$TSLA: Tesla stock will become even more complex if its China operation is structured as a Variable Interest Entity | Jan 2020


With all the great work that has already been done by $TSLAQ in dissecting the SolarCity bailout, there is one aspect of the fraud that hasn’t been given much attention yet: the numbers.
If you’re into it – a ridiculously long thread 

2. I think the subject of this thread is important because if Tesla’s Chinese operations are structured as a VIE, which seems to be the case, we’ll soon revisit SolarCity’s accounting mess. With ample opportunity for Tesla to misrepresent it’s financial wellbeing. 

3. For those who are new to the concept of VIEs (Variable Interest Entities): it’s a special purpose vehicle, owned for 99% or more by outside investors who have a deal with the parent company that owns 1%, to give back full ownership to that parent at a later stage. 

4. VIEs are common practice in the solar leasing business because it allows the outside investors to profit from incentives in the form of tax deductions – something the solar companies themselves can’t do as they are too miserable to pay taxes. 

5. VIEs are also common practice in China because the country doesn’t allow foreigners to invest in Chinese companies. If you invest in Alibaba, for example, you actually invest in a shell that has a deal with a private company which is owned by private investors. 

6. The shell collects the money from investors in the US, lends it out to the private company and if they ever fancy to give it back, the US investors can collect their profits. That sounds sarcastic but every of these Chinese vehicles has similar language in their risk factors. 

7. Here’s a fine example of such language from the company TAL Eduction Group. It says the company can not assure that the CEO and other executives will act in the interest of investors when a conflict of interest would arise. That’s quite something, isn’t it

8. For accounting – and then I’ll come to calling out Tesla again 😇 – the financials of the VIEs have to be fully consolidated in the financials of the minority parent because it will in the end be the beneficial owner. 

9. That’s why BABA’s financials look like investors are owning the actual retail giant. It’s because the financials of the private company are consolidated in what is otherwise an empty shell. At SolarCity the financials of the VIEs were also seamlessly consolidated. 

10. Okay, Tesla time:
When Tesla proposed to bail out SolarCity it had this paragraph in a letter to shareholders in which they asked them to vote Yes.

11. Sounds good so far, and to back it up with numbers the paragraph went on like this:

12. The paragraph closes with:

13. Let’s also include the start of the next paragraph – just for fun

14. My point is about the second part of the previous paragraph though, which at first seems fine and attractive but is as deceptive as can be, to a point which in my opinion is far beyond the grey area in which Tesla seems to thrive 

15. The first problem is with the expected $8B which was overly optimistic in itself but also was just a projection of revenue. And revenue is as such not very useful to pay back debt. Cash flow is, but that number wasn’t projected. 

16. At the end of 16Q2 Tesla indeed had $5.2B in solar assets on its balance sheet. It also had $1.5B in recourse debt, and $1.7B in non-recourse debt. Which brings us to problem number two. 

17. Did Tesla overlook the $1.5B in recourse debt when they said “These customer payments fund the retirement of SolarCity’s non-recourse debt. SolarCity’s recurring cash flows exceed a net present value of $2 billion above and beyond non-recourse debt repayment”? 

18. I think that many Tesla investors overlooked the fact that $1.5B of the remaining $2B in cash flow would be needed to also pay back the recourse debt of the company. Leaving just half a billion for Tesla investors to party with.
But it gets worse. 

19. Far worse. Because when you re-read that paragraph from the shareholder letter you’ll notice that there is one group of stakeholders that Tesla, in its hurry to get the deal done I presume, completely overlooked: the third party investors in the VIEs. 

20. At the end of 16Q2 all third party investors in the VIEs had collectively brought in $3.1B in equity in those VIEs, in exchange for 99%+ of the ownership. A few of them were also providers of non-recourse debt but the equity is completely separate from that debt. 

21. And the problem is that these third party investors also wanted a return on investment. Some of them were even promised guaranteed returns, independent of how much revenue the solar systems would generate. 

22. As explained in tweet 4, part of their return would come from the government, in the form of tax reductions, so that’s a relief. But the other part would have to come from revenue generated by the leased solar systems which these investors had funded. 

23. The fact that SolarCity only mentioned repayment of non-recourse debt in the paragraph is due to the fact that the money generated by the VIEs would first go to the outside investors, before SolarCity, or later Tesla, would be able to use it to repay recourse debt. 

24. Needless to say that the $2B mentioned in the paragraph would not be enough to give the outside investors, who had brought in $3.1B, a decent return and also repay the $1.5B in recourse debt.
It’s why the bailout was needed and it’s what could not be told to Tesla investors. 

25. As a sidenote for those who’re new: “Net income (loss) attributable to noncontrolling interests and redeemable noncontrolling interests in subsidiaries” at the bottom of Tesla’s income statement still refers to the part of income that “belongs” to these 3rd party investors. 

26. All this isn’t new, of course, and I’m probably a bit late to the party to call the SolarCity bailout a tad fraudulent anyway, but it is an important story to keep in mind when Tesla soon publishes its Q4 numbers. 

27. Because here’s the thing: with Tesla not having paid a dime yet for the factory in China and with China’s rules for foreign investors in general, it seems very likely that the factory in China is owned by a VIE – a special purpose vehicle owned by Chinese 3rd party investors. 

28. Now that Tesla effectively started using the factory, showing that they are the “beneficial” owner, there is a chance that the assets and debt of this Chinese entity will from now on be incorporated in Tesla’s balance sheet, which wasn’t the case until now. 

29. Same goes for the income and cash flow statements. Which is all fine from an accounting perspective, but it can soon become nearly impossible to know what parts of these numbers belong to the activities in China. 

30. Which is important if there’s a VIE because it could mean that these parts of cash flow, assets etc. are completely out of reach for Tesla and its investors. 

31. And then there’s Tesla tradition to keep silent about third party investors, who have likely brought in most of the capital needed to build what is commonly called “the two billion factory”. These guys will makes sure they get a return before any Tesla investor will get one. 

32. In other words, when Tesla next month shows an increase in its cash position up to $5.5B, for example, it might already be impossible to know how much of that money is actually Tesla’s and within Tesla’s reach to use for their activities. 

33. Another aspect, if we’re dealing with a VIE, and then I’m referring to the TAL language earlier, is that Tesla maybe cannot assure that the management in China will always act in the best interests of Tesla, should any conflict of interest occur. 

34. Long story short: it looks like our favourite freak show has just been upgraded to the next level. In a way that leaves far more opportunities to deceive than ever before.
And with only one cash hungry man left in the cockpit, that’s asking for trouble. 

35. Except for the man in the cockpit. For now

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