Sahm Adrangi short CARG; China comments; GE; McKinsey; Sheryl Sandberg; Israel; Matt Rose; Tesla

1. Another speaker from our shorting conference two weeks ago, Sahm Adrangi of Kerrisdale Capital, gave us permission to share the video and slides from his pitch of CarGurus (CARG).

2. A friend who's lived and invested in China for many years sent me these interesting comments in response to an article I sent to my China email list, China's Economy Slows Sharply, in Challenge for Xi Jinping (if you'd like to be added to this list, simply send a blank email to china-subscribe@mailer.kasecapital.com):

Yes – things here are challenging – though more it seems from a general sentiment perspective than the day-to-day actual financial results folks are experiencing. That being said, poor sentiment and future outlook could over time become self-fulfilling – especially if the current trade/nationalistic rhetoric/actions continue to deteriorate.

In the manufacturing-related businesses that we are close to (like those discussed in the article), we have actually seen strong results to date with much of their 2018 businesses being dramatically front-loaded in anticipation of a worsening trade situation. Essentially they have completed their year's work early, and in most cases with significant gains over last year in terms of total expected 2018 revenues and profitability. While 2018 looks quite good, there is a great deal of concern for 2019, and many of these companies have been focused on developing/implementing alternative plans for the coming year to manage their business either through diverting production to factories outside China or markets other than the United States.

For more domestically focused businesses, we have seen mixed results. Definitely a slowdown in large scale discretionary purchases like autos or homes, though day-to-day consumption continues to expand significantly. for example, has experienced substantial (mid/high teen) growth this year at retail (including through 3Q) with significantly higher growth in terms of online revenues. Overall there continues to be quite robust consumption growth and a relatively positive outlook going forward. That being said, the capital markets have been off dramatically since the mid-January 2018 highs, and this has taken its toll on overall domestic sentiment.

Important to keep in mind that 2017 was a big year for China, with the equivalent of nearly $1.2 trillion in additional GDP, the highest level of absolute economic growth ever experienced to date in China, equivalent to the size of the entire Mexican economy. The China-related capital markets had a banner year in 2017 as well. In early 2018, the Chinese government felt things were getting overheated and started their deleveraging campaign to calm things down. The resulting capital markets decline and RMB depreciation were well on their way when the trade war/United States-China relations challenges started gathering momentum in the summer.

While I'm generally optimistic over the medium-/long-term for continued economic growth here in China, I am quite concerned that the rhetoric on both sides of the trade dispute and more generally overall United States-China relations is misguided and getting out of control. This is not in either country's interest and most unfortunate given all of the areas that the two countries need and should be working more closely together (trade, energy, environment, public health, regional security).

We certainly live in interesting times...

3. Some very long and insightful articles over the weekend. Let's start with the WSJ, GE Powered the American Century—Then It Burned Out. Excerpt:

The leadership meeting usually left executives refreshed, reassured that the foundation of GE's success was not the power turbines or the jet engines so much as the people in that room, managers groomed in Crotonville who believed they could enter any industry, anywhere and dominate it.

Now, as they shuffled out after Bornstein's talk, many felt shock and confusion. The reckoning had been a long time coming, and it was far from over. GE had defined and outlived the American Century, deftly navigating the shoals of depression, world war and the globalization of business. Even when things were at their worst, its belief in its history and its prowess made it feel titanic and impregnable. And, yet, unsinkable GE was taking on water fast.

4. How McKinsey Has Helped Raise the Stature of Authoritarian Governments, NYT. Excerpt:

For a quarter-century, the company has joined many American corporations in helping stoke China's transition from an economic laggard to the world's second-largest economy. But as China's growth presents a muscular challenge to American dominance, Washington has become increasingly critical of some of Beijing's signature policies, including the ones McKinsey has helped advance.

One of McKinsey's state-owned clients has even helped build China's artificial islands in the South China Sea, a major point of military tension with the United States.

It turns out that McKinsey's role in China is just one example of its extensive — and sometimes contentious — work around the world, according to an investigation by The New York Times that included interviews with 40 current and former McKinsey employees, as well as dozens of their clients.

At a time when democracies and their basic values are increasingly under attack, the iconic American company has helped raise the stature of authoritarian and corrupt governments across the globe, sometimes in ways that counter American interests.

Its clients have included Saudi Arabia's absolute monarchy, Turkey under the autocratic leadership of President Recep Tayyip Erdogan, and corruption-plagued governments in countries like South Africa.

In Ukraine, McKinsey and Paul Manafort — President Trump's campaign chairman, later convicted of financial fraud — were paid by the same oligarch to help burnish the image of a disgraced presidential candidate, Viktor F. Yanukovych, recasting him as a reformer.

