Good morning!
Let's see what the RNS feed has in store for us this morning:
- Minds Machines (LON:MMX) - trading update. Gross margin below expectations for FY 2018.
- Animalcare (LON:ANCR) - change of CEO to "big pharma" executive and H1 trading update. Delays to some new product launches.
- Warpaint London buys its USA distributor for between $2 million and $3 million
- The private equity backer of Luceco (LON:LUCE) has spent £2 million to buy back some of Luceco's depressed shares.
- Initial admission of Argo Blockchain (ARGO), a company created in December 2017 "to develop a global datacentre management business facilitating cryptocurrency Mining as a Service (MaaS)". £25 million was raised. If extreme leverage to the price of Bitcoin Gold, Ethereum, Ethereum Classic and Zcash is what you're looking for, look no further.
- S&U (LON:SUS) - trading update for the period from 18 May to 31 July. Sounds reassuring but the company does not refer to performance vs. expectations.
- Keywords Studios (LON:KWS) - H1 trading update. All in line with expectations despite a severe currency headwind. A good achievement.
- Pets at Home (LON:PETS) - Q1 trading update. Good like-for-like revenue growth. Addressing the challenge of a shortage of vets. This is the most heavily shorted stock on the LSE right now.
Ranger Direct Lending Fund (LON:RDL)
(Please note that I currently hold RDL shares)
Princeton and Portfolio Update - some promising news from this lending fund which is currently in wind-down. One of its major investments, which has caused it so much of a headache, is making progress through the bankruptcy courts.
There has been a preliminary award for a net amount of almost $31 million in favour of Ranger and another fund managed by the same investment manager.
Will it pay, and how much will Ranger get? I don't know. Ranger says:
The Company is unable at this time to determine whether Princeton's assets are sufficient to pay the entire judgment.
I have managed to find a court document and this shows (to the best of my understanding - I'm not a lawyer) that Princeton claims to have assets of between $50 million - $100 million, versus liabilities of $1 million - $10 million.
If we could write the value of the Princeton investment back up to around $30 million, which it is currently in the books for, then I think that Ranger's NAV per share is c. 1012p at latest exchange rates. Without any boost from Princeton, it is more like 869p.
In any case, I am happy to hold at the latest share price of 801p and am thinking about adding more.
Tesla (US:TSLA)
- Share price: $349.54 (+16%)
- No. of shares: 170 million
- Market cap: $59,350 million
Apologies that this is off-topic but I honestly think it's one of the most interesting stories right now. It's important to write about the stories which I am personally interested in, because otherwise I will run out of steam!
Those of you who follow me on Twitter will have seen that I posted a bearish graphic in advance of this Q2 update from Tesla. The shares went on to rally by 16%, so I'm glad that I didn't have a short position!
Short interest in Tesla was last reported at 34.7 million shares. That's 20% of the entire company, or about 25% of the free float when you exclude the shares owned by Elon Musk. In terms of dollar amount, I think this is the biggest outstanding short position in the US (and therefore in the world).
That is one of the main reasons I've been hesitating to short Tesla myself. I would be terrified of a short squeeze. Imagine if nearly 35 million shares needed to be bought back in a hurry - it would be financial meltdown for the bears.
We don't need to look back very far in history to see a similar example. In 2008, Volkswagen shares multiplied by almost 5x in two days and caused $30 billion of financial destruction to hedge funds. Porsche, a buyer of VW shares, was thought by some to have orchestrated this event, but hedge funds failed in all of their legal actions to prove that.
In the same way that Porsche had little sympathy for the VW shorters, I suspect that Elon Musk would have little sympathy for Tesla shorters if a similar accident were to befall them.
Based on a $49 move in the share price, Tesla shorters are now collectively approx. $1.6 billion poorer than they were prior to the Q2 update (although some of them are likely to have closed their positions).
The update
I don't listen to a lot of company conference calls, but I enjoy Tesla's.
Musk comes across as extraordinarily passionate, as you would expect. He is of course the driving force behind the company, for example in the same way that Steve Jobs was the driving force behind Apple for so many years.
