The degree to which Elon Musk manipulates GAAP accounting in awe-inspiring. That the various regulators in charge of protecting investors allow Musk to commit accounting fraud is shocking.
Note: The commentary below is an excerpt from the latest issue of the Short Seller’s Journal. It’s based on Tesla’s earnings press release. In the next issue I’ll layout the facts about Tesla’s numbers based on a close-reading of the 10-Q which was filed Tuesday.
Tesla both shocked and awed short-sellers with its earnings report. The financials Musk presented to the public were produced from a contorted interpretation of GAAP accounting standards which stretch beyond legality. Any analyst with an intermediate level understanding of accounting can quickly see through the skeletons beneath what can only be described as a financial report awkwardly fit with a Halloween costume. This probably explains why Elon Musk and the CFO did not sign the quarterly letter for the first time ever.
From what has been made available in the earnings release, Musk has outdone all of his previous works of artistic accounting with his latest masterpiece in an attempt to deflect attention from declining revenues and cover-up poor earnings. On a YoY basis for Q3, total revenues declined 7.6%, with automotive sales revenues down 12.7%, with revenues in the U.S. down a shocking 39%. The difference in total vs automotive sales is predominantly revenues derived from services.
Tesla’s gross profit fell 22%, operating profit plunged 37% and net income free-fell 54%. Of the $143 million of reported net income, $107 million was Government subsidies in the form of environmental credits that Tesla sells to the large OEM’s who need to buy them to remain in compliance with environmental regulations (auto manufacturers are required to produce a certain percentage of zero-emission vehicles; if they do not meet the test, they can buy ZEV credits from companies like Tesla which generate a surplus of these credits). But the ZEV sales will eventually disappear as the large OEMs ramp up their line of EVs.
Some portion of the revenues was the recognition of deferred revenues. Deferred revenues occur when a company sells a product for which the complete product is not delivered but which is paid for up-front by the end user. Typically companies that derive revenues on a contractual basis have deferred revenues.
Tesla’s source of deferred revenues includes features like auto-pilot,smart summons and supercharger access which are sold up-front but available only a limited basis or not yet available. Deferred revenues are set-up as a liability on the balance sheet and amortized into revenues. When recognized, deferred revenues are non-cash because payment from the customer was received at the time of the sale. The amount of deferred revenue recognized, for the most part, flows through the income statement to the bottom line.
In June Tesla said it planned to recognize about $500 million in deferred revenue over the next 12 months, which means Q3’s income statement contained at least $100 million in non-cash deferred revenues. The amount of deferred revenue in any given quarter shows up in the cash flow statement as a source of cash. The cash flow statement in the earnings letter did not have deferred revenues as a line-item in the cash flow statement but there should be a disclosure of the amount amortized into revenue in the 10-Q when it’s released.
The bottom line is that Tesla recognized some portion of deferred revenues in the revenue line, which means that gross profit, operating profit and net income are overstated by the amount of deferred revenues that was used in Q3’s revenue number.
There several more highly problematic aspects to Tesla’s Q3 financials. The 10-Q will help shine light on most of the areas in which Musk and his financial goons impose the questionable interpretations of GAAP standards on s financials.
Why did the stock jump $73 in two days? Revenues missed Wall Street analyst estimates. Margins were lower than expected. Net income smashed estimates. The net income “beat” expectations because the degree to which Elon Musk is willing to commit accounting fraud is unpredictable. It certainly can’t be modeled into an analyst spreadsheet.
I believe the move in Tesla’s stock was an orchestrated short-squeeze in conjunction with rabid momentum-chasing by daytraders and hedge fund algos. Let me explain first by sharing this tweet from Charles Gasparino (Fox News business reporter): “Senior management tell bankers they have the short sellers where they want them (on the ropes) with the latest financials.”
Assuming that’s true, and I’m 99.5% certain that it is, it shows that targeting short-sellers is one of Musk’s primary agendas. Reading between the lines, it implies that Tesla manipulated the financials specifically to cause a short-squeeze. I also believe that Musk orchestrated the short-squeeze in conjunction with a couple of Wall St banks, likely Goldman and Morgan Stanley, both of which have significant financial exposure to Tesla stock and to Musk’s personal financial health.
How to orchestrate a short squeeze. Keep in mind when you short shares, your brokerage firm borrows shares from funds which make shares available to borrow. They do this because they can earn interest on the shares loaned. In the case of stocks with a high short interest like the TSLA, the stock loan rate can be double digits.
Goldman and Morgan Stanley would contact a few of the large “friendly” fund shareholders and ask them to recall the shares they have loaned out. If they agree, their back office contacts the back office of the hedge fund or broker-dealer to whom the shares are loaned and asks for the shares back (a “recall”). No reason has to be given. The entity being asked to return the borrowed shares either has to find a new source from which to borrow shares or buy back the shares in the open market to return them.
Keep in mind that, outside of Musk and his circle of friendly shareholders (Larry Ellison, Bailey Gifford, etc), the true free-float of Tesla shares is maybe 30% of the shares. A lot of those shares are borrowed and shorted as a hedge against Tesla’s outstanding convertible bonds.
In the case of a large short-seller, like Greenlight Capital (Steven Einhorn) or Kynikos Partners (Jim Chanos), it might be difficult to find a source from which to borrow the amount of shares being recalled. In that situation, the short-seller has three days to find and return the shares borrowed. It’s likely that large short-sellers were forced to cover part of their short position and then look for a new source of borrow to re-establish the short. In a situation like this, the stock can be driven up sharply in a short period of time.
The move made by Tesla’s shares on Thursday and Friday is similar to the short-squeezes that occurred during the internet bubble. Most of those internet stocks were very obviously highly overvalued and were aggressively shorted. The slightest positive news headline would cause the stocks to move 20 to 30 percent in a couple days from a short-squeeze despite the obvious superficiality of the news reported. Goldman and Morgan Stanley were two of the largest Wall Street promoters of internet stocks.
There’s no telling when the short-squeeze will subside but I think it might be running out of steam. The stock is now – per the RSI – more overbought than it was when it squeezed higher after the “funding secured” tweet by Musk. The stock dropped $120 in 20 trading days after that.