TSLA

Tesla is down 13% today while the broader market is up. The reason is that Elon Musk issued an update in which the company let go of 7% of their headcount (some ~3,000 folks) including almost all temps and contractors, and Musk’s tone was quite drastic. He implied that it was going to be extremely challenging work, to achieve higher volume and economies of scale in order to deliver on their vision of the Model 3 at $35,000 and be profitable. He called this the only way forward.

Musk also ended a long-running buyer referral program that he stated was adding too much cost to the cars. He noted that a federal subsidy in the form of a tax credit is going away. Basically they make a tiny profit and they expect pressure on that profit margin going forward. Profitability is a super critical goal, yet will be very hard to achieve.

I want to make sure that you know all the facts and figures and understand that the road ahead is very difficult.

So what I am thinking about is buying these call options:

  • $360 call expiring 3/1/19 ($7.20 / share)
  • $325 call expiring 1/25/19 ($3.95 / share)
  • $360 call expiring 2/15/19 ($5.50 / share)

This is a short-term and medium-term bet that there is a rebound in the sentiment around Tesla. The last time Tesla suffered such a major move down was, I believe, because Elon Musk made statements that people thought could be construed as securities fraud by the SEC, around securing a buyout of the stock at $400. The price bounced back hard; I believe it bounced back due to some fundamental news, though I can’t remember and am now trying to find out.

This time is a little different; the price moved down majorly because of serious profitability concerns. If we need fundamental news to move the stock up, then our best expectation is that we would get it in the Q4 earnings report. I think it’s likely we do get good fundamental news; the market is hunting for news to act on. Any good news would move it up, but any bad news would move it down (well that seems like stating the obvious).

The bet here is simply that the market has overreacted on its move down of ~14%, and we should see a bounce back before earnings (hence the $325 call); and then a second bet that earnings goes well and the prospects of the company are seen as bullish again.

Long-term I think the company is extremely well-positioned. But this isn’t a long-term bet.

Actually I think one possible outcome of earnings is that these layoffs will have positioned TSLA extremely well for the future. After all, they cut a lot of costs, which should bode well for profitability. The question is if the market believes that the demand for the car is there.

Why would Musk flip so negative. Well I think he actually has to sound negative if he is cutting 7% of the workforce. So the question is why would he cut 7% of the workforce; was it a one-time cost that he wanted to incur that leaves benefits going forward? What part of the workforce is getting cut? It sounds like Musk is shifting from growth mode to survival mode. But I think if cutting the workforce is the correct move then we should disregard his tone as his tone needs to be negative. Moreover this is one month ahead of earnings so people will forget by then. I think the question is whether the Model 3 ramp required those extra people and now maintaining the same level of production, or same level of ramp, doesn’t require them anymore.

Now let me think about something else; how could I make the opposite argument? The opposite argument is that this company is worth $50 billion on a low single-digit profit margin and probably something like $25-$30 billion of revenue projected forward. The P/E ratio is high. The broader market is due for a downturn, although I’m not sure that matters for the timeframe of this investment. So how would we see a further downturn in the price of the stock? It really depends on media coverage. It depends on what Elon says. It depends on the earnings report; if it comes out that even more people should have been cut because profitability is that thin. If it comes out that earnings will miss, and actually go red, and demand is flagging. Could demand be flagging and that be why they’re cutting people?

Musk says the $35,000 Tesla 3 would cause the company to die. But now he says it is necessary.

If Tesla can’t profitably build the $35,000 car, can no longer benefit from the federal tax credit, can’t sell in China because of tariffs, and is still going through the EU homologation process, then where is the demand and where is the growth story?

On the other hand the Model 3 is the #4 bestselling passenger car in the U.S.

And on the bear side, they have a ton of debt and there are some statistics that show that demand is flagging. Could Tesla already have saturated their market? This tracker from Bloomberg seems to show that production growth has slowed, though it is stable. So production is solid.

However this report from Green Tech Media seems to demonstrate that there may not be much of a backlog anymore.

  • In July TSLA said it had 420k reservations
  • In July TSLA denied that Model 3 cancellations exceed new orders
  • TSLA is estimated to have produced 155k Model 3s in 2018
  • So that leaves a backlog of 250k Model 3s. 200k of those were for the 35k version that Elon Musk has said is a profitless proposition.
  • So if they have a backlog of only 50k, and let’s be generous and say 100k, then what they have is a demand shortage.

So I think they do have a demand shortage, which would cause a cut, they will have backwards looking profit, but have a tough path forward to stay in the black every quarter especially with the headwinds of the broader market (risk off). I would actually prefer to buy puts if there is a rebound in the stock.

In order to take the opposite side, I would have to be bullish on their product development (awesome new vehicles) as well as their expansion into new markets and proof that demand is actually building not shrinking. But when you build a waitlist in a bull economy you get ALL the initial interest, especially when you are selling a dream. And you give time for the market to catch up. I’m willing to bet the demand is stalling and they don’t know where it’s coming from, and they have a do-or-die proposition which is get to 35k or else. They have options, they can operate unprofitably, but not for long.

I’m a bear.

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