National Post (National Edition)
Before taking a flyer on a company like Nikola, consider these five things
The electric vehicle sector continues to be red hot. We all know how well Tesla has done, up 770 per cent in the past year.
Within the sector, the whole recent fiasco with Nikola (NKLA on Nasdaq) has been fascinating. After a quick reverse takeover IPO, the company had a market capitalization of US$35-billion in early June (it is US$7.7 billion today). The story has it all: rampant speculation, a critical short-seller report, a flamboyant founder and an electric truck that was filmed in a video `in motion' but actually was proven to be just rolling down a hill and under no power of its own.
Sure, the Nikola story makes for great press. But people forget that real people have lost real money on this stock. Perhaps they should have known better. But no one went into the stock with the expectation of losing money. So, what can we learn from this whole mess? Here are five things. Perhaps keep them in mind the next time you want to take a “flyer” on a company.
Watch the founder/CEO closely
Sure, what an entrepreneur has done before is very important. But what else are they doing? Do they like the spotlight? Do they like talking about their company's stock price? Are they highly critical of any opposing viewpoint? These can all be negative signs. For us, while we did not do much in-depth due diligence on the company, it all came down to a couple of videos of the CEO we watched, where Trevor Milton came across not as a genius engineer (à la Elon Musk) but more like a spoiled child or an aggressive stock promoter hyping a stock on the Venture Exchange. But it was Mr. Milton's giant house that really made us wary. Less than a year ago, Mr. Milton spent $32.5 million on a house/ranch in Utah. It was a record price for the State. Now, we have no issue with a successful entrepreneur spending some of their wealth. But a company essentially in startup mode should see their CEO essentially live at the office. We are not sure the demands of a 2,000-acre ranch are what shareholders want to see their CEO spend their time on.
A company with real sales is less risky
Let's face it, no investor has the ability to properly evaluate all the potential emerging technology out there. Some is real, some is hype, some is fraud. One of the best ways for an investor to gain comfort is to look for actual sales. When a third party ponies up cash, then at least we know that there is a product that customers want. Without this, one never really knows. It guarantees nothing, of course, but some sales at least show that the company has the eventual potential to earn cash flow and profits. Nikola has had no sales to date, and estimates call for just $200,000 in sales in 2020. At its prior valuation, investors were taking a giant leap of faith that a saleable product would materialize at the company. Tesla, in contrast, is expected to have US$30 billion in sales this year.
How they respond to short sellers is key
When a company is attacked by short sellers, we think the best solution for a company is simply to put up strong financial numbers. “Reacting” is never a good plan in the stock market. In response to allegations, Nikola admitted that the promotional video of its truck was that of it simply rolling down a hill. The company claims that this was OK, because the video said the truck was “in motion,” which of course is technically true. But come on, seriously? This statement, and other rebuffs it made to the short report, really only made it look worse. Even ignoring the report completely might have been a better response than what the company came up with.
Valuation still matters
Despite some stocks showing the contrary, valuation is still important in the stock market. Should a company with no sales, losses and negative cash flow really be worth more than US$35 billion? Maybe, if it is a high-margin software company with massive growth potential and a giant addressable market. But a car or truck manufacturer is typically none of these things. Last year, for example, Tesla only had gross margins of 16.6 per cent and net margins of negative 3.5 per cent. It is not a high-margin business. Let's contrast that with one of my favourite growth companies, Veeva Systems (VEEV on Nasdaq). Its gross margin last year was 72.5 per cent, and net margin was 27.3 per cent. Veeva trades at 20 times' sales. But that is still better than an `infinite' valuation on a company with no sales.
Reverse takeovers can be dangerous
Nikola went public through a complex reverse takeover. This allows a faster public debut than a regular IPO process. But it also means less scrutiny. This is not always “bad” but certainly needs to be added to the list of possible risks when one is looking at any investment. Mr. Milton had numerous family members involved with the company, including his brother as “Director of Hydrogen.” According to the short report, his brother had prior experience pouring concrete.
We don't follow the company closely enough to make any sort of investment suggestion. We are not likely to, either. But a company with an expensive (still) valuation, minimal sales, negative cash flow, short sellers circling, nepotism, losses, over-promotion (to be kind) is certainly not the type of investment we look for.