Thread by @ChrisBloomstran

Let’s get ready to tumble! Come Monday, $TSLA enters the S&P 500, as the world is aware. This is the one you will tell your grandkids about, or at least the new crop of investors, wondering what the bubble of 2020 was like. Tesla can be your example of the insanity....1/

For all of the cost-saving benefits of passive investing, the Standard & Poor’s committee that actively chooses the components for its indices will prove why passive investors are the dumb money with this coming Monday’s inclusion of $TSLA into its venerable S&P 500 index. 2/

The committee is not known for a price consciousness. It chases what’s hot and eliminates from its august roster what’s not. 3/

It’s disregard for fundamentals or value was seen sharply in late 1999 & early 2000 when bubble darlings like Peoplesoft, New Century Energy, Global Crossing, Xilinx, Teradyne, Quintiles Transnational, Citrix and JDS Uniphase made their way into the index. 4/

Pull up the long-term charts to see how these “timely” additions fared post admittance. The most prominent additions in 1999 were America Online (discussed in my 12/5 thread) and Yahoo, whose mania also reminds me of Tesla... 5/

Yahoo went public in 1996, priced at $13 per share, opened at $24.50 and closed at $33 on its first trading day, a market cap of $850 million. From there the shares zoomed ahead by more than 6x in 2 years reaching $354 in January 1999. 6/

The company then bought Geocities for $3.6B and Broadcast for $5.7B and the stock was more than cut in half, trading down to $120. Recovering by late 1999, the wizards at S&P announced they would add Yahoo to the index on 11/30/1999. 7/

The stock climbed 67% from $210 on the day of the announcement to $350 on the day of its inclusion on 12/7, one week later. Sound familiar? The rollercoaster didn’t high point for another month. 8/

Yahoo peaked not quite a month later at a share price of $475, a market cap of $127B on January 3, 2000 (the cap didn’t include another 124 million option shares, 38M granted in 1999 alone, which implied an additional ~$50B in market cap on January 3, 2000). 9/

In hindsight, or for anyone with reason, which was lacking in those days, there was no need to count the fully diluted shares. Why? Those options would not be exercised. The stock fell 98.3% over the next 1 ¾ years, from $475 to $8.11 on 9/26/2001, a market cap of $2.2B. Yep. 10/

At the peak, Yahoo's $127B market cap compared to $600 million in trailing 12-month revenues, so 211 times revenues. 11/

But the Yahoo and tech bulls would get right in your face (or on the Yahoo Finance message board) and tell you, moron, that sales had grown 141%, 248%, 258% and 1,345% in the prior 4 years, which they did. 12/

Heck, even after the stock dropped from a market cap of $475B to $17B (a mere 96.4% in a year for those counting) by the end of 2000, sales still GREW by 88% to $1.1B, to “only” 15 times revenues! From there, however, the company flailed. 13/

Sales actually fell 35%, from $1.1B to $717m from 2000 to 2001, which is what drove the shares down to $8.11 and a $2.2B market cap. To what had been the first and dominant home page, and really the dominant search engine, competition came fast. 14/

Yahoo even eventually outsourced its search function to upstart Google if you can believe that. Yahoo did ultimately grow its revenues another 5x to $5B by 2016, when it was bought by Verizon $VZ in 2016 for $4.5B, excluding a sub's partial investment in Alibaba. 15/

The buyout was at a far cry from the day Yahoo came into the S&P 500 as the 30th largest capitalization in the index, with a market cap of roughly $90B and I’d guess at a weight of 0.7%. 16/

At its January 3, 2000 peak, Yahoo had climbed to the #15 spot in the index, well ahead of Berkshire Hathaway $BRKA $BRKB (which was not yet in the index despite its mere $83B market cap, $131B in assets and $38B in shareholders equity.) 17/

Had Berkshire been in the index the day Yahoo peaked it would have held only the 37 spot, behind notorious tech darlings Cisco at $358B, Intel $290B, Time Warner $184B, Lucent $171B Sun Mico $168B, AT&T $160B, WorldCom $148B, Dell $130B, HP $120B, Oracle $120B, EMC $116B,... 18/

Qualcomm $116B, DirecTV $102B, Verizon $93B, AOL $93B, Motorola $90B, and Bellsouth $87B. Many of these are gone today, which leads us back to $TSLA. 19/

Never has the S&P 500 committee brought in a company so large by market cap as will be the case with Tesla's inclusion. Nor have they ever brought in a company at so high a spot in the cap-weighted index, at #6, one notch ahead of Berkshire Hathaway. Insanity. 20/

