Robert Leonard  1:49

How would you describe yourself as an investor? Are you value oriented? Are you a growth investor? Do you weigh heavily on ETFs, dividend type stocks or are you just more active in the market?

John Engle  2:01

I have a fairly idiosyncratic investing philosophy because I think value investing ultimately is the you call it the correct way to invest in the sense that it is focused on actually trying to find companies that are genuinely undervalued that are earning money, and that can return capital to investors.

However, I layer that with an understanding that we live in a world where capital markets are very much focused on the future, the idea of growth stocks, and just growth, economic growth disruption are all factors that have to be incorporated into an investment thesis into an investment philosophy.

I think of myself as a value investor, who’s also a realist about the way the market works, which is fundamentally not value oriented, and hasn’t been for the last 20 years or so.

Robert Leonard  2:52

Yeah, especially over the last decade through the last bull market, the value investors have kind of gotten crushed, specifically related to growth and just the market overall.

John Engle  3:01

Traditional value investors like Benjamin Graham-style looking for cheap companies that are earning it, those that have not… There hasn’t been a particularly effective investing strategy by comparison to sort of momentum and growth stock strategy over the last decade, which is understandable based on a lot of the underlying drivers that have been fueling this bull market since 2008. Everything from monetary policy to the way the market has oriented towards a technology and disruption focused attitude.

Robert Leonard  3:37

Yeah, less focus on book value more on goodwill and things that are intangible and subjective in nature, qualitative.

But I mean, there’s always periods of time, at least in history where different strategies have done well over periods of time. So value could come back into grace.

You are very active on Seeking Alpha regarding Elon Musk’s companies like Tesla, SpaceX, and previously Solar City, Tesla, which is ticker TSLA. It is often considered a polarizing stock. I haven’t had someone on the show to talk about it yet. So I’d like to spend some time covering it. Most people listening probably know who Elon Musk is, and what Tesla is. But for those who don’t know, who is Elon Musk and what is Tesla?

John Engle  4:22

I agree that is highly polarizing but Elon Musk is an entrepreneur, originally South African naturalized American citizen who has spent his life in the tech world and Silicon Valley world, but has tried to move the focus from software to basically heavy industries.

So I doubt many people are unfamiliar with Tesla as a company, at least on the surface level, which is basically one of the first pure play electric car companies in the world and in America in particular. Its focus is originally luxury but has been trying to move towards the mid market similar to other automakers.

Basically, Elon Musk is the sort of modern day attempt at innovating a future of sustainable energy that is how he portrays himself and the way he’s portrayed in the media.

He has electric cars in the form of Tesla. He’s involved in the space economy through another company that he founded called SpaceX, which originally focused on satellite satellite launch and sort of rocket payload launching into space on behalf principally of governments and NASA, but is venturing towards sort of manned spaceflight.

He used to be the chairman of another company called Solar City, which had been founded and led by his cousin. That company was then due to essentially imminent insolvency absorbed by Tesla. He’s also ventured into a couple other spaces, including a neuroscience company called Neuro Link, which claims to be seeking a way to integrate human brains and machines.

Robert Leonard  6:07

Why would Elon Musk want to acquire a company like SolarCity who’s on the verge of insolvency?

John Engle  6:14

That is an excellent question and one is actually going to be discussed in the Delaware Court of Chancery, which is the most important court in terms of corporate and securities law in the US. It’s why most companies are incorporated in Delaware, is because they have a much deeper and more rigorous and larger case law involving corporate law.

There are few reasons from an objective standpoint, why any company would buy out at a premium, another company that is functionally insolvent. So the question is why would someone do that?

The explanation given by Tesla, as a company and by Elon Musk, as its CEO, and chairman, was that Solar City, a solar panel installer for people who don’t know, would be synergistic in that Tesla was apparently devising a solar roof product, basically a solar roof solar panel, that would essentially not just be a panel attached to the roof, but instead replace the roof, whereas sort of individual solar unit shingles.

The explanation was that Solar City’s large footprint for installing these things would be beneficial towards installing the solar rings.

The problem with that, as it emerged, was that the solar roof product didn’t actually exist at all. It’s only just recently entered a phase where they’re actually installing it commercially, four years after the merger.