5. The Rise, Lean, And Fall Of Facebook's Sheryl Sandberg. Buzzfeed. Excerpt:

It wasn't until November — and the New York Times investigation — that Sandberg became the focal point for external and internal blame. She reportedly pushed for others to take the fall for actions she'd approved or overseen, including opposition research intended to "slime various and sundry detractors," as Kara Swisher put it, including George Soros. "So now come the calls for her comeuppance."

The logic makes sense: Why blame Zuckerberg? He's just a kid. Blame the adult in the room. Blame the unicorn. But optics make that blame difficult, or at least difficult to act on: As one anonymous Facebook employee explained, "One does not simply fire the author of Lean In and pretty much the sole female executive in top leadership."

And so Sandberg soldiers on, even as employees increasingly turn against her, however privately. Externally, Swisher and others have interpreted the critical pile-on against Sandberg as sexist, or ammunition for those retrograde few arguing that this is what happens when women attempt to "have it all." Others have pointed to the ways in which her fate exemplifies the hollowness at the heart of leaning in: Sandberg's advice has always centered on getting a seat at the table, Molly Roberts argues, and then keeping "everything exactly the same," from how Silicon Valley conceives of women to how Facebook considers its responsibility to society at large. Within this paradigm, "leaning in" is fundamentally about abdicating responsibility or desire for substantive change.

That reading feels true — but also just one component of a large, complex reaction. When Sandberg became a public figure, she was represented as exceptional, a paragon of female leadership, rooting for every woman in the world. But there was something missing from that image: her actual work at Facebook. The reality of Silicon Valley is that it's commerce by any means necessary. And the reality of Sandberg is that she's excellent at it. Which explains why her COO behavior was treated as a "revelation": There was so little room in her tidily constructed image to accommodate behaviors presumed natural for men operating within a capitalist system.

Back in 2013, one of Sandberg's former professors was trying to explain her appeal and aura to Brad Stone at Bloomberg Businessweek. "One time my wife said, 'There are so many things that you want to be envious about and hate her. And you just can't.'" Sandberg's armor of likability is gone now, and it's far easier to blame her for what Facebook's become. But in blaming, or even hating, her — without situating her within the larger context of Silicon Valley, the demands of venture capital, and the logic of the stock market — she becomes something just as mythical as she was before: a supervillain.

6. Good to see inbred corporations and boards in Israel being shaken up: The Tycoons Ruled Israel. Then Came Billionaire Paul Singer. Excerpt:

The tycoons had amassed so much power that by 2013 about half the value of Israel's stock exchange was effectively run by 20 families. A new law at the time sought to limit their influence by splitting conglomerates that owned major financial and industrial companies. But while some started to reduce stakes, their influence in boardrooms endured.

"The market here is small and everyone knows each other," said Amir Shachar, a partner in the Israeli law firm Shibolet & Co. who specializes in areas such as corporate governance. "If you're an activist, you're going to pay a price socially.''

7. An interesting (and rare) in-depth interview with Matt Rose, who will retire in April after six years as Executive Chairman and 13 prior years as CEO of Berkshire Hathaway-owned BNSF Railway. Buffett said of him: "It was a very lucky day for me and for Berkshire Hathaway when I met Matt Rose. Under Matt's management, BNSF has become a major source of profit and pride for Berkshire. And, as a citizen, Matt has been an exemplar for corporate leadership." Matt Rose: "Less is NOT better". Excerpt:

I think we're at a tricky time now. The Street—I'm talking about sell-side analysts—has been extremely aggressive with the publicly traded railroads. They're saying that less is better. Less capital is better. Fewer market opportunities are better. Fewer unit trains are better. It's all about lowering the operating ratio. I disagree with almost all of that. I truly believe that every industry, every business, needs growth.

Vantuono: So you would say less is not better?

Rose: Absolutely. It's not. Let me tell you why. If you go back to the 1980s, you saw where some railroads had a singular focus on operating ratio. And the easiest way to reduce operating ratio is to take out track and reduce maintenance expenses. That's really not the covenant, if you will, we have with our regulator, the STB, and even public policy makers. The Staggers Act wasn't, "Railroads, haul only what you want to haul on your network." It's "Haul everything, and you have the ability and the flexibility to differentially price on your network." That's the deal, and it's in the public's best interest to move more tons to the railroad network, not to move tons off the railroad network.

So, I think we're going into an interesting period where that will all be sorted out. I can't tell you how it's all going to work out, but there's going to be a lot of activity.