Of course, by sales & profits, plenty of companies have entered the index as larger constituents, but that’s not what counts in the passive index. It’s all about float adjusted market cap. Fundamental valuation matters not. Qualifying for index inclusion required some hijinks.21/

Tesla had cut R&D & SG&A, drew on reserves and leaned on environmental carbon credits to “earn” a GAAP profit for a necessary four quarters. They did so for five. Oddly, revenues only grew 15% in 2019, prior to the pandemic, in part for a reduction in customer tax incentives. 22/

Impressively, they have grown revenues 15% for the first 9 months of 2020 during the crisis while the incumbents saw sales decline. No doubt the business is growing. But how to value it? 23/

On November 16, the S&P index committee announced Tesla would be added on December 21. The market cap was $380B. Here on Saturday December 19, the stock price at $695 yields a market cap of $659B ($BRK, the current #6 is $528B) up $279B or 73% since the announcement. 24/

The gain matches the percentage rise seen by Yahoo during the week between its announcement & addition. The $279B gain is LARGER than the $215B market cap of the world’s largest auto manufacturer, Toyota. Tesla’s $659B cap is on 948M shares out at 9/30 (up 5% since YE 2019). 25/

The share count excludes another 157M unvested or unexercised option and RSU shares, which would add more than $100B to the market cap on a fully diluted basis. 26/

Let’s not count those for the same reason they were excluded in the Yahoo calculation. Why? Many may go unexercised. Why? Nobody in their right mind would pay $659B, $760B diluted, for a car co w/ $30B in sales, little or no economic profit and an enormous growth capital need.27/

25x sales? 2,030x GAAP earnings? 422x earnings assuming Toyota’s best in industry 6% profit margin? Heck, even 85 times Microsoft’s 30% profit margin (a bone for the Tesla is not a car company but also a software/robotaxi crowd). Welcome to the game, index fund investors. 28/

80% of Tesla’s shares float, not owned by insiders, which means the adjusted market cap weight will be $528B, compelling somewhere between $50 and $75B of direct index purchases, not to mention those needed by index huggers and closet indexers. 29/

The stock will come in at ~1.75% of the $30.5 trillion index, itself significantly overvalued, not unlike when Yahoo peaked in January 2000 and the index peaked at over 30x earnings and 44x cyclically adjusted (CAPE) shortly thereafter. 30/

What prospective return does the Tesla bull expect, or the passive investor with 1.75% of capital in the shares come Monday? At 15% a year, the market cap, assuming no further dilution, grows to $3T over the next decade, ~10% of the market value of the entire S&P 500 today. 31/

At “only” 10% per year, the fully diluted market cap grows to $2 trillion, almost where $AAPL is valued these days. At a 10% shareholder return, to trade at 30x earnings, Tesla will need to be earning $67 billion. 32/

For grins let’s assume the company actually earns some blend of auto maker profit (most earn ~3%, Toyota ~6%) and a subscription software, robotaxi margin of 30%. Generously call it a 20% blended profit margin, which I’d bet heavily against. 33/

At the impossible 20% margin, $67B would sit under $335B in revenues, roughly 11 times today’s run rate. Revenues will need to grow by almost 28% per year, and profits to 20% of revenues, to get to a 30x multiple on earnings. 34/

To finance the necessary capital stock to produce $335B in revenues will require about half that much in capital, either debt or equity. 35/

Car companies require roughly a dollar in capital to produce a dollar in revenues, but remember we are "assuming" this is a software company or whatever else hallucinogens conjure up in the minds of bulls. 36/

The best course of action for Tesla is to keep selling “at-the-market” blocks, with no prospectus, road show or risk warning, to the dumb money that is willing, or compelled, as is the passive crowd, to pay dangerous prices. The dilution at today’s prices is infinitesimal. 37/

Through the end of 2019 Tesla had sold $12.7B in shares and borrowed $16B in debt and preferred stock. Total capital raised of $28B exceeded FY 2019 revenues of $25B and produced a $6B cumulative LOSS. 38/

So far in 2020, Tesla has borrowed an additional net $200m and sold $12.3B of new shares (assuming a sale of the most recent $5B “at-the-market”). Bulls revere the cash on the balance sheet, but it didn’t come from profit or free cash. 39/

Total capital raised is now $40B before retained losses. What does Tesla earn on capital? Nothing yet. Equity is less than capital raised from stock sales by the amount of cumulative losses. Per share book is of course higher thanks to successful stock sales way above book...40/