So the question is, why would someone choose to do that? The answer partly lies in the fact that all of Musk’s companies are sort of interconnected. So you had Solar City which issued a bunch of bonds in 2015, which Musk’s other companies then bought, and so those companies would have lost money on it, if Solar City went under.

But more importantly, and this is entering into more opinion, is that if Solar City, which was attached to the Musk brand, which is attached to his personal brand of but sort of futurism and sort of advancing technology, if it went under, it would have tainted his reputation in a way that could have compromised his other companies.

So it is the opinion of the plaintiffs in the lawsuit and the opinion of many other observers that the reason wasn’t so much economic as face saving, and an attempt to preserve his personal image and the broader empire of companies that he runs.

Robert Leonard  8:50

This might be a simple question, but who is the plaintiff? I mean, if Elon Musk and it’s a public company, so I’m assuming because the shareholders but who is essentially taking this company or Elon Musk to court, because I’m assuming the US government isn’t just saying, “Hey, we’re going after Elon Musk and Tesla” without any type of plaintiff bringing it to light. So who is the plaintiff in this case?

It’s a class action lawsuit. So it’s a class of Tesla shareholders who opposed the merger, because Musk essentially has effective control in a corporate law sense of Tesla. He has the ability to basically do whatever he wants.

John Engle  9:29

So a group of minority shareholders is suing him on the basis that didn’t sort of show the merger was not in fact, a merger, but rather a bailout of his cousins and of himself as a significant investor and stockholder in Solar city. So the actual plaintiffs are at least were when they at the time of the merger, shareholders of Tesla.

Robert Leonard  9:52

And so, where do you generally tend to fall on the bear or the bull side of Tesla overall?

John Engle  9:58

Like fundamentally, very bearish in the sense that even if Tesla succeeds in everything that it wants to do in the sense of moving people towards battery electric vehicles, it is already valued at more than GM and Ford combined companies that are producing millions of cars a year.

Tesla reached 1 million total cars produced this week, they multiplied as in Ford and GM each produce multiple times that number of cars profitably every year, whereas Tesla has yet to be profitable in any year.

Robert Leonard  10:35

So what is the other side of the coin saying, what is the bull side of PESA? What did they like about the company?

There’s a couple aspects. So first and foremost, it’s the momentum. I think of the last of this decade of technological disruption, where people imagine a world in which because individually, a single company can take over an aspect of the sort of software stack and become the monopolistic player in that. That kind of business model can be replicated in other industries.

John Engle  11:09

That’s just been fundamentally proven false, like time and time again. In the case of automakers it’s always been a highly competitive business. More importantly, it’s an extremely capital intensive business, or the margins are difficult. So it’s basically a dichotomy between people who understand the auto industry and people who come from a tech background.

Also, the problem is that a lot of the narrative that’s created around companies and stocks is created by the people who are more media and tech savvy, so you end up with a story that often diverges meaningfully from the economic realities that are in play.

Tesla opened a factory in China and there’s talk like they’re working towards opening one in Germany, but they would need to open 678 more factories before they’re going to be at the sort of production capacity on board. You’re talking 10s of billions of dollars of capital expenditure, which aren’t being appreciated. You’re talking about a cyclical industry that is the automaker industry that isn’t being priced in this sort of taste of a bear market that we’ve been getting over the last few days… is the warning sign about companies like Tesla that are radically overvalued, based on their economic fundamentals.

In addition, even the most ambitious, sort of forward looking view… And part of that valuation comes from beyond like just the production of cars.

Let’s talk about their focus on autonomous vehicles, right? That’s the sort of the other side of the Tesla coin. Again, with autopilot, you’re getting a few different things going on.

People talk about Tesla’s being able to drive themselves. The National Transportation Safety Board made it abundantly clear in their most recent meeting that not only is the name autopilot extremely misleading, but the way that it operates is probably deleterious to consumers.

That’s like an issue that people are valuing the idea more than the company. People are imputing the notion that Tesla and that Elon Musk is a leader in this technology. When you look at the actual data, it’s not the case.

Robert Leonard  13:22

For an investor who knows a bit about investing in the markets, but just really hasn’t spent much time studying or falling Tesla, specifically, what are the most important things to know about Tesla as a potential investment opportunity?

John Engle  13:35

I think the most important thing to recognize is that like it is a company and a stock that is untethered from its economics. So whichever side of the trade you end up coming down on, it’s important to recognize that it isn’t being driven at least right now by those fundamentals.

