Tuesday, 2 October 2018

Tesla Could Be Ripe for a Short

[Note: This does not include Fundamental Analysis of Tesla. Public availability of all fundamental information, common knowledge of liquidity and solvency issues, reduces to zero the value-added of fundamental analysis, in this case]

Tesla [TSLA] (01-Oct-18) +17.35%
Rating N/A
Price (01-Oct-18, US$) 310.70
Target price (US$) 263.00
52-week price range (US$) 244.59 - 387.46
Market cap (US$ m) 52,870
Enterprise value (US$ m) 72,370

On Thursday of last week the SEC announces it has charged Elon Musk with Securities Fraud. By Friday, the stock closes down 15%, and before Saturday, Musk agrees to settle. At this point, the general consensus is Musk plans to fight it and it won't be pretty. The media receives the settlement surprise with such fanfare that they forget to weigh in on some important facts: 1. The settlement changes the image of the company and of the "founder;" 2. It changes the fundamental story behind the stock; 3. Musk is no longer Iron Man; 4. The stock is still under-performing the general market, and looks dead from a technical perspective; and 5. Musk is no longer Chairman.

There appears to be an excellent short term opportunity for shorts at yesterday's closing price of 310.70.

Market Sentiment/Catalysts

The SEC Settlement means Tesla may finally be a viable short. One key point that the market seems to be missing is that Tesla's and Musk's settlement takes away the surprise element or "x factor" of the story. Not only does an SEC charge look bad for the company, but the settlement could be even worse. With no settlement, at least the surprise element is still there. A big unknown. However, with a settlement, there really is no big unknown that exists about the company - at least not that involves any significant upside. The only unknown left is the DOJ's ongoing criminal investigation of Musk.

One of the greatest obstacles for shorts up to this point has been the upside risk in "the unexpected." Any day Musk could have come out with a surprise story about a trip to Mars or a new Tesla pick-up and the stock would rally almost systematically. However, much of the stock's reaction has to do with Musk's credibility and him eventually delivering. Now, after the settlement, the invisibility cloak appears to have been removed. There no more mystery to Musk. The fraud charge makes him awkwardly human. This, combined with the law of diminishing margins could be the combination needed to make the stock a viable short, particularly at the 310 level with a stop loss of 322, and a take profit at 263. Other than the risk of the high short interest and concentrated holdings, today's rally could provide the most favourable entry point in a while.

Settlement terms overlooked
Another aspect of the settlement that the market appears to be failing to appreciate is the fact that Musk is no longer Chairman of the Board. This makes one of the few CEOs of a Silicon Valley large cap that isn't both the CEO and Chairman. This also opens him up to termination once the new board members are elected. Depending on the share vote rules, a new Chairman will also prevent Musk from wielding control over the company, which puts his fate as CEO in the hands of someone other than himself. This makes him an employee--a position he likely doesn't plan to hold for a long time. Without Musk in as CEO the intangible value of the company is greatly reduced. Given the choice, Musk will likely choose his freedom over preventing the company from collapsing.

Technical aspects
- Significant resistance at the 320ish level. 
- One-day rally with range > 2.5X 14-Day ATR.
- Large moves in either direction typically prove a successful fade the following day/week, for this stock.
- Since end of Q118, short interest shrank over 5%, from 30.9% to 25.73%, while the stock declined -3.57% during the same period (-5.32% YTD).
- Over 6M of the shares that have been purchased in the open market over the past six months is due to short covering.
- Aside from the price action that followed the going private tweet, bulls have made a number of unsuccessful attempts to push a weekly close above 322. 
- Any support above the 322 level would need to be accompanied by a new narrative, which the company lacks for the foreseeable future.

A 17% move in one day is not healthy. In fact it's unhealthy. If a stock rallies 17% in day, you can be sure it isn't being accumulated by insiders. The guys who accumulate stock do so on the quiet and leave minimal forensic evidence. They also accumulate gradually, over a long period of time, at lower and lower prices. They're not in a race to buy and definitely don't bid their own stock up 17% in a day; they generally see that as an opportunity to sell into strength, if it can be done at a profit.

The stock has been too volatile even for day-traders. It's been a lose/lose for longs and shorts alike. However, the fundamental change in perception as a result of the SEC's charges has tainted the company and makes the narrative less compelling going forward. The out of the money call option that is Elon Musk and Tesla has shifted to an out of the money put option, and for the first time there appears to be more headwinds than tailwinds. The settlement with the SEC does not prevent further actions in the near future, the DOJ probe is a criminal probe which is far from over, and the company has a pile of debt maturing in early 2019 that it will likely default on sans an additional cap raise.

Who will be the new Chairman of the Board? Who will fill the two new board seats? Does the Settlement open Musk and Tesla up to more lawsuits? What will be the effect of the new communications limitations the SEC has placed on Musk? Will he stick around as an employee of Tesla or will his entrepreneurial spirit seek greener pastures? There are a lot of questions at this point, and none of them are bullish.