Tesla: Burry’s next big short

When Michael Burry – famed for profiting handsomely from the 2008 subprime mortgage crisis – makes a big call, investors tend to listen. Especially if he is selling something short. That’s why markets are rippling with chatter following the publication of his hedge fund’s latest quarterly filing with the US Securities and Exchange Commission (SEC): Scion Asset Management has purchased put options on 800,100 Tesla (US:TSLA) shares worth over half a billion dollars.

Scion’s Tesla short shouldn’t come as a surprise – Burry has long expressed unease at the way the company makes money and is being managed. But the size of the position is interesting. At $534m (£377m), the Tesla put options are Scion’s biggest single holding, accounting for roughly 40 per cent of the fund’s portfolio.

Burry isn’t the first hedge fund manager to short Tesla. The electric vehicle (EV) manufacturer’s shares have been on the wrong side of industry demand repeatedly over the last few years – and fund managers have paid dearly for their negativity. According to S3 Partners, Tesla’s surging share price cost short sellers over $38bn in 2020.

But this time might be different. Burry has taken out his put options at a time when Tesla is facing two fundamental challenges to its enduring success – questions over its green credentials, and the legitimacy of its driverless vehicle claims. Both could pose problems that even Elon Musk’s celebrity cannot explain away. Add that to the general market unease which has spiked since inflation fears began to take hold in the US, and there are reasons to think that short might be the best position for Tesla investors.

Carbon credits: not a legitimate business model

Tesla’s battery efficiency has taken the world by storm. At a time when global governments are setting ambitious climate targets, the average lifetime emissions of a US grid-charged Tesla Model 3 – which is produced out of the company’s Fremont factory in California – look very attractive. According to the company’s 2019 Impact Report, Model 3’s produce around 180 grams (g) of carbon dioxide (CO₂) per mile in the US, while the average mid-sized premium internal combustion engine produces just under 500g per mile.

For car enthusiasts who want to protect the planet without compromising on style, the Model 3 has been a solid choice. In 2020, Tesla sold around 455,000 of these cars, up from 442,500 in the previous year thanks to strong demand in the UK, US, Germany and China. The flashier Model S – which accelerates from 0 to 60mph faster than a Porsche 911 – is also proving popular in these markets.

But Tesla’s Asian expansion is blurring its environmental credentials. Just over a fifth of the company’s revenue came from China in 2020, where electricity is still largely powered by coal. This means that a Model 3 produced in the new Shanghai ‘gigafactory’ and sold in China is not nearly as green as its US counterpart.

Add that to the furore around Tesla’s $1.5bn investment in bitcoin, and it is no wonder that the green energy credentials which have boosted the company’s popularity among investors are being called into question. Estimates vary, but according to cryptocurrency expert Danny Bradbury, it takes 72 terawatts (TW) of power to mine one bitcoin. Assuming Tesla’s $1.5bn investment bought 40,000 bitcoins back in January, the mining efforts used nearly 3m TW of power – that’s a frightening statistic when put in the context of Elon Musk’s green energy efforts. At Tesla’s ‘Battery Day’ last September, Musk said that his company was aiming to manufacture 3TW hours (TWh) of battery capacity by 2030.

But it’s not Tesla’s waning green focus which worries Burry; it is how the company makes money from it. Last year, $1.58bn of Tesla’s $31.5bn of revenues came from selling carbon credits to fellow vehicle manufacturers. These credits are awarded to companies that undershoot their carbon emissions targets for the year and can be sold to their gas-guzzling peers at a profit margin of 100 per cent. Tesla’s credits therefore contributed a large proportion of its $2bn operating profit in 2020 and the company would not have generated a statutory net profit without them.

But the longevity of these credit sales is now being questioned as Tesla’s competitors pick up the pace in EV production. Volkswagen (VOW3), for example, launched a new fleet of EVs in 2020, which are already outselling Tesla in Europe’s greenest markets.

