Streetwise Professor

I’ve long been a Tesla–and Elon Musk–skeptic.  Indeed, I think it’s fair to say that I was one of the earliest doubters: my first posts on Tesla date to almost exactly 5 years ago–May, 2013.

Little has happened in the intervening five years to change my opinion.  Indeed, I make a conscious effort to battle confirmation bias, because most of the Tesla developments reinforce my opinion.  But no matter how hard I try to make the pro-Elon/Tesla case to myself, I come away unconvinced.

My two primary criticisms are (1) that rather than being a visionary genius who will revolutionize autos or space travel or whatever suits his fancy today, Musk is a rent seeker who has been most successful at exploiting government largesse, and (2) he is a serial exaggerator whose promises constantly–with probability one–greatly outstrip the execution.  Here I’ll focus on (2).

There are so many examples to choose from, but I’ll focus on one that I called BS on from the moment the words left Elon’s mouth: the merger of Solar City and Tesla.

The Musk narrative was that this was a strategic masterstroke, that would create a vertically integrated clean energy company: “We would be the world’s only vertically integrated energy company offering end-to-end clean energy products to our customers. This would start with the car that you drive and the energy that you use to charge it, and would extend to how everything else in your home or business is powered. With your Model S, Model X, or Model 3, your solar panel system, and your Powerwall all in place, you would be able to deploy and consume energy in the most efficient and sustainable way possible, lowering your costs and minimizing your dependence on fossil fuels and the grid.”

I ascribed a very different motive to the deal: it was intended to prevent Solar City’s bankruptcy, which would have seriously damaged Tesla’s biggest asset: Musk’s reputation as a visionary genius:

Indeed, Tesla bleeds cash like a Game of Thrones battle scene. Hence the need to rush out the Model S (and collect deposits) while huge questions about production remain. Hence the repeated returns to the equity markets to issue new stock.

Which will now be harder, because paying for Solar City in stock–and hence diluting existing shareholders substantially–mere weeks after a big equity offering will make investors to whom Musk will have to sell stock in the future to meet his voracious needs for money think twice: will he take their money then dilute them again a few weeks or months later?

This move looks very short sighted, and it almost certainly is. But Musk is doing it because he needs to address very pressing immediate concerns, and he’ll worry about the future ramifications when the future comes.

Musk has made a living off of suckers. Suckers in government (including most notably the federal government, and the states of Nevada and California) who have lavished huge subsidies based the dubious environmental benefits of electric vehicles. Suckers enamored with the technology and performance of Tesla vehicles–despite the questions surrounding Tesla’s ability to produce those vehicles.

To keep the suckers coming, Musk has to perpetuate his image as the Great and Powerful Oz. A major fail–like the bankruptcy of Solar City–threatens to pull back the curtain and demolish that image. Musk needs to prevent that from happening. He needs to buy time, and to buy time, he is having Tesla buy Solar City.

Desperate times call for desperate measures. The proposed purchase of Solar City reeks of desperation, because it facially makes no business sense, and is explicable only as a way to keep a con alive.

Enough time has passed to evaluate who was correct.  And Musk has proved me right by deeds, not words.  If the “vertical integration” argle bargle was the truth, Solar City should have expanded.  If I was correct, out of necessity Tesla would have to scale back Solar City dramatically to stem the bleeding of cash.

The latter has clearly happened.  In 1Q18, installations by Solar City are down about 65 percent since 1Q16.  Installations in 2017 were down between 17 and 57 percent from the corresponding quarter in 2016.  The business is clearly in wind-up mode.

But Tesla continues to spout the bull, and truculently at that:

“Regardless of whatever misinformation critics happen to be pushing this week, we are building the world’s first vertically-integrated sustainable energy company, and solar is an important part of that effort,” Tesla said in a statement. “Far from being a cash burden for Tesla, our solar business was actually cash flow positive in 2017, and we expect that trend to continue in 2018.”