If you’re going to take the long side, you can take the long side, but we have occasionally just the momentum. But if you’re looking at sort of a long term play, if you’re looking at a company that is the second most valuable automaker in the world, now, that is an enormous amount of growth that you’re going to need to grow into before your valuation, as it stands now, could be justified.

My principle suggestion to any investor, whether they believe that the future is better electric vehicles versus hybrids or hydrogen fuel cells, like whatever you believe about the auto industry, this is a company that has a lot of hope and a lot of expectation valued into it. Unless you are 100% committed to the idea that this is the company that is going to dominate the auto industry for the next 30 years, then its current share price cannot be a buy.

Robert Leonard  14:48

Do you think people are getting caught up in the idea of what the technology could potentially be or what autopilot could technically someday evolve into right?

I think some people who aren’t necessarily studying the fundamentals or who don’t have a background in finance or just accounting in general, they see Tesla as the “leader” in these vehicles that someday are going to take you from point A to point B without you ever touching the steering wheel.

Then of course, when you think about that, that’s just a massive idea. It could be worth multiples of what it is today. But when you actually bring that to reality into the fundamentals of the business, and try and extrapolate from where they are financially, today, to getting to that point, there’s a big disconnect, like you’ve said.

Do you think that’s where a lot of the valuation is coming from?

Partly, when you look at the autonomous vehicle space, there’s a few things that we need to unpack.

John Engle  15:38

First and foremost, is the fact that Tesla is not actually even in the lead, technologically, on autonomous vehicles. Google, specifically their subsidiary Waymo, has significantly more data miles driven.

So what you’ll hear a lot of the time, when people talk about Tesla’s advantage with autopilot, is that they have billions of my they claim billions of miles of driven data when that informs their AI, right?

If you ever watch a CNBC discussion of autopilot, and autonomous driving, that’s what comes up.

The problem with this thinking is that it’s thinking that just a bunch of raw data makes the more data makes a better neural net makes a better AI. This is not true because the issue with creating an autonomous driving system is not just having more data, being able to flag the issues that arise from it and being able to find patterns. The raw data that’s coming into Tesla is essentially unusable most of the time.

For example, if you own a Tesla, you can’t get an over the air update of your software package unless you’re on your Wi Fi. The reason for that is that Tesla won’t actually pay to have LTE for everywhere, because that would be onerously expensive.

So this data that they claim to be collecting isn’t even being collected in a way that can be then processed into meaningful results. That’s point one, is the idea that that Tesla, because it drives because there are more driven miles, but that has an advantage. There is no inherent advantage. In fact, there’s a demonstrable lack of advantage.

Moreover, their whole argument for autonomy basically ignores most of the technologies that are almost certainly going to be essential towards autonomy. So Tesla’s autopilot is based purely on cameras.

So it has cameras across the car that are able to pick up images and that recognition is what over time, they hope we’ll be able to create a genuinely autonomous vehicle, no other company, zero other companies, even ones that are pure play autonomous driving, have accepted that as correct.

Elon Musk is the only person who has said that cameras alone are the technologies that can facilitate autonomous driving. Everyone else is operating under the not just the assumption, but the like the rational conclusion that you require other inputs, including, for example, LiDAR, laser based viewing, because these are like the overlapping elements of the technology or the ability to see the world in multiple different ways is critical to a safe, autonomous driving program.

I think that one of the issues is that what Tesla essentially optimizes for the short term doesn’t think when it operates in a way that’s about long term sustainability is about creating a short term appearance of innovation that they end up paying for later.

Robert Leonard  18:30

As you talked about that, you mentioned that Waymo actually has more miles than Tesla. As someone who’s heavily invested in the stock market, but doesn’t necessarily follow this space so much, one of the questions that popped in my mind was how does Waymo have more miles than Tesla, with Tesla having so many cars on the road already, when, as far as I know, Waymo doesn’t have any?

Waymo has lots of test cars on the road? Let’s take a step back.

John Engle  18:55

So Tesla has more obviously tested the cars on autopilot to have more physical miles. The question is, how usable are those miles? Are those miles being driven and the data being compiled in a way and tagged in a way that can be used for creating better programs?

