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Tesla: In defence of short selling

Tesla’s Elon Musk isn’t the first chief executive to be annoyed by short sellers – and he certainly won’t be the last. However, selling short is a vital function of efficient markets.

by
Garry White

in Features

28.09.2018

Critics argue that investors who seek to profit when a company’s share price falls can spark wider market slumps and even recessions. It also provides an incentive to put false rumours into the market to talk down a company’s prospects, some say. However, being able to sell short is an essential part of the capitalist system. The ability to turn a profit by uncovering a failing – or even fraudulent – company gives short-sellers a good incentive to identify bad businesses; it is healthy for markets and it is certainly ethical.

Mr Musk has accused short sellers of conspiring to bring Tesla down. He’s called them “haters” and “jerks who want us to die”. The billionaire entrepreneur thinks these investors don’t understand electric vehicles and their entrenched short termism means they do not properly comprehend what opportunities the future holds for a business such as Tesla. This, patently, is nonsense.

Most of Tesla’s short sellers are industry professionals who have based their decisions on fundamentals after doing thorough research. They are not a rabble that wants to see the world burn, or fraudsters looking to make a quick, dishonest buck. These investors have rigorously examined the company’s level of debt, manufacturing issues, missed targets and cash burn. This has led them to the rational conclusion that the unprofitable company’s valuation of $51bn (£38.8bn) looks rather steep. The bears have also been bolstered by Mr Musk’s increasingly erratic behaviour, which has seen him smoke cannabis on an internet chat show and accuse a British diver involved in the rescue of twelve trapped boys from a cave in Thailand of serious sexual offences. The latter has led to a number of law suits.

There is no doubt that Mr Musk has taken criticism of his business far too personally – and it could now have got him into some serious trouble. Not only has his behaviour prompted some valid questions about his suitability to hold the dual role of chairman and chief executive, but the regulators are now investigating his business in a way that could genuinely damage its valuation, giving short-sellers exactly what they want.

Last month, Mr Musk tweeted that he had the “funding secured” to take Tesla private at $420 a share. This prompted an 11% rally in Tesla shares, resulting in paper losses of around $2bn for short sellers in a matter of days. Mr Musk had previously told his 22 million followers that the shorts had “about three weeks before their short position explodes”. Interestingly, the second tweet came about three weeks after Mr Musk’s warning of a share-price explosion.  However, the billionaire was ultimately forced to admit that the funding wasn’t agreed at all.  The incident led the Securities and Exchange Commission (SEC) to launch an investigation and reports this week suggest the Department of Justice (DoJ) is also running a parallel probe.

Some have suggested that the “funding secured” tweet may have breached the SEC fair disclosure rule. “Regulation FD” addresses the selective disclosure of information by publicly-traded companies. “One set of shareholders should not be able to get a jump on other shareholders just because the company is selectively disclosing important information,” the SEC says. However, Twitter has already been shown to be an acceptable method of disclosing such material in what is known as the “Reed Hastings Rule”.

Reed Hastings is the chief executive of Netflix. The SEC looked at a Facebook comment he made in 2012 that declared the video-streaming service had exceeded one billion hours in monthly viewings for the first time. Netflix did not report this information to investors through a press release or an official Form 8-K filing, and a subsequent company press release later that day did not include this information. In 2013, the regulator concluded that listed companies could use social media outlets such as Facebook and Twitter to announce key information in compliance with Regulation FD, as long as “investors have been alerted about which social media will be used to disseminate such information”.

Others saw the tweet as problematic from another perspective. Harvey Pitt, a former chair of the SEC, said that if the purpose of the tweet was to boost the share price, it would be considered securities fraud. He said the move was “highly unprecedented” and raised significant questions about “what his intent was”. If the intent was to damage the irritant short sellers, this could become a real problem for Mr Musk – and, in turn, Tesla shareholders. We will now have to await conclusion of these two investigations.

Whatever the truth in this case, as an investor, Mr Musk’s “funding secured” tweet did not feel like an appropriate way to put market-moving information into the public domain. His obsession with short sellers has now become something of a liability for Tesla.

The battle between the bulls and bears will continue. The only way Mr Musk can answer his detractors is by actually delivering on his targets and achieving serious profitability. Getting into Twitter arguments with individuals and making libellous comments about others can only do his business harm. Indeed, the involvement of the DoJ is potentially more serious than the SEC probe – so the Tesla shorts are likely to be particularly happy right now. Unlike, I suspect, Mr Musk.  

A version of this article appeared in Wednesday Daily Telegraph.  

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

 

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