Jim Chanos vs. Elon Musk – Here’s How You Side With the Winner

Keith Fitz-Gerald Aug 03, 2016
17 

What do you do when you’ve found a stock with fabulous long-term potential that you love… but one of the world’s best short-sellers hates?

That’s the situation thousands of Tesla and Solar City investors find themselves in today.

Most have no idea what to do next, which is why I want to use the situation as a teaching moment. This isn’t the first time two Wall Street titans have been at odds, and it won’t be the last time you’ll see it as an investor.

My goal is to show you how to read between the headlines and identify the winner early on. That way you’ll know how to place your money for maximum profits.

It comes down to this.

No One Ever “Talks Their Own Book” for Somebody Else’s Benefit

Millions of investors follow legendary traders like billionaire activist Carl Icahn into and out of stocks like Apple, Xerox, and Netflix, believing that doing so is a surefire way to make millions. So why is it that they’re not the ones getting rich?

Very few investors understand a nasty practice called “talking your own book.”

If you’re just joining us, that’s a derogatory term to describe when an insider, an activist investor, or a hedge fund manager makes a statement of opinion on a stock that’s a good buy or a solid sell, typically without the express caveat that he or she stands to profit from the public reaction that inevitably follows.

For example, activist Carl Icahn bought into Apple at a time when share prices were trading around $463 ($66 split-adjusted), then promptly made a very public case for it being worth $625 a share ($89 split-adjusted). Millions of investors watching the news bought in hook, line, and sinker. Not surprisingly, Apple shares took off 5.8% in a single day and Icahn’s holdings jumped a stunning $104.4 million.

Or consider Netflix. On October 31, 2012, Icahn revealed he had a 10% stake in the company… and the stock surged 14% in a single day. He picked up $5.5 million in shares through either options or direct acquisitions, then did the rounds talking up the company’s virtues and laughed all the way to the bank as shares soared when individual investors piled in, too.

In the old days, you couldn’t do this… at least not so directly.

Instead you’d make the rounds and try to convince fellow traders or “hedgies” to join your trade based on the merits of your analysis. Or, you’d hit up the sell-side analysts – meaning those facing the investing public – for a favorable report.

But now, thanks to changes in securities laws and the JOBS Act, specifically, hedge funds can advertise their services to a much broader section of the investing public and issue “research” reports that, not surprisingly, play to supposedly independent thinking, then talk about them in the mainstream media.

Illegal, you say… manipulation?

Not according to the law.

Manipulation is untruthfully talking up your book with the expectation of profit. Simply talking up your research and your opinion involves the truth… more or less.

Enter Jim Chanos.

He’s Chairman of Kynikos Associates and one of the best short-sellers in the business – meaning he makes money when companies go down in price. He’s as smart as they come when it comes to identifying companies on the brink of failure.

He thinks SolarCity Corp. (NasdaqGS:SCTY) is a company “headed toward financial distress” and has made no bones about it in widely syndicated media appearances on CNBC and Bloomberg.

According to Chanos, SolarCity is “burning hundreds of millions in cash every quarter,” and that’s a burden “Tesla shareholders will have to bear” at a total cost of more than $8 billion.

It’s thoughtful of him to help spread the word, right? He certainly wouldn’t want anybody to lose money on a bad company. Or would he?

Actually, Chanos doesn’t care… as long as he’s not the one losing.

Like any competent short seller or trader, Chanos isn’t interested in whether or not you sell at a loss, nor does he care whether your long-term investing philosophy falls prey to short-term market movement.

His only real motive is to get you – a card-carrying individual investor – to back up his position using every means at his disposal, including making his case as forcefully, bluntly, and publicly as possible.

Which, in turn, keeps the buyers away and drives prices still lower and his profits higher.

Now to the fun part… making money.

Chanos Has Plenty of Frenemies Who’d Like to See Him “Burn”

Short sellers like Chanos don’t get where they are by playing nice. Chances are he’s got more than a few hedge fund enemies who’d want to see him “burn.”

That’s another Wall Street expression you need to know.

When short sellers go against a stock like SolarCity, they sell it first to collect their money, then buy it back later at a lower price and keep the remainder of their money as profits. It’s the opposite of buying stocks first and selling later, which is how most investors do it.

Every share they sell increases the “short interest,” which is the total number of shares shorted divided by the number of shares outstanding that have not yet been covered or bought back.