So it’s a question of is the data being collected in a way and then analyzed and tagged in a way that lets you improve the system? With Tesla, you have an enormous number of miles being driven. But because that data isn’t being transmitted to Tesla in a usable way, it’s essentially useless most of the time. That’s the problem. The conflation of a physical number of miles with usable integratable miles from an AI standpoint.

Robert Leonard  19:43

Yeah, that makes complete sense. So it’s not that Tesla’s cars have driven or “recorded” less miles than Waymo, it’s that a lot of those miles just aren’t useful in terms of improving data or integrating with their AI or any other type technologies that they have.

Whereas with Waymo everything is being tracked because they’re all test vehicles. So nearly every mile that they drive or test is useful data.

John Engle  20:06

Exactly. They’re using a much deeper and broader sensor suite, they’re pulling in significantly more data per mile driven.

Robert Leonard  20:15

So that makes sense. How do you see the competition between Wei, Mo and Tesla playing out over the next five years?

The autonomous vehicle space is going to be very weird, I think, because you’ve got so many companies investing so much money into the space. It’s difficult to know who’s going to win. The only thing we can be certain of is that Tesla is investing an order of magnitude less into autonomous vehicles than several other companies are and in this particular field, where it’s going to be an enormous amount of data analysis, it’s going to be the companies that invest a lot that will end up succeeding.

John Engle  20:50

So in the competition betweenWaymo and Tesla, I don’t think Tesla stands much of a chance. I don’t think Tesla stands much of a chance against even the likes of General Motors and their Cruise program, which, as an interesting point is like Softbank, you know the company that they make some weird bets, but they bet very much on the future. They bet on Cruise over Tesla.

Part of the reason for that is because Cruise, Waymo, Uber, Lyft, Aurora, every single other AV focus company is using different sensor suites, but especially LiDAR, like the laser guided night vision. The reason for that is because you’re going to need multiple sensors to be able to do this not only from a physically potential point of view, but also probably from a compliance and legal point of view.

It’s very unlikely that governments are going. Once autonomy is actually cracked it is almost certain that they’re going to require multiple sensor suites to function on that.

So the reason for the reasoning Tesla claims and like Elon has claimed that it’s unnecessary, but there are emails that have leaked discussions from their previous autonomous partners.

It shows that the reason why they’ve said that is because those other sensor suites are expensive. They basically couldn’t afford to have LiDAR in all their cars and also looked bad. So they decided to ignore it and pretend that they don’t even need it.

It’s bizarre to anyone who has not read deeply into it. Why would a company do that? And the reasoning is, as I said, it’s sort of a short term optimization. It’s like this bizarre attitude towards the way that happens. Almost every aspect of the Tesla business model functions in that way. It’s high performance, highly fragile, not very effective long term and requires significant replacements. That’s sort of almost all their products are like that.

Robert Leonard  22:47

Do you see there being a good chance that a company not named Waymo or Tesla actually wins this space?

Either. So it depends on what we mean by autonomous vehicles. This is taking another sort of like abstraction, that they… is that AI experts and AV experts have basically subdivided basically five levels of autonomy.

John Engle  23:10

Level five is where a car can do everything better than a person in any environment. Tesla and Elon Musk publicly claimed that that would happen a few months ago, whereas almost any credible expert will tell you that it is somewhere between 10 and 20 years from now that we will achieve that.

So I think that there are aspects to which the Tesla story has sort of mutated into like the way people perceive autonomy, and expect it much sooner than it’s going to come because it’s incredibly complicated.

What’s going to happen first is a lot more sort of geo fenced, set courses that autonomous vehicles are going to follow, you’re going to have them on their own dedicated lanes for years.

Maybe a decade from now, I’m a fairly optimistic person. I like to say a decade. pessimists say, 20 years and extreme pessimists say that we may never crack level five autonomy.

But I think within a decade, especially given just the egregious amount of money being spent on things that have a technology, that it will be achieved. When that happens, it’s unclear what the economic benefits will even be to the person who makes it, or the company that does it.

What is the business model they are going to use once you have autonomy? Will it be applicable across all vehicles? What will that mean to transportation? Those are questions that are unclear and yet to be answered, especially in light of issues, like ride sharing, have increased congestion, rather than decrease it in cities.

So you’re going to have a lot of really interesting civic discussions about sort of how we optimize infrastructure? Is it even worth it in certain safe spaces? So we’re talking about the future in a very sort of abstract way.