... BNSF's mission has simply been to provide a great service through the heartbeat of the railroad—capital investment. Expand the railroad. You see every year that we do expansion in our company, and then provide service that's going to get more customers to use our railroad in more locations.

... Vantuono: How do you view hedge funds coming into our industry? Do you think it's been beneficial, or not? Is the hedge fund era over, if there was a hedge fund era?

Rose: When we were publicly traded, I would go to sell-side conferences. It used to be me with investors and sell-side analysts. And then it changed. The meetings got larger. There'd be 20 hedge fund analysts; they all seemed to be under 30 years of age. Creating transparency about how you're doing versus another company, and the old spirit of how you're running your company versuss somebody else, I think that's fine. But when a hedge fund says, "I really want to know how you're going to do next quarter" on a railroad that is making 30-, 40-, 50-year-long asset investments, it's really not consistent.

The day after we had our shareholder meeting, and the shareholders voted 97% in favor of the Berkshire Hathaway transaction, it was snowing in Fort Worth. I'll never forget. I called Warren, and I said, "Okay Warren, you now own a railroad. Congratulations. What do you want me to do? You want me to come to Omaha and bring a power point and show you what our next five-year plan's going to be?" And he said, "No. I want you to run this company like you own it, and you're going to be in charge of it for the next 100 years." And I don't think that's consistent with a hedge fund wanting to know what the next quarter's going to look like.

8. Yet another article documenting Musk's erratic (at best) behavior: Dr. Elon & Mr. Musk: Life Inside Tesla's Production Hell. Wired Magazine. Excerpt:

"You're a fucking idiot!" Musk shouted back. "Get the fuck out and don't come back!"

The young engineer climbed over a low safety barrier and walked away. He was bewildered by what had just happened. The entire conversation had lasted less than a minute. A few moments later, his manager came over to say that he had been fired on Musk's orders, according to two people with knowledge of the situation. The engineer was shocked. He'd been working so hard. He was set to get a review from his manager the next week, and had been hearing only positive things. Instead, two days later, he signed his separation papers.

On a Wednesday morning a few weeks later, Musk returned to the Gigafactory on his private plane. Tesla had started firing hundreds of other employees for performance reasons—more than 700 would eventually be let go. Musk was scheduled to talk to the plant's workers, to inspire them to push through what Musk had forecast would be a "manufacturing hell." The Gigafactory needed widespread fixes; there was no way the plant would produce 5,000 batteries a week anytime soon.

When he arrived, Musk began marching through the factory. He walked along the assembly line, red-faced and urgent, interrogating workers he encountered, telling them that at Tesla excellence was a passing grade, and they were failing; that they weren't smart enough to be working on these problems; that they were endangering the company, according to someone who observed him.

Employees knew about such rampages. Sometimes Musk would terminate people; other times he would simply intimidate them. One manager had a name for these outbursts—Elon's rage firings—and had forbidden subordinates from walking too close to Musk's desk at the Gigafactory out of concern that a chance encounter, an unexpected question answered incorrectly, might endanger a career.

After Musk had patrolled the factory floor for a while, executives pulled him into a conference room. "I think we can fix this," one of his top lieutenants, Jon McNeill, told him, according to someone who heard the conversation. McNeill tried to calm Musk down, and repeated a proverb he had once heard: No man comes up with a good idea when being chased by a tiger. At that moment, Musk was the tiger. (A spokesperson for McNeill said he did not want to participate in this story.)

Musk, though, had other concerns. "What's that smell?" he asked. Everyone went silent. They knew Musk was so sensitive to odors that job candidates were told not to wear cologne or perfume when they met him. They had seen him become upset over small issues like this, had observed him attack executives for their incompetence and inabilities. One person explained that there were vats of liquid silicon nearby. When heated, it sometimes smelled like burning plastic.

These vapors were going to kill people, Musk said. They were going to kill him.

9. An interesting discussion of Tesla on the ValueInvestorsClub.com message board, which I sent to my Tesla email list (to be added to it, send a blank email to tsla-subscribe@mailer.kasecapital.com):

376     HTC2012, Reasonable Bull Case?

I am a bear on Tesla, but recently met a bull on Tesla who I consider quite smart who provided me with his positive take on Tesla being worth several hundred billion dollars in 10 years.

Overall, his thesis centers around the belief that electric cars are going to be much cheaper than ICE cars in the long-run and Tesla has a huge headstart when it comes to battery technology.

