The Worst Is yet to Come for Elon Musk | Opinion

Tesla CEO Elon Musk, a real-life Tony Stark, has revolutionized electric cars, solar roofs and reusable space rockets. Musk's irreverent playboy style, bold proclamations, ability to cut through red tape, and flare for the dramatic have made it hard not to cheer for him over the years. However, like other visionaries with egos and hubris that outpace their stratospheric IQs, Musk appears way over his skis in his quest to please his investors.

History has shown that inventors of revolutionary products are often not the ones who make the actual profits from their world-changing ideas. Nikola Tesla, Musk's company's namesake, died broke. Similarly, Westinghouse and GE made fortunes off the light bulb and electrifying America, not Thomas Edison. And Howard Hughes, despite being extraordinarily wealthy from his family's tool business, went mad as he created a string of misadventures in aviation, Las Vegas and Hollywood.

Tesla has never earned an annual profit in nearly two decades of existence, yet its shares are valued more than Ford, Chrysler and General Motors combined. This valuation makes Musk's stake in Tesla worth nearly $30 billion despite the company selling just a fraction of the cars sold by its American competitors. Such a high net worth has not diminished Musk's ambition, as he is known for sleeping on production lines and issuing tyrant-like demands of his employees. Musk is under constant pressure to exceed quarterly Wall Street estimates, as Audi, Porsche and other competitors are catching up to Tesla on the electric vehicle front. An even greater source of stress, according to Musk himself, has been short-sellers—investors (such as this author) who bet that Tesla's shares will lose value.

Musk's lofty promises of futuristic Tesla Semis, Cybertrucks, solar shingles, and robotaxis have kept the public's focus off the company's poor bottom line, deteriorating balance sheet and constant need for fresh cash. In signs of internal distress, Tesla has stretched out payments to its suppliers, raised equity cash immediately after saying they had no need, recently threatened not to pay its showroom rents and desperately defied California lockdown orders to squeeze in a few extra days of auto production. Tesla is expected to burn a staggering $2-$4 billion this quarter alone as sales are expected to collapse up to 80%, according to Morgan Stanley.

As car sales plummet for all automotive manufacturers, one wonders if the growing haze around Tesla's accounting might finally catch up to Mr. Musk. While no hard evidence exists that Tesla is the next Enron or WorldCom, famed fund manager David Einhorn (who called the Lehman Brothers collapse) recently wrote an open letter to Musk requesting evidence that Tesla's receivables are not, in fact, fabricated. Besides mocking Einhorn, Musk curiously has still not answered the question.

Accounts receivable are essentially IOUs from customers who promise to pay for already-received goods—in this case, mainly Tesla cars. Surging accounts receivable relative to total sales has often been an early indicator of companies reporting questionable sales just before a financial period ends. In 2018, Tesla's accounts receivable surged with little explanation. This puzzled analysts because auto dealers—and Tesla acts as its own dealer—are usually paid in cash for cars sold immediately by the customer or a car financing company. Hence, big auto dealers don't sport large accounts receivable relative to sales, yet suddenly Tesla did. Tesla, when repeatedly pressed, said it had to do with a calendar quarter ending on a weekend, yet the big receivables balances have not corrected themselves as expected. Tesla later offered up a confusing explanation that the jump in receivables was due to strong Model 3 European sales and slow payments from financing banks there. Again, this explanation didn't seem to line up, as the spike in receivables predated the Model 3 introduction in Europe.

Selling tradable regulatory credits is another accounting well that Tesla seems to frequently tap. Specifically, Tesla receives credits it can then sell for cash from the state of California and other governmental agencies for selling certain quantities of its electric vehicles. Tesla has significant discretion as to when it can recognize these credits on its income statement. Much like IBM and some of the other famous earnings "smoothers," Tesla shows the occasional quarterly profit from time to time by selling these credits. But, as other automakers increase their electric vehicle production, they should have far less need for emission credits—which could spell bad news for Tesla. These government subsidies are, by far, Tesla's biggest source of profit.

On the expense side of the ledger, Tesla has been systematically lowering its warranty reserve per car sold. Critics point out that this has the effect of inflating profits by provisioning insufficient funds for future warranty claims each car is modeled to have over its life. As reports of deteriorating production quality continue to mushroom, Tesla ought not to be decreasing its warranty reserve per car.

Elon Musk's most recent invention may be how to operate two car factories cheaper than one. Lost amidst the fanfare of Tesla's recently opened massive factory in Shanghai (their main car plant is in Fremont, California) was the company's sequential decline of total depreciation expense last quarter. Legendary short-seller and frequent Tesla critic, Jim Chanos, commented "declining [operating expenses] with another factory open is of course, ridiculous." For those who don't remember, Chanos was an early critic of Enron and has a phenomenal record of ferreting out fraud over the last four decades.

Is Tesla engaging in accounting fraud? The Securities and Exchange Commission charged Mr. Musk with fraud in 2018, but that was related to his infamous $420 "funding secured" tweet. If Tesla is cooking the books, it would be the financial scandal of the decade. One interesting tea leaf has been the revolving door of C-suite executives, especially key legal and accounting people, who all left substantial money on the table to quickly get out of Tesla. Some were only there for a matter of weeks. Why would so many people in the accounting and legal departments quickly exit after learning about Tesla's financial and business practices under Musk?

Perhaps another clue was the shocking announcement last month that Elon Musk personally wrote his directors their D&O (directors and officers) insurance policies out of his own pocket. One is left to wonder if traditional D&O insurers either wouldn't insure Tesla's board due to Musk's erratic behavior, or would only do so at such a high price that Musk preferred the horrible optics of him personally underwriting the insurance and potentially tainting the independence of all of Tesla's directors. This is the epitome of a red flag and is almost never seen among public companies.

The exhausting effort of spinning Tesla's subpar numbers also seems to be weighing on Mr. Musk. Musk, who owns 20% of the company, has pledged nearly half his stock as collateral for personal loans. Should Tesla's stock sell off, it could trigger a death spiral of forced margin selling just as with Bernie Ebbers and WorldCom. This also raises the question of why Musk recently tweeted that Tesla's stock price is too high.

In 2018, Musk told The New York Times that "from a personal pain standpoint, the worst is yet to come." As expectations for Tesla crank up over the coming quarters along with increased accounting scrutiny, one wonders if Musk's words were prophetic.

Todd J. Stein is a Dallas-based investment manager.

The views expressed in this article are the writer's own.