Robert Leonard  24:53

Yeah, I mean, that’s, again, I’ve mentioned this a couple times throughout the show, and which is one of the reasons why I’m so excited for this conversation. As I don’t study this space at all, I’m a complete beginner.

So I’m here learning with the audience completely from scratch. One of the things for me that just seems really out there for this whole autonomous vehicle concept is not even so much the vehicles. I have a feeling that people in technology, they’ll be able to come up with some way that these vehicles are able to do what they claim they can do, but the bigger concept is actually implementing them in the world, right? I mean, you have hundreds of 1000s of millions of regular cars out there, how are they going to interact with one another? How are you going to phase out all those cars when obviously, not everybody can afford an autonomous vehicle?

So we’re talking probably decades until everybody’s on an autonomous vehicle. What does that look like until we get there, I just think there’s a long road ahead? Not even just from a technological perspective, and not even considering all the financial resources that Tesla would need to make all of this happen. It’s a really big mountain to climb.

Looking at it from a completely different world and it’s the question of if we have autonomous vehicles exist, why would cars look the way that they do?

John Engle  26:02

GM actually just recently had an event where they unveiled what their autonomous sort of pod is going to look like. It doesn’t look like a normal car. It looks vaguely like a street car and it’s because like, why would you have sedans carrying people around with autonomous vehicles, as opposed to a larger conveyance? Like these are all questions that are going to become big issues over the next several years. It could radically alter the way public and private transit works.

 

Robert Leonard  26:30

Yeah, that’s a very good point. I mean, vehicles are the way they are now, both for style, but also for functionality. But if we get to a point where they’re fully autonomous, does it really matter?

I mean, couldn’t you put everybody in a box, or something of that nature that you know, can carry all kinds of things that people need, and a lot of people or, you know, whatever that may be, it doesn’t have to be in the same style that it is now. So maybe it won’t even look like a car, maybe it’ll look more like a train or something along those lines.

It’s a really interesting dynamic and this whole conversation really makes me think of the Jetsons, or flying vehicles and things of that nature, more futuristic type stuff.

John Engle  27:04

I think the Jetsons flying cars are a great example of a technology like engineering capability. But the really hard part of any issue, where you’re talking about mass transit, or anything that affects everybody is how you do it in a way that is not just like cost effective, but efficient, and reliable.

Reliability is so important in all transportation and that is frequently underappreciated when we talk about sort of the technology silo might be. It has to be more reliable than what we have now for it to be something that people will want.

Robert Leonard  27:41

Reliable and safe. It’s so much better than just the company and the engineering technology that’s behind Tesla. It’s like we’ve been talking about it for the last few minutes. It’s all the infrastructure that goes around it. I think that’s even the bigger issue that I have with Tesla and the overall just concept of autonomous vehicles.

Now, we’ve seen Tesla fetch some, arguably questionable valuations and price increases over the late. But when you look at a company that you’ve mentioned, a couple of times GM, they have, like you said, the Cruise program that’s doing well, in terms of the same type of Tesla technology yet…

When you look at their stock chart, they’re actually down over the last five years. They’re arguably trading at a much more favorable valuation than Tesla. They’re trading under six times earnings under a $40 billion market cap. Why are so many people overlooking GM if they have such a valuable or potentially valuable autonomous technology in their business?

Because they’re valuing GM like an automaker, like all other car companies are valued like car companies. Tesla’s the only car company that’s valued not like a car company.

So Tesla’s being valued like a tech company, whereas all the other automakers, even though they have autonomous technology are being valued like historical terms of just car manufacturers.

John Engle  28:57

Exactly. There’s a disconnect between what Tesla is and what Tesla is perceived to be. It is fundamentally an automaker, that’s what it is. It has sort of dabbled in solar unprofitably. It has an autonomous vehicle program, but that will take many, many years for it to yield benefits, which they’ve already charged for, even if their particular technology suite works, which given its limitations, possibly not the case. However, because they don’t know a lot of these interlocking bits that are required.

It’s basically a lot of different special knowledge areas that they operate in. If you don’t  have at least a grasp of lots of them, you can easily sort of buy into a story, especially when it’s a pleasant one. It’s easy to buy into this idea, but this is the future. So yeah, it is valued essentially, as a tech company.

