say that this is probably the peak.
JAKE MERL: And as things progressed, have you gotten more bearish, or have you been super bearish the entire time?
JAY VAN SCIVER: We have been bearish the whole time. I think we built a lot of really good tools because Tesla was such a dangerous short. So in June of 2017, this is a stock that has just run over the short seller community.
We're coming in amid a lot of responses like I won't even look at it. It's too crazy, right? It's like, well, it's a big alpha opportunity, so maybe take some time to look at it.
So we built some tools to track what's going on for Tesla in real time. This is, I think, a real competency that some of my teammates have developed at Hedgeye, where we're able to look at, for example, how many people are test driving Model S and X, or later in October, Model 3s.
So we were able to see that, basically, right around the 420 tweet, right around when Musk is sued for fraud, we see a big drop in demand. I did have sort of this real moment of doubt when we did our first survey, which are our most expensive content, as we always point out. Surveys are fabulously expensive to run.
But we asked this question-- hey, which of these three companies has the best build quality? Tesla, Mercedes, BMW. And 86% of people in the survey of likely car buyers responded Tesla. And I was like, really? Like, do you guys data at all? Do you watch the news?
So I think that is one of the things that gave us pause at the time was that the brand was so strong, that there was a lot of-- like, the bulls were right that there was a lot of interest in potentially buying a lower priced Tesla.
So there have been times when you sort of think, like, OK, this could go the other way. Maybe there really is this infinite demand. Maybe they really will make 12,000 Model 3s a week and do so profitably, or whatever it is.
But as we really got into the data and looked at deterioration in brand metrics-- which are still really high but have come down as we look at the attractiveness of competing vehicles and things like that.
I would also say the one thing I didn't anticipate when we started was how much-- I'm personally a Musk fan. I know that's probably a weird thing to say.
JAKE MERL: Interesting.
JAY VAN SCIVER: I get why people don't like him and whatever, but I think that he is funny on Twitter. I think he's innovative. I think he does push the industry.
JAKE MERL: Do you think he's a good CEO?
JAY VAN SCIVER: I think he is not a good CEO over the last year.
JAKE MERL: And why is that?
JAY VAN SCIVER: Well, I think he's actually helped the bear case enormously by, for example, disincentivizing and firing a lot of the sales staff in the first half of this year. That is not the way to-- if you want to generate infinite demand, you want a very active sales force.
And people often underestimate the value of sales and marketing. I think Musk has done that. Like, you can have the most clever widget in the world, but if you can't market, and sell it, and explain to people why they need It, you're not going to get very far.
I think his skirmishes with the SEC have been incredibly destructive to the brand. Buying a car is like a 6, 7, 8, 9, 10 year commitment. It's a little bit like getting married. Nobody wants got married to a fraudster, right?
So when that's in line with your name, it's not helpful to-- we can see those things in real time. Traffic dies to the stores when he's in front of a judge or whatever. He is very intimately tied with the brand. So I think we underestimated the extent to which some of his more colorful behavior would actually help the short case.
JAKE MERL: Could Tesla be successful without Elon Musk as the CEO?
JAY VAN SCIVER: I think the company could be successful. I think the stock will, obviously, not do well. I think when you meet with longs, one of the things that they will say is that they see him as the next Edison. And I see where they get that. I may or may not-- how I feel about Elon Musk is finally immaterial.
They probably would not continue to embrace Tesla so warmly if the next Edison were not at the helm. Could he be the director of technology or something? Probably. But, in general, Musk having problems in the headlines is bad for Tesla.
JAKE MERL: And so shifting back to demand, could you please talk a little bit more about that and how Elon has cut prices recently?
JAY VAN SCIVER: Sure. It's funny. So we track this kind of traffic data in real time. And every time it dropped, year to date, like right around January, price cut. A few weeks later, we saw it drop even more. Price cut. And then coming into this quarter, it's, like, dead. So price cut. So I felt like that was a good confirmation of the data.
But the reality is that the EV market-- even though I personally like EVs-- I like hearing the radio. My feelings are immaterial about it. The market exists because of subsidy and regulation, right?
They are cars that are generally more expensive than comparable internal combustion engine products. They are more complicated. You have to install chargers at your house, at your, most likely, weekend house if you're a Tesla owner.
There are aspects to it that are more complicated if you have an accident. You really can't get it serviced very easily. It's not a trivial proposition. So the tax credit, I think, is really important.
And even in our June 2017 deck, we said it was intellectually dishonest to forecast sales growth into 2019 because everywhere we've seen, subsidies for EVs come down. We've seen demand for EVs fall and not recover. Like, it doesn't magically come back.
People like free government money, and when that goes away, their interest in buying EVs also goes away. Evidence of that is that Musk and Tesla themselves make reference to pre-buys ahead of subsidies stepping down or going away.
We actually saw-- there's news today out about the tax credit-- there was actually a rumor that the EV tax credit would go away in the fourth quarter of 2017. So you saw a rush to buy Teslas before tax reform went through.
These are markets that are very sensitive to the subsidy regime. And, basically, for the next year, we're looking at the subsidy regime in the US, which is Tesla's key market, coming down.
JAKE MERL: And so what about the balance sheet? Are you worried about their debt maturing?
