The value of a business is the amount of cash it produces over its life discounted back to the present. Tesla has no earnings. They report positive earnings, but they use various accounting gimmicks to make it that way. The same can be said of its manipulated gross margins, cash flow, and other important financial metrics. We provided an overview in a previous article.
We believe Tesla is a company that engages in fraudulent and deceptive practices on many levels from its accounting and financial reporting, its marketing, its snookering of regulators, and CEO Elon Musk’s incessant lies to the public.
The company, intrinsically, is worth nothing or very close to nothing. Cars manufacturing requires lots of capital and comes with very low margins.
Tesla has many narratives about what it’s going to do in the future to promote its stock price. But the reality is that it’s a car manufacturer and one that’s not very big or efficient.
Tesla is not even close to the production or financial performance of GM or Ford, yet is valued at around 20x each of those companies or around 10x Ford and GM combined.
Full self-driving (“FSD”) does not exist. The company is merely pushing a Level 2 ADAS on consumers and charging them $10,000 a piece for it through fraudulent claims that it’s indeed “full self-driving” or will be very soon.
A huge gamma squeeze has been put on the stock to drive its valuation well above the $1 trillion mark.
This is the process by which market makers have to hedge their exposure from selling/underwriting call options by buying more of the underlying stock. As options get closer in-the-money, more and more stock needs to be purchased.
Done on a large enough scale, this can lead to a parabolic rise in the price of a stock.
This also comes at a time that Musk and other insiders are offloading shares.
At a valuation of around $1.3 trillion (fully diluted), and with U.S. GDP at somewhere around $21 trillion, that means the equivalent of about 6 percent of the United States’ annual goods and services production is wrapped up in a company that doesn’t produce any earnings. That has implications when the bubble finally pops.
There are other public companies worth more than Tesla (Apple, Microsoft, Amazon, and Google). But they are massive conglomerates producing lots of cash.
Their valuations might be somewhat high by historical standards, but they are also deserving of those valuations considering their financial performance.
Tesla is a totally different story.
It trades at around 30x revenue with no genuine earnings or operational cash flow.
Which brings up more serious considerations…
Is the Tesla bubble a systemic risk to the entire economy?
Bubbles seem like a good thing because it means people are making money in the short-term.
But bubbles eventually lead to corresponding busts. The problem is exacerbated when people use debt to buy into the bubble.
They make money if they can successfully sell to someone else willing to buy at an even higher price. But the asset itself isn’t throwing off enough cash (from its earnings) to validate its valuation.
It’s basically a gigantic leveraged game of the greater fool theory.
Eventually a reckoning takes place, overleveraged borrowers will need to sell or go broke, and potentially create cascading effects if not contained.
Right now, Tesla’s bubble is mostly met with amusement by those on the sidelines or euphoria for those long, but again, we’re talking about the equivalent of around six percent of the country’s GDP. It’s gotten to an enormous scale.
If Tesla’s valuation collapses, the loss of over a trillion dollars is not immaterial.
It brings back memories of Long-Term Capital Management (LTCM), whose failure was large enough to threaten the financial system in 1998.
In 2008, a bubble in residential real estate – facilitated by out-of-control lending and leveraging practices – created a classic debt bust.
Though the economy was smaller in 2008 than it is now, common estimates of bad debts on the balance sheets of global financial institutions were at around $800-$900 billion.
In other words, that “wealth” didn’t really exist because it wasn’t backed up by earnings and had to eventually be written off.
The bigger the Tesla bubble becomes, the worse the eventual consequences.
The role of central banks in inflating the bubble
The 2008 bust created the start of a monetary policy regime of ZIRP and QE that we’re now perpetually engulfed in.
The Tesla saga is going on with a backdrop of 0% interest rates provided by the Federal Reserve in addition to the purchase of $120 billion of securities a month.
This is leading to asset bubbles today and threatens to inflate them further. Bubbles are most likely to occur near the tops of business cycles.
Even though the economy is most vulnerable during bubbles, people are feeling the wealthiest and most euphoric.
Central banks mostly ignore bubbles because they concentrate on their mandate, which is typically either inflation or inflation plus output (unemployment).
However, it’s their policies that help inflate bubbles in the first place.
If the money and credit created by central banks goes into things that don’t increase productivity much or at all and won’t effectively be “paid back,” that has big implications for growth and inflation going forward.