Robert Leonard  29:50

I’m really curious to get your opinion on this next question, because as someone who doesn’t necessarily follow this space super closely, I sometimes struggle as to how to answer this.

A lot of times people that I know, friends, family, colleagues even know a little bit about investing, but they’re not necessarily experts, per se. They just kind of hear the headlines. They always ask me, what should I invest in? Should I invest in Tesla, things like that.

For example, my brother, he’s an engineer. So he’s into technology and he’s younger than me. He doesn’t necessarily have an understanding of finance or investing. But he asked me, maybe last year, should I invest in Tesla?

I said  I personally would not and if you think that the company is going to do well, and of course, recently, he sent me a text and said, “Ah, see, I told you, I should invest in Tesla.”

How do you handle situations where you don’t necessarily have people, you know, questioning whether your answer as to whether they should invest in something or not, but how do you answer to people of should I invest in this company, in specifically companies like Tesla?

John Engle  30:49

I tell people whether if someone asks like, does Company X thing that I should invest in? I’ll usually say what my position is. Then I’d say like, but it depends on what it is. It’s hard to say like Tesla is a particularly challenging one in that no matter what you think about the fundamentals, or the business like sort of long term, let’s say, 10 years from now, there’s no doubt that the stock price is acting in a way that is almost no connection about what the stock jumped 10% today, despite the fact that Coronavirus is shutting down our economy. It’s shut down the Chinese economy for over a month.

These are things that we know happened. But I’ve had essentially zero impact on this particular stock. It’s like anytime you’re dealing with companies, like my recommendation is that, how is the stock? It’s not so much whether to buy, first of all, but firstly, to ask yourself, “How is the stock behaving? And what is driving the price?”

So is it being driven by the fact that there was an earnings surprise to the positive that why the stock is up? Or is it because there’s some narrative that’s changed? Those are the sort of things you have to unpack for yourself sometimes.

Though individual stocks are driven by different factors. But beyond sort of no fear and greed, the way people usually think about it in a very simplistic way, there are companies that are industries that are understood that have been around for a long time, and that are valued a certain way at certain times like automakers and industrial.

People know how those companies behave in different economic conditions. You can understand the company even if you disagree with a pick of evaluation at a particular time you kind of get why it’s valued a certain way.

Then there are companies that are valued in ways that are unfathomable. What makes people think that Tesla is worth more than GM and Ford combined, that clearly there’s an element where it’s technology. There’s clearly a hype element, there’s a FOMO element, there’s lots of other things, but it’s a very complex stock that is driven by a lot of emotions and psychological factors that are difficult to compartmentalize.

So there are different kinds of stocks perceived in different ways. I think if someone asked like, what about this stuff, you kind of have to first think about, is it a normal stock? Or is it one of these weird ones? If it’s a weird one, you have to warn them that fundamentals don’t matter? Like it’s sort of a question of, “Do you think that the story can go forward from here for a while, or permanently?”

Robert Leonard  33:24

You wrote an article titled “Tesla is structurally bankrupt.” Talk to us a bit about that.

John Engle  33:30

So Tesla has managed a few quarters of profitability lately, but that has been due to a few factors, some being selling of basic carbon credits, which are different across different regimes like California which has been very big about them. The US has been pretty big on them.

So selling credit has been basically the principal source of Tesla’s profitability, but it is a source that is dwindling over time. Firstly, because the subsidies that grew to people who buy Tesla’s essentially expired now in the US. They are expiring in other countries.

But the most important aspect that is frequently overlooked, is that the reason I call them structurally unprofitable is that the only reason they were able to report profits at all was because they were able to report that their costs were lower than they should be. By lower than they should be, I mean that their suppliers basically gave them sweetheart deals over the last couple of years. They basically agreed to reduce the price that would normally have to be paid for various inputs, everything to seats to batteries, like their deal with Panasonic, for example, to provide them with batteries.

These are arrangements that are devised to reduce costs in the short term, but that obligate Tesla to pay significantly more over the long term. The question is, will Tesla ever hit the sort of volume production and demand necessary to meet the requirements they’ve agreed to?

But at that point, they basically need to prove douce within five years then you produce, *inaudible* need to pin tuple their production in order to meet their personal obligations with Panasonic.

Well, the reason I call them structurally unprofitable, is that barring, it basically will require other companies to once again cut them a deal in order for them to meet the obligations they already have.

