Why the Man Who Predicted the Housing Market Crisis Went ‘Short’ On Tesla

Image: Business Insider

If there’s anything I have learned in my investing journey, it’s been to ‘not bet’ against Elon Musk. Whenever the skeptics went ‘short’ on Tesla a vast majority of traders had lost money betting this “extraordinary billionaire visionary”.

In short Elon Musk can be compared to a ‘real-life Tony Stark’: “Genius, Billionaire, Playboy, Philanthropist”.

But Dr. Micheal Burry who is well known for his bets against big banks during the 2008 housing market crash has recently gone on Twitter to express his views about Tesla, and this clash of the titans has Wall Street in shackles.

According to a recent tweet, the veteran investor stated the following:

“So,@elonmusk, yes, I’m short $TSLA, but some free advice for a good guy… Seriously, issue 25–50% of your shares at the current ridiculous price. That’s not dilution. You’d be cementing permanence and untold optionality. If there are buyers, sell that #TeslaSouffle”

Image taken from Dr. Burry’s Twitter account on December 2nd, 2020

When taken at face value the tweet can simply be viewed as a clash of egos between two “gurus” who both know their game well. But besides the tweet, Dr. Burry had posted a spreadsheet that had details of all the leading auto manufacturers in the world alongside Tesla, to justify his hypothesis.

Image: Flowbank

Dr. Burry’s main hypothesis was the fact that the revenue, EBIT, and total market capitalization for the leading 32 auto manufacturers were $2.3 trillion, $99 billion, and $806 billion, whereas for Tesla the revenue, EBIT, and total market capitalization were $24.5 billion, -$69 million and $438 billion.

In a nutshell, if you see the numbers from a valuation perspective you are essentially paying roughly 50 percent more than Tesla to acquire a stake in all the other 32 auto manufacturers, and in the process, you’d be getting 90 times more in revenue!

Following the announcement shares of Tesla Inc. (NASDAQ:TSLA) plummeted by 7.4 percent the very next day!

This is essentially what short-sellers benefit from!

In simple terms, when you are selling short a particular stock you are betting against the stock price going up. The simplest way to profit is to sell the shares at a high price to repurchase them later at a lower price, and the “short-seller” pockets the difference. The one thing which needs to be kept in mind is that the shares that were sold short, are in most cases borrowed from someone else. Thus it is essential to buy the shares back later so that the short position can be closed.

What we don’t know is how long Dr. Burry plans on keeping the short position ‘open’.

A few weeks prior to Tesla’s stock split the share price rose to a whopping~$1,100, taking the company’s market cap to an incredible ~$209 billion. This put Tesla roughly $6 billion ahead of Toyota back then, making it the most valuable automaker in the world!

Tesla’s massive ambitions were initially heavily reliant on the success of the Model-3, an affordable mass-market electric car that was supposed to revolutionize the auto industry.

Elon Musk had outlined this in his master-plan memo way back in 2006 —

The strategy of Tesla is to enter at the high end of the market, where customers are prepared to pay a premium, and then drive down the market as fast as possible to higher unit volume and lower prices with each successive model.

Step 1: Build a luxury electric sports car that could make some money.

Step 2: Use the revenue from selling the sports car to create a more affordable luxury sedan.

Step 3: Once the luxury sedan takes off, use proceeds from this sale to market and sell a truly affordable electric car that the masses could afford.

Elon Musk was about to bet the entire company on this little dream.

Manufacturing facilities were hence subsequently upgraded. New factories were built. The company invested heavily in automation to cut costs across the board, and they desperately tried to scale from being a small manufacturer of luxury sports cars to a massive player in the mass market segment.

Eventually, though, the expectations went into overdrive. In March 2016, the company started accepting reservations for the Model-3. Within just one week, Tesla received more than 325,000 bookings — roughly $14 billion in implied future sales. It was the single biggest one-week product launch ever.

All the company had to do now was start pushing those vehicles out of the assembly line. Unfortunately, there was a problem.

Production Hell

Musk had laid out the unit economics that could potentially put the company on a path to profitability. He needed Tesla to churn out 5,000 Model 3’s each week to break even — the point at which the company could potentially turn a profit on each car sold.

But when the company originally began producing Model 3’s, they could barely meet this target. There were problems in the assembly line. There were problems with the robots. There were problems with battery manufacturing. And it was taking forever to solve these niggling issues. The company’s automation dreams were falling apart and in an infamous interview with CBS, Elon Musk called it production hell.

As an article in the Wired previously quoted—

“Even Musk had conceded that the company’s fully automated factory vision, the “alien dreadnought,” wasn’t working. Workers ripped out conveyor belts inside the Fremont plant. Employees began carrying car parts to their workstations by hand or forklift and stacking boxes in messy piles. At one point, Musk halted production for an entire week to make repairs. On some level, Musk seemed to recognize that he was undermining Tesla. “Excessive automation at Tesla was a mistake,” Musk tweeted. “To be precise, my mistake.” He once told a colleague: “We just have to stop punching ourselves in the head.” ”

However, as Tesla was trying to grapple with its many problems, the company’s valuation kept skyrocketing. Between March 2016 (when the company first started accepting orders for the Model 3) and July 2017 (when the company shipped its first batch), Tesla’s market value soared — from $30 billion to $60 billion. People were still hoping the company would deliver on its many lofty promises and retail investors were willing to gamble on the stock.

But not everyone was sold. Several prominent investors believed the company was burning through cash at a rate that would soon push it to the brink of bankruptcy. They were convinced Elon Musk was driving the company to oblivion and that judgment day was close. They concocted a compelling narrative around why Tesla shares were worthless and began short-selling the stock.

Observing the chaos Wall Street started aggressively shorting the stock back then, and it was more or less guaranteed to make traders a hefty profit by betting against Musk’s capabilities.

The same premise now seems to come back into play and when you combine that with the backlog of orders, Dr. Burry’s bet, and the email sent to Tesla employees regarding cutting costs, the possibility of Tesla stock getting “crushed like a souffle under a sledgehammer” does seem to make sense.

What will be interesting to see is if investors actually manage to recognize the company’s potential as a leading battery manufacturer and alternative energy provider heading into the future or will they continue to take a “short-sighted” trading approach based on daily price fluctuations.

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