Who you gonna believe, Tesla or your lyin’ eyes?

Although Tesla is downsizing its solar business dramatically, legacy contracts and obligations still pose a threat to the merged company.  Elon kicked the can, but it still exists.

The other example is Musk’s earlier promise to revolutionize manufacturing, by almost completely automating the production of the Model 3.   This failed utterly–as even Musk was forced to admit when he conceded that the company was in “manufacturing hell” and that he had underestimated the challenges of automation.

What he had done, in fact, was ignore the experience of the entire automobile industry, which had found decades ago through bitter trial and (mostly) error that automating assembly was impractical.  That experience showed that auto assembly is a tightly coupled process, and that a glitch anywhere in the process can cause cascading failure.  Further, it learned that greater automation exacerbated the tight coupling problem, and greatly increased the risk of such failure cascades.

But Elon knew better.  Until he found out otherwise.

Yet despite earlier expressions of humility about the automation effort, in his crazed earnings call yesterday, Elon doubled down on automation promises, pledging that the Model Y will represent a “manufacturing revolution.”  Further, he promised that this revolution would be televised in 2020–but with no capex until 2019! New model, new assembly process, new plant and equipment, all completed within a year-plus.  Even established manufacturers take years to complete the construction of facilities to build relatively conventional vehicles.

The earnings call may be a watershed–an inflection point.  Musk faced the first serious skepticism from the analyst community, and he did not handle it well.  To put it mildly.  He had what to me appears to be a meltdown at the withdrawal of his narcissistic supply.

As a result, there is widespread shock on Wall Street, and even die-hard boosters (e.g., Adam Jonas of Morgan Stanley) are clearly shaken by Musk’s performance.

This is incredibly important because the only thing that has sustained Tesla through its incessant cash burn is the willingness of the markets to fund him by buying his stocks and bonds on the basis of faith in his reputation as a visionary (the same reputation that compelled the acquisition of Solar City).  That was Tesla’s primary asset–arguably its only asset.  If that Wizard of Oz aura is removed, it is hard to see how Tesla survives.  It still needs massive amounts of cash to implement its existing promises.  It has tapped many fragile sources of funding–customer deposits, and especially, credit from suppliers who wait months to get paid–but still depends on issuing equity and debt to stay afloat.  Doubts about Musk’s competence–and arguably, his sanity–clearly jeopardize Tesla’s ability to do that.

Skepticism will also cause people to revisit Musk’s previous promises, which are almost too long to list, let alone discuss in detail.  Solar roof panels? A national charging network? Autonomous driving technology? A $35K Model 3? Semis? And on and on.

There is also the serious risk that the SEC will start to revisit those promises–AKA “forward looking statements.”  How big does N have to get until the failure to deliver on N out of N promises constitutes securities fraud?

Then there is the issue of looming competition from companies that actually know how to make automobiles.  I also find it bizarre that Tesla’s fate supposedly rests on its ability to build in volume a type of vehicle–sedans–that buyers are shunning to such an extent that established companies are fleeing the space because of low margins.  (The strong preference of American drivers for SUVs and trucks casts doubt on the supposed EV revolution more generally.)

Where do things go from here?  I am obviously bearish, but predicting timing is devilish hard in these circumstances.  The timing of a jump from a high-trust to a no-trust equilibrium is very hard to predict, but these recent events have definitely increased the probability of such a jump.

Perhaps Musk’s hole card is the fact that he owes banks hundreds of millions, collateralized by Tesla stock.  Remember the old joke about if you owe the bank $500K and you can’t pay, you have a problem, but if you owe the bank $500 mil and you can’t pay, the bank has a problem?  Well, that’s a fair summary of the situation facing Goldman, et al.  They have an incentive to prop up the stock price, or at the very least, not to become very public doubters.

Perhaps it is too early to say it is the beginning of the end for Tesla and Musk (but perhaps not).  It is clear, however, that this is the end of the beginning because it is the end of the affair.