Robert Leonard  35:21

With everything you just mentioned, as well as everything we’ve talked about so far, do you short Tesla stock or do you think that’s a bad position to take?

John Engle  35:30

I think going naked shorting Tesla is gambling. I know people who do sort of shorter term options trading. Also, it’s gambling, we have a sort of long term, couple years out put option trade, which we expanded when the run up happened, presumably, because two years from now. There’s very little probability, in my opinion, that Tesla can be anywhere near where it is right now because it’s basically, as I said, optimized for the short term in such a way that 24 months from now, purchasing obligations be coming in the under investment in service infrastructure, support staff, all these things that they basically cut to the bone.

Here’s the thing about Tesla, do you know of a growth company that spends negative capex? Nope, Tesla is. Over the last three quarters, Tesla has spent less on capex than depreciation, which is the amount of negative capex, basically by not investing in the infrastructure they need to do. So they’re not growing the way they claim to be.

Robert Leonard  36:35

And so, that doesn’t sound like the characteristics of a company that is going to scale and conquer the world.

John Engle  36:42

There’s a lot of things about Tesla that don’t equate with what you would normally expect from a growth company, which is the thing that originally caught my attention about it. It’s such a weird company, it’s almost mind boggling the way that it operates.

But it is important to realize, like in the world of public markets, that perception often defines reality, at least for a while. Sometimes for a lot longer than you think.

My warning to anyone who takes my opinion to heart is that shorting Tesla has been an expensive and dangerous proposition for many people for years. It is unclear when things will happen. I think even when a recession actually happens, that’s basically when the rubber hits the road with a company like Tesla, which has been reliant on external capital, and has never experienced in its current form as a mass automaker.

What it means to have a cyclical downturn like automakers all went broke last time, there was a recession, most of them are better capitalized now, after having gone through bankruptcy, but the company with essentially no cash and a big cash burn lots of obligations, that’s a really bad place to be, as the economy gets dicier.

Robert Leonard  37:57

GM and Ford going into bankruptcy is very different than Tesla, I think, and their bailouts or their bankruptcy court proceedings, whatever that might look like, I think would look very different than those two companies may have in the past.

This is sort of like putting on the PE a corporate finance hat where what happens is Tesla was on the verge or in danger of insolvency. In 2008 and 2009, when you saw the auto bailout, you had millions of people whose livelihood was going to be affecte.

John Engle  38:28

With Tesla, it is trying to grow in a way that it will have those sorts of employees but doesn’t have anything like the number of active and former employees that would be absolutely destroyed by it. The main issue, when GM was bailed out, the main impetus rather for the bailout was that you’re dealing with so many people who were retirees on pensions from the company who would have been annihilated by the company going under?

The question was, how do you save them? So yeah, I think it’s one of those things where Tesla is not yet too big to fail at which puts it in a precarious position.

Robert Leonard  39:06

Yeah, that’s exactly the verbiage that I was thinking is too big to fail. Exactly what you just said was exactly what was running through my mind.

Now, you mentioned naked shorting Tesla can be a very risky and even a gamble. For those who aren’t sure what a naked short is, what exactly does that mean? Then why is it such a speculative or just risky investment you can make?

Naked shorting is  basically just taking it like borrowing a stock and pasting that being a direct bet against the share price. That’s the purest way to short a stock.

John Engle  39:39

The other ways to do it are to take basically buy put options, where you’re basically betting on the price going down in future and you’re paying a premium basically have an amount of time in which that can happen.

Being direct, naked, short, or like unhedged, short, any short position really, other to be honest, a long position is extremely risky and anything that’s as volatile as Tesla’s stock where it’s dropped to 180, a few months ago was hit 900 is now at 600. Like, I don’t know, where’s the price? How do you do that?

Options prices are reflected in that it is quite an expensive company to short, or to go long now on options. If you’re very, very confident, for whatever reason, the company succeeding, owning the stocks, probably the only way to go, I would definitely not be buying call options right now.

If you’re going to go short, I’d go for very out of the money like a suit, like basically betting on a very significant correction a couple years from now is anything else, just like the cost of the cost of making that taking that position is just too high.

Robert Leonard  40:44

So we’ve spent a lot of time talking about Tesla, I want to transition talk about another company that might be somewhat similar. I kind of see it similar, maybe not as much, but pretty similar to Tesla.