A small short interest suggests that there are a small number of people who think the stock will decrease in price while a large short interest suggests that more people think it will drop.

SolarCity has a short interest ratio of 4.32, meaning that it the total short positions is 4.32x greater than the average daily volume. Amazon, by contrast, as a short interest ratio of 1.4. Even Exxon, which is one of the most “hated” stocks on the planet at the moment stands at only 4.51 – just a smidgeon higher than SolarCity’s.

That tells me a huge number of traders are vulnerable to a SolarCity rally, including Jim Chanos.

Why?

Psychology.

Remember, short sellers make their money as prices drop, but they can only drop so far. Zero is as low as prices can go. But, buyers make their money when stocks go up and the profit potential is unlimited.

Not surprisingly, sellers are far more prone to panic as a result.

And that means, in one of the great ironies of modern finance, the very people who are betting a stock will go down actually are those most likely to drive a rally if prices start to rise, because they will pay whatever it takes to get out to avoid mounting margin payments.

Hence the term “burn,” because that’s what their wallet feels like if they cannot get out quickly enough.

So now to the bottom line… Chanos or Musk.

I’m with Musk.

  • He’s got a proven long term track record and a vested interest in seeing both companies succeed. Chanos is simply interested in a short term profit and could care less about you, me, or even Elon Musk.
  • Revenue is up 81.6% year-over-year, according to the company’s latest filings.
  • The Price to Earnings Growth (PEG) Ratio stands at just 0.02; anything under 1 suggests good value.
  • Eight analysts have issued upward revisions for SolarCity over the last 30 days.

The way I see it, Chanos has his work cut out for him.

The markets love an underdog with vision and I can’t think of an executive today with more vision than Elon Musk.

Until next time,

Keith Fitz-Gerald

17 Responses to Jim Chanos vs. Elon Musk – Here’s How You Side With the Winner

  1. Albert Mouton says:

    Well at least two of your associates will find this article amusing…
    But very informative, nonetheless.
    Thanks, Keith.
    I always enjoy your articles.

    • Keith says:

      Thanks for the kind words, Albert!

      Best regards and thanks for being part of the Total Wealth Family, Keith 🙂

  2. Andy Hayward says:

    Keith,
    I cannot believe that you are a TSLA kool-aid drinker!
    These two cash furnaces will only ever burn more cash while Elon gets his butt saved by the SCTY bailout. Your metrics don’t make sense as they have never made a single $ profit and as you have just mentioned so called ‘experts’ are hoping to pump the stock higher which is why they are revising their estimates. This one will go bang before very much longer and I must say that I am disappointed in you being one of the shills pumping the stock. Incidentally, I own a Model S which is a very good car. The company, not so much. I hope it succeeds but eventually the market will tire of supporting this ‘green’ cause and a lot of retail shareholders will lose their shirts very quickly.

    • Keith says:

      Hi Andy and thank you…I think.

      First, there’s no Kool-Aid here. Today’s markets are driven by vision not necessarily capital and the same cash burning comments could be applied to Amazon, Apple, Google, Facebook and dozens of other companies over the years as they grew.

      Yet, the personalities who drive them stand tall – Bezos, Jobs, Page, and Zuckerberg just to name a few – as do share prices. Every $10,000 invested in Microsoft at the IPO is worth approximately $5.6 million today despite overwhelming opinion that Gates would fail in the early days.

      Second, the notion that a stock will go bang “before much longer” is a matter of opinion. That we agree to disagree is good because that’s how the game is played. For every buyer, there is a seller and vice versa.

      My opinion is that it’ll be very hard to lose money with Tesla if you have the right perspective and tactics which, by the way, can include both longs and shorts. The fact that you seem to think investors will lose if prices drop suggests you are only playing one side of the game and, by implication, missing half the profit potential.

      That’s too bad because waiting out the dissenters is merely a matter of appropriate risk management. For every Chanos, there is a Soros…or a Rogers…or a Templeton.

      In closing, I take issue with your use of the word “shill.” I do not and will not ever accept compensation for recommending a stock, bond, ETF or other financial instrument and that’s been very clear from the beginning. In fact, we have strict policies against that sort of thing that bind not only me but my entire staff as well to prevent precisely the kind of behavior you’re suggesting.