Europe had been a comforting source of carbon credit sales for Tesla thanks to stiff emissions rules, which state that the average emissions of automakers’ new car fleets in the EU should not exceed 95g of CO₂ per kilometre. But it is growing gradually less attractive. Rivals including Ford (US:F) and Volvo have teamed up to hit these climate targets, while Fiat Chrysler’s merger with Peugeot’s emissions-compliant owner PSA means that it will no longer need to lean on Tesla for support.

Richard Palmer, the chief financial officer of the newly-formed group known as Stellantis (US:STLA), recently said that about two-thirds of Fiat Chrysler’s €300m (£260m) credit expenditure in 2020 went to Tesla in Europe. That means that it accounted for about 16 per cent of Tesla’s carbon credit revenue last year. Without that contribution, Tesla’s 2021 numbers might not be so attractive.

Automotive profits: delusional 

Tesla's second big investment hook lies in automation. Musk – and other Tesla bulls – think that the autonomous capabilities of future Tesla software will help justify the company’s exorbitant valuation because (they claim) the technology can be sold for pure profit.

At the company’s annual results call in January, Musk boasted about the profit generating capacity of driverless cars, envisaging a world where Tesla ‘robotaxis’ spend a lot more time on the road.

“[L]et's just assume that the car becomes twice as useful,” he said of fully autonomous vehicles. “[I]f you made $50bn-worth of cars, it will be like having $50bn of incremental profit basically from that because it's just software.”

Tesla’s vehicle sales are expected to increase at an annual rate of more than 50 per cent between now and 2025, when Musk forecasts annual production of 20m vehicles. At that point, software upgrades might be available to turn these cars into robotaxis, thus providing an incremental increase to the company’s earnings generating capacity.

But these forecasts are nothing more than a pipedream. Automation doesn’t double the value of a Tesla. Cars’ selling prices are rarely determined by how often they will be used, and even well-established software isn’t sold at a 100 per cent margin. It is also hard to believe that Tesla’s driverless technology – whose role in a fatal accident in Texas is currently under investigation – will be ready for use in robotaxis by 2025. With safety advocates campaigning for more discerning federal standards for driverless technology in the US, regulation might yet unhinge Tesla’s autonomous ambitions.

And that is without even accounting for competition. Alphabet’s (US:GOOGL) Waymo has 20bn hours of real and virtual driverless miles under its belt, and has partnerships with many carmakers. Apple (US:AAPL) is also reportedly working on its own driverless vehicle, which could be powered by an Apple-designed battery. In December, Morgan Stanley’s Adam Jonas said that “Apple’s potential entry into autos represents perhaps the most credible/formidable bear case for Tesla’s stock that investors have had to consider for some time.”

The Big Short 

At $604, Tesla’s share price is some way from its January peak, but a $584bn valuation is still ludicrous for a company that has thus far only ever made a profit thanks to the sale of regulatory credits given to it by national governments. At the time of writing, investors deem Tesla more valuable than Ford, General Motors (US:GM), Nissan (JP:7201), Toyota (JP:7203) and Volkswagen put together. In 2020, these five carmakers sold 46m vehicles between them, while Tesla sold just under 500,000.

And even after taking into account net debt, Tesla’s valuation is inexplicable compared to its peers. The company’s enterprise value is 11.6 times its forecast sales and 115 times the number of vehicles sold in 2020. True, other car makers can’t match it for growth, but with rising competition in both the EV and autonomous space, Tesla is unlikely to dominate the future car industry in the way many investors have previously been expecting. Margins – driven by the software and battery technology – could be better than the industry average, although they won’t come near the figures dreamed up by Musk.

Tesla's valuation dwarfs its peers

Source: Factset

But Tesla’s enigmatic chief executive remains the biggest threat to Burry’s big short. Musk has a knack for moving his company’s share price, which has posed a problem in the past for short sellers who don’t have the capital to cover a surge. The next few months are likely to be an interesting ride for Scion Asset Management – one day it might be worth making a film from the story.