A financial asset (like a stock or a bond) is a claim on future income. If income/earnings aren’t generated in line with those expectations, then there’s a problem with its valuation.
Historically, the biggest economic pain has occurred after bubbles burst. If policymakers don’t control them, then who’s going to?
The cost of allowing bubbles to inflate and burst is so high that it’s not prudent to ignore them.
The problem is that bubbles typically occur in some parts of the economy and not others. So monetary policy on its own is not adequate in managing them.
And a lot of what’s going on with Tesla can be lost within the context of the overall stock market.
Tesla may be an extreme bubble, but the stock market is acting in a more orderly way. Tesla is 2-3 percent of the S&P 500, so a 10 percent daily move in Tesla is just 20-30bps in terms of what it means for that index.
However, that 2-3 percent is still a lot in terms of what it means for people’s retirement accounts, for example, as the S&P 500 is the most tracked stock index in the world. Tesla effectively hacked its way into the index by contriving profits to meet standards for inclusion.
When the housing bubble was occurring, because growth and inflation were normal and policymakers were heavily focused on those metrics, they ignored it until it was too late and there was a painful outcome.
Consequently, their inadvertent financing of a bubble nearly sunk the country’s financial system and has had ramifications until this day.
But it’s easy to lay blame in hindsight.
A key reason why policymakers don’t proactively go after bubbles is because of the difficulty in knowing with confidence when the market is mispricing an asset.
Despite the concerns in the housing market in the years leading up to 2008, regulators didn’t aggressively try to slow down frothy mortgage lending for that reason even though it became so systemically bad that it would eventually torpedo virtually everything.
Tesla is also the perfect storm for a financial bubble due to the hopes, dreams, optimism, and supposed virtuous causes that it supports.
However, many see the utter lack of financial sense in its valuation and view the company and its CEO as fraudulent and deceptive.
Musk and Tesla have managed to attract substantial amounts of taxpayer money and private capital to fund a questionable standalone business model (and of dubious ESG merit), have concealed their true performance through creative accounting and financing maneuvers, and hyped the stock to levels that are virtually impossible to sustain.
Tesla and the failures of other regulators
A lot of blame is placed on central banks when bubbles occur and inevitably burst. But the central bank also directs things on a high level and has a limited set of macroprudential policies.
It’s important to note that using interest rate and liquidity management policies intended to affect the macroeconomy is not efficient to use when targeting sector-specific problems (or problems within a certain company or entity).
Tesla doesn’t get to its extreme valuation without a lot of help from Fed policy. But much of what’s wrong with Tesla and the numerous ongoing regulatory failures surrounding it falls way outside the scope of the central bank.
When Musk committed securities fraud lying about having funding to take Tesla private over Twitter, the SEC had its chance to remove him from the company and bar him from serving in a role as the officer of a public company going forward.
Instead it chose to settle the fraud charges for an extremely small sum of money (a $20 million fine to Musk and $20 million fine to Tesla) relative to the level of fraud committed.
Musk breached his fraud agreement later and had to re-settle. The SEC has been between a rock and a hard place since then and is effectively doing nothing about Musk’s additional violations.
Musk has mocked regulators with sexual innuendo, bullied NHTSA regulators, used his account to promote various forms of cryptocurrencies to benefit himself financially, and has essentially used Twitter as a free-for-all despite (impotent) SEC sanctions.
And it’s not only the SEC at fault for failing to take sufficiently punitive measures to enforce the law and ensure appropriate conduct is followed.
For example, the FTC has failed to rein in the sale of FSD, a so-called “beta” product that’s been deceptively marketed and sold to consumers under false promises.
FSD is also a big lever of promotion for the stock, as it pertains to Tesla’s misleading public narrative on autonomy, and thus could also fall under the purview of securities laws.
The NHTSA has not done a good job in ensuring Tesla’s Autopilot and FSD meet appropriate safety standards (among other issues, such as defective suspensions, battery fires, and other problems).
Musk’s actions of committing fraud, breaking laws, exploiting gray areas, acting in bad faith, and flouting regulations and thumbing his nose at regulators – and getting away with it – have only emboldened his actions and cemented his belief that he can get away with practically anything.
Many regulators are at fault for failing to adequately enforce the law as it pertains to a self-absorbed CEO who has no regard for following rules, laws, and regulations.