      Best regards and thank you for being a part of the Total Wealth Family, Keith 🙂

      • Andy says:

        Keith,

        I apologize for the use of ‘shill’ I should not have used it. I purely meant that these feelgood items seem to always surface when there is something bad happening (earnings?) and it almost seems like they are orchestrated, but maybe that it just my jaundiced view. Anyhow, I am short via long dated puts so I am actually playing this stock with my convictions. I just can’t help feel that there is nothing more than just a story keeping this buoyant. However, despite how much I am sure we would all like to see them succeed, the cash is not going to be there for them to do so.
        best regards and thanks for the dialogue.

  3. Matthew says:

    There are too many question marks about the books with both of Musk’s companies. It’s a speculative trade at best. Wouldn’t recommend either.

    • Keith says:

      Thanks for chiming in Matthew.

      You’re spot on in that it’s a speculative trade. Taking it involves a look in the mirror for any investor who should (as you are) assess whether or not it fits their individual investment objectives and risk tolerance.

      Best regards and thanks for being part of the Total Wealth Family, Keith 🙂

  4. Gary says:

    I have solar city and it’s a losing position if I sell, so I decided to keep it. Don’t like selling at a lost. I think Musk was right to buy Solar City. To me it makes sense and he has enough financing behind him to keep it going until it turns around. So I’m with Musk. I think solar is a long term play.

    • Keith says:

      Hello Gary and thanks for taking the time to write a thoughtful reply.

      The transaction makes a lot of sense to me, too. Obviously there is a long way to go here but that doesn’t change the upside potential. In the meantime, there are all kinds of ways to play both sides of the fence as it moves up and down while things get sorted out. And, not coincidentally, I’ll be addressing that in an upcoming column.

      As for not selling at a loss, if I may respectfully offer a thought…losses come and go if you invest long enough. So while we may not like selling at a loss, remember to keep your risk under control. Loss or not, there’s a point where you want to be profitable not “right.”

      Best regards and thanks for being part of the Total Wealth Family, Keith 🙂

  5. Tom Behan says:

    Hmmm – not sure I can get on your side with this one Keith – at least in the short term.
    I agree in the long term, but I think existing shareholders face significant dilution along the way
    as Musk gasps for cash.

    • Keith says:

      Hello Tom.

      I think that’s an interesting point and very valid one, too – albeit it something that I am not personally very concerned about given what I perceive the end game to be. Time will tell!

      Best regards and thanks for being part of the Total Wealth Family, Keith 🙂

  6. Joseph Huber says:

    Keith:

    As a Passport Club subscriber I am commenting that Shah Gilani (Short-Side Fortunes – 7/22/16 alert) is bearish on Tesla while Dr. Kent Moors is bullish (Ride the $48 Trillion Energy Revolution). Notwithstanding the financial motives of Jim Chanos, having two of your analysts take opposing views on the prospects of Tesla is a concern for those of us who are considering this as a possible investment.

    As an accountant who has performed due diligence on numerous proposed mergers for a Fortune 200 company, It would be helpful to have a re-evaluation of the proposed Tesla / Solar City merger on the basis of the revenue and expense synergies which may result as a consequence of this merger. The combined company will have different operating characteristics than the separate entities. Absent this analysis, it’s not apparent to me whether the transaction is in the best interest of the current shareholders.

    In all fairness to the subscriber base Dr. Moors and Shah Gilani should update their followers based on the “synergized” entity which will result from the merger.

    I appreciated the analysis of the potential motivations of Jim Chanos. Thanks for the analysis.

    Joseph A. Huber

    P. S, I hereby absolve you from the “shill” label conferred on you above.

  7. Dave Freeman says:

    How can you calculate a P/E ratio of 0.02% when they show a negative income and negative cash flow. If the price is $24.30 and the LTM earnings are ($0.63), then the P/E ratio is negative.

    • William Dahl says:

      Hi Dave,

      You are of course correct — the 0.02 figure applies to the price-to-earnings-growth (PEG) ratio, not the PE ratio. That was an editing error. The text has been corrected.

      Best regards and thank you for keeping us on our toes,

      William Dahl, Associate Editor

  8. Martin says:

    Michael Lewitt’s “Sure Money” is recommending puts on Tesla since the merger – he’s with Chanos! It’s a game!

  9. Barb says:

    Any updates on Ekso and Gtn?

  10. Michael Hassan says:

    I think it is a very healthy organization that can hold two diverging views on the same stock. Think of it this way: you have access to both sides of the story so you can make a better decision whether to participate or not. This is not something to complain or worry about, rather use it.

    Just my opinion
    Mikey

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