The bull says that there are far fewer parts and moving parts in a electric car than an ICE vehicle (less than 20 in electric vs. 200+ in an ICE) with the single largest cost in the electric vehicle being the battery (makes up the vast majority of the cost of the electric car). The bull believes that Tesla has a large lead in battery technology and that further advances in battery technology will contintually drive the cost of the battery down over time. As a result, at scale, an electric vehicle manufacturer can make sustainably much more $$$ per car even at lower price points than an ICE manufacturer since the cost per electric vehicle at scale will be far lower than an ICE vehicle at scale. This will give electric vehicle manufacturers a sustainable cost advantage vs. ICE manufacturers that will enable them to take significant share over time.

The bull believes that Tesla will be the first company to get to scale in electric vehicles and therefore develop this sustainable cost advantage vs. ICE manufacturers. Why Tesla and not another company?

#1: He believes that Tesla's battery technology is by far the best and that other electric vehicle manufacturers costs are much higher than Tesla's. It will take years for others to catch up to where Tesla is today by which point Tesla will widen its battery advantage and drive down its cost.

#2: ICE manufacturers who are now starting to make electric vehicles (GM, Ford, Jaguar, etc.) are not incented to sell those vehicles en masse because it's cannabilizing their higher margin, profitable ICE vehicles. They are just doing it to get tax/incentive credits and comply with regulators.

The overarching view/thesis is that the electric vehicle at scale will be far cheaper than an ICE vehicle at scale because electric vehicles have far fewer parts and battery costs will be going down. Tesla will be the winner because they have the best battery technology.

As a result, he believes that Tesla will be able to earn 15%+ operating margins at scale in the long-run while underpricing the competitors.

I have my own view on this thesis but curious what other people think.

377     Light62, Re: Reasonable Bull Case?

Not really an answer to your question and I'm not that close to the situation but doesn't Tesla intentionally not patent anything? If that's true how could they have a durable (and expensive to cross) moat around their battery technology ?

378     hkup881, Re: Re: Reasonable Bull Case?

A TSLAQ battery is just an off-the-shelf Panasonic battery and due to the price they signed their long-term take-or-pay contracts at, is set at a price level that is competitively more expensive than Panasonic sells the exact same batteries to other producers.

TSLA then takes those batteries, puts them into bandoliers (old tech vs what everyone else is doing) and punctures a few along the way.

They have ZERO competitive advantage here. Much like they have no competitive advantage in pretty much anything else except stock promotion...

There seems to be a lot of anecdotal evidence that demand is collapsing in Q4 (inventory cars building up in random SHLD/M/JCP parking lots and the assembly operating at half capacity the past few weeks) and what is sold is at lower ASPs. Q1 may see one last uptick due to them selling into Europe, but that is only a few weeks of demand at the higher priced ASPs. Then what? Le Deluge?

379     TallGuy, Re: Re: Re: Reasonable Bull Case?

For starters – I think EV adoption will take much longer than forecasted due to supply chain issues (see my thoughts in my ORLY write up). Second it took me a minute to write this up and Hkup and Light addressed the same points.

#1 Quoting Elon, "all our patents are open sourced" and see blog https://www.tesla.com/blog/all-our-patent-are-belong-you This should inherently limit Tesla's ability to have a sustainable competitive advantage from technology alone.

One could go down the rabbit hole of Tesla's relationship with Panasonic as well to counter this point.

Another element of tech advantage is human capital. Simply smarter people want to work at Tesla rather than GM and F. This is likely true and I buy that argument. Here is the WSJ's take. https://www.wsj.com/articles/tesla-is-the-hot-spot-for-young-job-seekers-1543150801. Arguably the number one asset for recruitment is Elon. Arguably the largest liability and reason for turnover is also Elon. I see Elon as a net liability to Tesla's work place environment.

#2 Since battery technology is not a durable advantage then 15% operating margins (if Tesla get there) will likely not be sustainable as competition enters the market. Consumers will then make their choices based on branding, capabilities, and ultimately price. If you have time read The Machine That Changed the World: The Story of Lean Production -- Toyota's Secret Weapon in the Global Car Wars That Is Now Revolutionizing World Industry. It was written over the 80's and 90's and its amazing how many blunders Tesla has run into that were addressed during this period.

On a broader point – When I read initially read point 2 I thought of every TMT thread on VIC. Increasing competition is disrupting legacy business models and the consumer is the ultimate beneficiary through increased purchasing power. If EVs are going to be cheaper than ICE vehicles (or OTT cheaper than cable) then where will the excess discretionary cash be spent? This is the question that I have been pondering for some time and I do not have many great answers.

Finally I have debated sharing this for some time but now seems reasonable. We are all long Tesla. If they are successful in advancing EV technology and more importantly increasing consumer adoption of electric vehicles then we all win. If Tesla fails? Why hedge your long exposure with a short position?