Musk believes he’s above the law and so far he’s been right. His obsession with the stock price makes sense given it’s the best thing he has going for him, both in terms of his personal wealth and his general perception among the public.
Supposedly, if the stock goes up, you’re doing a good job. Everybody is happy and problems can more easily stay concealed.
Most financial promotions and frauds have been very obsessed with their own stock price, Tesla included.
How bubbles eventually pop
Bubbles get worse, and typically enter their later stages, when credit growth goes into purely speculative financial assets that don’t throw off earnings. This means the asset purchases being financed won’t produce the income required to service the debt.
Lots of new buyers typically enter the market, many of them unsophisticated with no prior experience in what they’re trading.
This is a common sign that things aren’t sustainable even if policymakers aren’t immediately concerned about these debt-financed purchases of financial assets, which if left to go further face a high risk of sinking the economy from the eventual bad debt crisis they create.
And because most stocks are purchased on margin (with borrowed money), stock gains have a magnified impact on equity values.
For example, say one wants to buy $100,000 worth of a certain company’s stock and has to use only $20,000 worth of savings to do so.
If the price of that investment went up to $160,000, then the investment effectively tripled (+$60,000 profit on $20,000 of collateral).
In turn, this allows for more borrowing and more lending, as it was profitable and helps attract other buyers into the market.
In many bubbles, lending standards are often lowered, even though it would be prudent to do the opposite as something becomes even more expensive and thus even riskier to engage in.
This credit-fueled buying drives up prices even more. In turn, this creates self-reinforcing expectations. More new types of borrowers and lenders are drawn in who fear missing out. This is classic during bubble periods.
There’s leveraging up to bet more aggressively on prices continuing to increase. But again logic should dictate that the opposite kind of behavior is more appropriate – namely, those betting on price changes should be more inclined to deleverage or sell. And those who lend to them to finance these purchases should be more cautious when this type of behavior is happening.
But the opposite of what’s prudent tends to occur because of the euphoria associated with what’s going on.
Those who spot the bubble and bet against it can have their own issues if they’re too early (as many usually are), and can get steamrolled with large losses if they aren’t careful.
The things that made a bubble self-inforcing on the way up flip into the opposite on the way down.
When asset prices fall, this decreases the equity and collateral values of leveraged speculators. Lenders are forced to pull back on what they’re doing.
Speculators have to sell, which causes prices to fall even further. Other entities pull out of the market and other risky investments if systemic/interrelated, fearing escalating losses.
If the market is big enough and leveraged enough, the losses can become systemically threatening, which means it’s a broader risk for the economy as a whole.
Lessons to be learned
Unfortunately, there are likely to be many lessons to learn from the Tesla fiasco.
Tesla is an extraordinary case of one company – especially one man (with a history of fraud to his name) – ballooning its financial wealth without creating real wealth (earnings/profits commensurate with the valuation).
Gates, Bezos, Buffett and many other household names climbed the Forbes list due to their retention of large stakes in massive cash-flowing businesses.
Musk made his way through fraud, lies, deception, and the mother of all asset bubbles.
It’s likely to lead to a watershed moment on corporate fraud and executive oversight.
It will shine a light on the lax enforcement as it pertains to accounting and financial reporting, securities laws, consumer protection, and other problems associated with Musk and Tesla that have been unfathomably ignored for far too long.
It’s unfortunate that one’s man extreme arrogance, fraudulent conduct, and callous disregard for the law – and others’ blind trust in a character who’s constantly thrown off red flags for years – and the regulatory incompetence on the other side of it, have led to a point where the company is a potential systemic threat should its extremely bloated valuation collapse (and especially if in a non-orderly way).
Free markets are great, but they require rules, laws, and regulations that are adequately enforced.
It shouldn’t have to get to a point that a single egotistical white-collar criminal can potentially threaten the entire system and expose the US’ failures in this regard.
Nobody should be above the law no matter how hard they pretend to be for the environment or other virtuous causes – and in Musk’s case, disingenuously uses said narratives to further his own power and financial interests.
The collapse of a multi-trillion-dollar bubble facilitated by lies, fraud, deceit, and regulatory failure can create economic, social, and political consequences that can threaten the entire system.
How ironic would it be if the so-called savior of humanity brought down the entire economy with him?