That company is Virgin Galactic. It’s been in the headlines a lot lately, and it’s billionaire Richard Branson’s company, ticker symbol SVCE. I know you’ve covered this in the past, what is Virgin Galactic and why has there been so much interest in the company in the markets as of late.

So Virgin Galactic has actually been around for quite a while as a company, they only just went public. They’re a space tourism company. So they basically designed over several years of space planes. That’s a space vehicle that enters essentially very low earth orbit, or rather, sort of touches the edge of orbit, then comes back down. So it’s not like a rocket into orbit, it’s rather more similar to a spaceship.

John Engle  41:34

So the company is a tourism company. The idea is they’re going to sell tickets to rich people to go and take short rides into basically like the edge of space. That’s their business. They’re valued at this egregious amount, because the space economy is big right now.

Virgin Galactic went  public and the stock price has gone through the roof. The reasoning behind that is basically that maybe there’s more rich people who want to buy tickets, but also, the sort of long term speculative play is that this company, because they built these space planes, will be able to turn them into commercial transit planes.

So basically, instead of taking an airline from New York to London, you would shoot up into orbit, and then drop back down, and basically reduce a six hour flight to like an hour and a half. That’s sort of where the valuation is coming from the idea that they might revolutionize the way people travel long distances. That’s the idea.

Robert Leonard  42:35

Why do you think Virgin Galactic is far too risky to buy right now?

John Engle  42:41

Because I think it’s phenomenally overvalued, in that people are, you’re talking about a couple $100,000 per ticket? Like there’s not that many people who are going to do that. They’re going to have a pretty great business for a while. But is it worth many billions of dollars in valuation, given the cost of maintenance launch, building these space planes and maintaining them? That’s highly questionable.

But the big issue is that the set of one time one of these things blows up, which happens in spaceflight. That’s it for the stock, the space plans are pretty good. Like, isn’t like Virgin Galactic has actually done some remarkable work with reusable space plane technology, their ships are decent.

However, if you look at things like the space shuttle, two of them blew up, one in launch one and reentry. It doesn’t take much at those velocities. With that sort of at the edge of space, like anything going wrong, it doesn’t take much to just destroy a vessel. So you’re talking about a passenger flight that burns up, it might not happen, but the probability that it does, the risk is there. And so, like taking a speculative position in the stock now, before they’ve launched, even a single commercial flight is very, very risky.

Robert Leonard  43:54

As we talk about Virgin Galactic being potentially overvalued, how do you even go about valuing a company like this?

John Engle  44:03

There’s a couple different ways of doing it. Where’s the what is their business now, which is basically space tour. So the question is, how many people are there in the world who can drop quarter million dollars or $150,000?

Let’s say if they like to get their cost down for a short jaunt to space not only and then like, how many are there? Then how many are willing to actually do it? Firstly, that’s always the money and then also that seems kind of dangerous. How do you size that market? The answer is not easy.

However, no matter how you do it, if you took like every single person who was a multimillionaire in the world, and assumed they were going to do it, even then you’re probably like the valuation still isn’t 100%. It’s due to things like cost management, with a capital expenditure and maintenance of these planes, presumably having to build enough to actually carry that many people.

These are all factors that are unclear but can really impact I’d say that even in the best case scenario, under its current business model, you couldn’t justify the valuation. So the valuation is more built on they’re going to be turning this into something much bigger.

If you look at Morgan Stanley, they actually published like when Virgin Galactic went public, their analysts published a note basically, that was to the effect of their spaceflight business is great. But what really matters is how this is going to revolutionize basically commercial travel.

I think those are the sort of narratives that are going to be sort of anchoring the stock a little bit, but none of that is proven. There’s no reason why you would believe that a company that has built one space plane model is going to be able to revolutionize what every aerospace company has been trying to do for decades.

Robert Leonard  45:46

John, I’ve learned a ton from our conversation, I really enjoyed our conversation about Tesla. Like I said, throughout the episode, I’m not an expert in Tesla, by any means, or any of these types of companies. so I’m here learning alongside the audience. I really enjoyed the conversation. I know I learned a lot. I’m sure the audience will as well.

Alright, guys, that’s all I had for this week’s episode of Millennial Investing. I’ll see you again next week.

Outro  46:52

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