Passion is not the same thing as polish, of course. Investors in Tesla don't care about this, but you could tell from his opening remarks that his brain was going in a million different directions at once, and that he was struggling with fatigue. I recorded the following quote:
“And eh yeah, em, yeah. Sorry if I sound a little tired, I’ve been working like crazy in the bodyshop lately.”
This theme of "tired Elon" would be repeated when it came time to apologise for his previous rudeness to analysts. His explanation for that behaviour? He'd had no sleep and had been working 110-120 hour weeks.
Before we get into the numbers, doesn't that seem possibly a bit extreme? As an investor, do you really want your CEO to have no sleep and to work 17-hour days? I would have thought no, that it's better to go at a sustainable pace. But then I'm not a billionaire, and Elon Musk is. So he is clearly doing something right.
As for the cars and the outlook, this was an encouraging update on a couple of fronts. Tesla managed to produce c. 7,000 cars during the final week of June, of which c. 5,000 were the new Model 3.
For July, Model 3 was the most popular premium sedan in the US, outselling all other cars in that category combined.
Producing 7,000 cars per week from now on (and Musk wants to get to 10,000 soon), he said that Tesla would be "sustainably profitable from Q3 onwards".
This was a bold claim. He said that "assuming the economy is reasonably good", in the absence of any force majeure type of event, and excluding the effect of loan repayments, Tesla would be profitable and cash flow positive for every quarter from now on.
It would be an awesome achievement if this turned out to be true.
In addition to this, Musk claimed that Tesla had no plan to raise fresh equity at any point. Loans from local Chinese banks will be used to build a factory in Shanghai, and other loans will be paid off with internally generated cash flow.
Do I believe it? No. I don't want to bet against this happening, but I will have to see it to believe it.
The numbers
These are some ugly numbers for Q2.
The loss from operations increased to $621 million and the company made a loss even if you add back R&D expenses and restructuring costs (these include the costs of Tesla's many staff redundancies).
The number of Model 3's produced in Q3 should be 50,000-55,000, close to doubling, and Tesla is betting that profitability will take off with the benefits of operational leverage and efficiencies from making better use of the existing production lines.
The capex budget has been slashed, however, and bears will suspect that this has something to do with Tesla's dwindling balance sheet strength.
Let's first consider working capital. Compared to December 2017, current assets are up slightly to $6.7 billion, although within that about $1 billion of cash has been converted into inventories. $2.2 billion of cash is left.
On the other side, current liabilities are up by $1.5 billion to $9.1 billion, with very large increases in accounts payable and current debt.
That gives us a current ratio of only 0.73, indicating the potential for stress in relation to short-term assets.
I understand that thanks to terms of payments with suppliers (60 days), Tesla will enjoy some headroom as it ramps up manufacturing and sells more Model 3's in Q3. But I would still feel a bit queasy about that working capital situation.
In terms of long-term assets and liabilities, Tesla has about $11 billion in PPE, $6 billion in solar energy systems, and $9.5 billion in long-term debt and leases.
Tesla's 2025 junk bonds, issued last year, are currently yielding around 7%. That's a higher yield than your typical junk bond, and higher than the yield they were issued at, but it's not critical. It says that bond investors are still reasonably confident that they will get paid back.
My view
If you haven't guessed already, I remain firmly in the bear camp as far as Tesla is concerned.
The market cap of $59 billion makes little sense to me for a heavily leveraged manufacturer with balance sheet equity of just $4 billion. It is forecast to make a very small net profit next year on sales of less than half its market cap. Federal tax credits will be ending soon, and competition against the Model 3 is about to heat up.
However, I have no plans to short it yet.
Something else I've been reading is David Einhorn's latest letter to shareholders from Greenlight Capital. In case you haven't heard of him, Einhorn is one of the biggest names in value-oriented hedge fund investing.
Einhorn and his team have in fact been getting crushed since around 2015. Among other mistakes, they have been hurt betting against what he has referred to as the "bubble basket".
This basket includes the stock market darlings Netflix (NFLX), Amazon (AMZN) and Tesla (TSLA).
Their longs haven't done particularly well, either, but their shorts have done most of the damage.
It just goes to show how difficult short-selling is, and why it might be best avoided entirely for most of us.
I'm calling that a wrap for the week. Have a great weekend!
Graham
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