JAY VAN SCIVER: No. I am not. And I recognize that that's going to make me probably unpopular with most people who watch this. I think that Musk has a lot of very wealthy friends and can probably raise cash. People are-- why hasn't he raised yet?
Well, they still have a pretty good cash balance on the balance sheet, probably, at the end of the first quarter. He was right that within their framework, they generated cash in the second half of 2018. So they haven't had this dire need to actually raise cash that I think a lot of people are worried about.
But if you look at just Elon Musk's social circle, he most likely can raise. And the SEC is very unlikely to prevent Musk from raising, which would functionally take Tesla down. who.
Wants to be the person at the SEC who destroys Elon Musk? That isn't generally the regulator's role. They kind of clean up the mess that a failure makes.
Some people look at the rating agencies, which have also not exactly been a bastion of bravery at taking down difficult credit situations. If we look back at the financial crisis, they generally are more of a rubber stamp than anything else.
So I think approaching this from the credit and balance sheet side, while not, maybe, technically wrong, has the same character as approaching it from the accounting side. In that, yeah, it's terrible. Everyone can see it's terrible. If it's a fraud, they're frauding wrong. These numbers look terrible. They should get better at it.
Where I think this story falls apart and what actually gets those holders to sell is the lack of demand. That is, I think, the key inflection that the marketplace will realize, assuming we're right, that there are-- you don't hear about Tesla ramping production of Model 3s to 10,000 a week anymore.
Why? Because they can't sell them. Inventories are going up. Amazingly, in the last delivery release, they changed-- I think they changed-- from what we can tell, they certainly changed the language around it-- the definition of in transit to include vehicles ordered.
So we have a measure of how many total vehicles were ordered in the first quarter, and production exceeded total orders. That is, in our world of overproducing, underproducing, which is a very important dynamic within any manufacturing sector, that's, like, the biggest red flag we get. Book to bill. Come on.
So I think that is where the story falls apart is on demand. There's only so many $50,000 plus vehicles you can sell. And as tax credit rolls off-- each $5,000 increment in cars typically reduces the market by about a quarter to a third.
These are big changes in the available market. For each $5,000, you're talking about a $7,500 tax credit going away. That has an enormous effect on the total available market and the potential for Tesla to price and do all the things that they wanted to do to generate profits in larger unit sales based environment.
JAKE MERL: So how much downside do you see for the stock?
JAY VAN SCIVER: I am not a, you'll notice, tweeter of TSLA-Q. I think that it is probably a dilution story over time. I am not a believer that the SEC is going to get in their way. And if they do, that's fine. From my standpoint, that works.
I just don't think that that's-- we think a lot about base rate. So base rate of competitive entrance into auto manufacturing from an existing market, right? Like, how many new car companies have showed up from the United States? Zero, basically, in the last 20, 30 years.
Actually, in all capital equipment. Like, competing with Caterpillar, things like that. It's very difficult to enter. A base rate of somebody like the SEC coming in and taking down a company that's got a, you know, $40, $50, $60 billion market cap, this rate is basically zero. They don't do that.
So I don't think that the SEC is going to prevent Tesla from raising capital and put it into bankruptcy. But I do think it's reasonable to expect Tesla to trade, like, a normal auto manufacturer as soon as demand growth is shown to be limited, right?
They've been overselling, meeting a backlog of demand. They've been overproducing, lower unit costs. They're probably going to have to reduce production. And demand growth just isn't there. And the Model Y just didn't look that compelling in the launch.
If that's the case, you know-- and you can throw a valuation on mobility. I'm a believer that that has some value. You know, the reality is it's very hard to get a share price for Tesla it's not between $0 and $50 and probably between $0 and $20 a share.
So I think our expectation is that it trades down to something in that range. And if it got down there, we would probably just kind of stop talking and writing about it.
JAKE MERL: And what would change your mind? You know, where would you reassess your thesis?
JAY VAN SCIVER: If we see the brand, and activity, and sales, and demand come back. So I don't know how that would happen, but Musk's a clever guy. He shot a car into space. It was great art. Does that, in fact, restimulate demand? No.
I think they're just fundamentally limited by the fact that the cars are really expensive, and there just isn't that much demand. It's something like 15% of car sales in total are above $50,000. And most of those are SUVs.
So it isn't like they're going to sell a lot of these cars. There just isn't that big of a market. And as they point out, already taken a lot of market share. They always tweet that gleefully.
But I don't think that it's that easy to suddenly stimulate demand or create something new. And they also aren't deploying capital in a way that would allow them to develop, like, a new manufacturing platform. I know they're building a factory in China. It takes a couple of years to build a factory under the best circumstances.
I don't think there's a near-term solution to the demand limitations that they're facing. But that would get me to change my mind. If I could understand why demand growth was going to resume sequentially to-- I know it's going to be up year over year on an easy comp. But particularly in the back half of the year, it's probably not going to be up in third and fourth quarter, right?
So as that demand growth story falls apart, I think the stock comes down. And if I see that inflect, I would probably change my mind.
JAKE MERL: Jay, that was great. Thanks so much for joining us.
JAY VAN SCIVER: Great. Thank you for having me.
JAKE MERL: So Jay is bearish on Tesla. He thinks the stock has downside risk as low as $50 over the next 12 months. That was Jay Van Sciver of Hedgeye. And for Real Vision, I'm Jake Merl.