From a business case and investment standpoint, the math doesn’t work. Consider that total automobiles sold worldwide peaked two years ago at about 95m passenger and commercial car and truck units. At $20,000 per new vehicle, we can call the global auto market $2T in size. 41/

Our example has Tesla’s market cap growing over the next decade at “only” 10% per year to a like $2T. Car companies, with the exception of Ferrari, which makes three cars per year, don’t trade for one times sales. They trade for less. 42/

Toyota, which earns a 6% margin and 6% on capital, trades itself at an all-time-high $215B on revenues of $280B in 2019, less in 2020. 43/

Auto manufacturers trade for less than sales because they make ~3% net margins and earn that same ~3% on capital and revenues grow at ~3%. We can call the industry 3x3x3 (new material here folks). The car business is a bad business, and that’s what Tesla is trying to disrupt? 44/

The best case for shareholders: If Tesla grows the aforementioned sales for the next decade by 28% to $335B (it won’t), the stock will trade for no more than 1x sales, because it’s a CAR company. 45/

If it earns Toyota’s best in class 6% margin, even allowing for software “upgrades,” it earns $20B and trades for 25x, or a $500B market cap, which is a 33% loss from here people using diluted shares. If sales, margins or the multiple are lower, shareholders lose more. 46/

The realistic case: The performance of the stock from here is a giant loss over time and the Tesla cult loses interest in the brand. In fact, they come to hate the brand because of their coming stock losses, customer and employee mistreatment. 47/

Ask the guys and gals on the S and X lines about their unpaid “break” here at quarter end. Rumor has it they can "volunteer their time" to help boost production before yearend. Sales grow nowhere near 28% a year. The incumbent auto manufacturers won’t roll over and play dead. 48/

My prior tweet elaborated on @elonmusk using his inflated shares as currency to acquire another manufacturer w/ capacity, as he mentioned he’d be up for in a friendly merger of equals. The point of that message was that the incumbents won’t take his dangerous scrip in a deal. 49/

That leaves Elon with having to sell new shares perpetually to finance his growth. It makes 100% sense when the shares are insanely overvalued to do so, and despite the ethics of doing so in these recent at-the-market deals. 50/

By contrast, Mr. Buffett points out he’d prefer new and current shareholders to have a fair experience in his company’s shares. If the auto makers won’t take them in a deal, and they shouldn’t, then that leaves new shareholders to provide growth capital. Hello passive crowd. 51/

We’ll see what happens after Monday, when Tesla assumes the #6 perch in the index. When the argument for passive is low fees, remind me in ten years how much of the loss in Tesla’s shares from here should be considered a “fee,” or a tax on stupidity. 52/

At 1.75% of the index, a decline of 80-90% would be heavy, but realistic. Impossible to decline that much? An 88% drop takes you all the way back to….where Tesla’s shares began the year. 53/

A 90% decline takes the cap to $66B, 2.2x current run rate revenues & 37x a hypothetical 6% net margin. A mere 80% drop gets to a $132B cap, 4.4x revenues, and to give the bulls on Tesla not being a car company credit, still 37x a 12% hypothetical profit margin. Ridiculous. 54/

You can play around all you like w/ assumptions for growth, market share, expansion into new markets, profit & returns on capital, but paying for some fractional ownership of today’s $760B fully diluted market value is highly likely to produce a disastrous investment result. 55/

Bravo, S&P. The decision to add $TSLA at present valuation is almost sure to exact pain on passive investors, compelled to “invest” 1.75% of capital in one of the most overvalued companies on record. Brilliant. As the other Buffett sings, “Come Monday, it’ll be all right...” 56/

As disclosure, I have a small short position in $TSLA. Don’t take this note as investment advice because it’s not. Do your own research. Stocks go up & down, and shorting is extremely dangerous. Upside is capped and downside is unlimited. $TSLA has risen 8.3x just this year. 57/

If Tesla repeats the same return over the next year the market cap would be $6.3 trillion. Two years of repeat performance and the cap becomes $52 trillion. Of course, that’s 70% larger than the entire S&P 500, but by then any short seller is long bankrupt. 58/58 END

Typo alert in /13. Should be: Heck, even after the stock dropped from a STOCK PRICE of $475 to $30 (a mere 93.7% in a year for those counting) by the end of 2000, sales still GREW by 88% to $1.1B, to “only” 15 times revenues! From there, however, the company flailed. 13/