Tesla is the poster child of the ZIRP insanity era. Even if you’re a “permabull” who has a shrine to Elon Musk in your living room, justifying such a high share price is impossible. With the market pricing its stock for perfection, “Tesla is the future bro!” doesn’t cut it at these levels.
Tesla has never posted an annual profit in its seventeen-year history, it’s founder Elon Musk declared on Twitter that the company’s “stock price is too high”, and the automotive industry faces a continuous slump. Yet, the market values the electric car company at a whopping $225 billion, more than all other major automakers combined.
But in this zero interest rate environment ripe with fraud, moral hazard, and risk, Tesla’s $225 billion market cap appears rational in comparison to the latest “story stocks” gaining energy in today’s mayhem-filled market. Take Nikola Corporation ($NKLA): a $26 billion EV truck company with not only zero profit but zero revenue. How is this possible, you may ask?
Nikola’s soaring stock price looks to be the result of clever stock promotion, not fundamentals. Insiders plant the seed, the story seeps into the media, and the stock explodes higher. They walk away with multiple times their money, leaving duped retail investors holding the bag — not to mention exacerbating the wealth inequality epidemic.
It’s a classic late-cycle sign when Wall Street embraces an unloved financial technique and turns it into a profit machine, but one on the verge of fraud like the madness of “CDO-squared” subprime mortgages in 2007. Stock buybacks have been the go-to way for Wall Street and the Fed to pump up stock prices and make up for the peak in corporate profits and real earnings growth. But with the Fed using most of its ammo to fight against COVID-19, stock buybacks have become unviable, and insiders have been forced to find “inventive” ways to make money.
Nikola’s stock price rise seems innocent enough giving Tesla’s stock price success, but it seems too good to be true. Nikola went public via a SPAC: a Special Purpose Acquisition Company — one of those terms Wall Street uses to confuse you and make you feel stupid while the concept remains simple. A SPAC “is a company with no commercial operations … formed strictly to raise capital through an initial public offering (IPO) for the purpose of acquiring an existing company.” In other words, SPACs allow anyone with decent financial connections to acquire companies and take them public without an IPO.
SPACs have existed for decades and have been associated with various frauds and stock promotion schemes. Still, the finance industry continues to embrace them. IPO fundraising has increased from $3.2 billion in 2016 to $13.6 billion in 2019, attracting big players from Goldman Sachs to high-level executives looking for short-term money-making opportunities. Even Richard Branson used a SPAC to take Virgin Galactic public in 2019.
Nikola is a legit company, of course, but its recent price action shows someone may have used the company’s vision to make a quick buck. In a crony capitalist system, all you have to do is create a story, a narrative that your company will change the world and you can profit from retail investors trying to capitalize on the next “big thing”.
In a more conservative environment, you had to convince investors that your idea was good enough to go public — even though most of the recent “tech unicorns” were a laughing stock, losing 50% or more of their original IPO price. To create the next big tech idea, all you had to do was build an app that provided a convenient way to perform an everyday mediocre task like buying dog food or hailing a taxi, and boom! You created an innovative company. And the best part is it didn’t have to make money. Profitless unicorns like Slack, Uber, and Peloton demonstrated that if you kept convincing investors to buy your debt, no matter how toxic or how risky, you survived — providing you had some resemblance of cashflow.
But SPACs bypass all that. When you take companies public without the initial media buzz of an IPO, the stock price stays muted while you build a covert position in the stock. Nikola merged with VectoIQ, a relatively unknown company with a limited online presence, and since few investors knew about Nikola back then, the stock popped initially but fell back to pre-merger levels, and the rest is history.
To cash out of a stock promotion scheme after a traditional IPO, you have to wait 180 days for the lockup period to expire, but with a SPAC, there’s no lengthy lockup period and you can cash out instantly. Once the “dumb money” has piled in, insiders who have bought a massively discounted stake can trundle straight to the ATM without raising any red flags at the S.E.C.
Wall Street knew that retail investors high on cheap money and stimulus checks would likely punt on a stock with similar characteristics to Tesla despite the blatant similarities. An EV company? Tick. Gets its name from Nikola Tesla? Tick. No recorded annual profit? Tick. A CEO with similar traits to Musk looking to sell the green dream? Tick. Quite simply, Nikola was a stock primed to explode once its story seeped into the mainstream.
With stock valuations approaching Dot-com Bubble levels, Wall Street knows the net is closing in and opportunities remain slim, so SPACs provide them with a vehicle to squeeze blood from a crumbling stone. With 0% interest rates and the Fed marking everything that’s junk as “investment grade”, it’s the ideal time to pump story stocks and take profits in an unethical but legal way, and that’s all that matters.
But if you think the party is coming to an end anytime soon, don’t be surprised when SPACs become the first of many ways Wall Street tries to fleece Main Street. If they are only a smidgen of what crony capitalism can create when left to fester and grow, then the ZIRP absurdity era has only just begun.
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Disclaimer: This article is not investment advice. The author does not hold a position in Tesla Motors nor Nikola Corporation.