The increase in short positions in NIO (NIO), the manufacturer of electric vehicles, is impressive. Many short sellers believe that they will be making tons of dollars when the share price collapses in the following months. I don’t know whether that will happen soon or later. However, I do believe that there is a significant number of reasons to justify a short position in NIO. In this article, I have found five reasons, but I believe that there may exist many others.
Number 1: Lack Of Profits
NIO has never been profitable. While the company reports sales growth, net income has been always negative. As a result, I would not expect that value investors will be investing a single dollar in the company. Short sellers know well about the company’s lack of profits. It explains why so many shorts decided to take a position in the company:
We have only recently started to generate revenues and have not been profitable since our inception. We incurred net losses of RMB5,021.2 million, RMB9,639.0 million, RMB11,295.7 million and RMB2,868.5 million (US$406.0 million) in 2017, 2018, 2019 and the six months ended June 30, 2020, respectively. In addition, we had negative cash flows from operating activities of RMB4,574.7 million, RMB7,911.8 million, RMB8,721.7 million and RMB523.1 million (US$74.0 million) in 2017, 2018, 2019 and the six months ended June 30, 2020, respectively.
Number 2: Lack Of Expertise
NIO has limited experience in high volume manufacturing. Most analysts out there have developed sophisticated mathematical models to justify the current valuation of NIO. They believe that manufacturing 10,000 cars is not as complicated as manufacturing one million. I don’t believe that they really thought about it. NIO does not currently have the due know-how to efficiently manufacture a large amount of cars. Of course, the company will acquire that know-how in the future. However, it will take time, and most importantly, it will take a lot of the shareholders’ money. If you are clever, you will wait a few years before buying shares. Let’s see whether the company manages to compete with BMW, Mercedes, and all the other old brands. Notice that they have manufactured brands for the last 100 years. You don’t get that kind of expertise in one day.
We have limited experience to date in high volume manufacturing of our electric vehicles. We cannot assure you that we will be able to develop efficient, automated, cost-efficient manufacturing capability and processes, and reliable sources of component supply that will enable us to meet the quality, price, engineering, design and production standards, as well as the production volumes required to successfully mass market the ES8, the ES6, the EC6 and future vehicles.
Number 3: Lack Of Infrastructure In China
There is another clear risk that nobody is talking about. NIO customers require a network to travel. You need to have charging stations all over the country to drive an electric car. As NIO noted in its annual report, China does not have a public charging network in place. As a result, many drivers will think twice before buying a NIO or any other electric car. Don’t be naive, the lack of infrastructure will diminish the company’s sales growth.
In addition, although the Chinese government has supported the roll-out of a public charging network, the current number of charging infrastructures is generally considered to be insufficient.
Number 4: State-Owned Automobile Manufacturer
NIO received a significant amount of money from the Government of China. Besides, the company manufacturers some of its cars in a plant owned by the state. Most investors don’t want to deal with companies that are controlled by politicians. There are many reasons to explain this. Politicians may decide to discontinue the plant operations, or they may decide to stop financing NIO. This type of events cannot be foreseen, and they actually happen. Read the following lines about how, in 2019, the government decided to decrease some of the subsidies given to NIO:
China’s central government provides subsidies for purchasers of certain NEVs until 2022 and reviews and further adjusts the subsidy standard on an annual basis. The 2019 subsidy standard, effective from March 26, 2019, reduced the amount of national subsidies and canceled local subsidies, resulting in a significant reduction in the total subsidy amount applicable to the ES8 and ES6 as compared to 2018. We believe that our sales performance of ES8 and ES6 in 2019 was negatively affected by the reduction in the subsidy standard.
There is more. According to documents given by NIO, the company agreed to pay state-owned partner JAC for operating losses. As said, NIO reports a significant amount of operating loses. Hence, it had to pay a significant amount of money both in 2018 and 2019. To sum up, shareholders not only suffer losses, but they also have to pay the Government of China for the losses. I am sure that short sellers know this:
In addition, to the extent the Hefei manufacturing plant incurs any operating losses, we have agreed to compensate JAC for such operating losses. As of June 30, 2020, we had paid JAC a total of RMB804.3 million, including RMB381.6 million as compensation for losses incurred since 2018 and RMB422.7 million for manufacturing and processing fees.
Number 5: Extremely Overvalued Market Capitalization
NIO currently has a market capitalization of $72 billion, which is more than the market capitalization of General Motors that has a market cap. of $65 billion. Many individuals in the market will not be able to justify such anomaly in the valuation of NIO. General Motors reports sales of $115 billion, and gross profit of $14 billion. NIO does not report positive gross profit, and has sales of $4 billion for the next year. Long investors will claim that NIO expects larger sales growth than General Motors. It is true. However, I don’t believe that NIO’s revenue growth could justify such massive valuation.
My Take
In my opinion, the market is currently wrong about the valuation of NIO. I don’t think that anybody could explain why the valuation of NIO is larger than that of General Motors. The fact that the Government in China is a partner of the company does not seem to bother people. Besides, NIO’s lack of expertise in the automotive industry is also not correctly understood. Yes, I do like NIO and believe that the business model is promising. However, don’t ask me to buy shares when the total market capitalization is equal to $72 billion. I am sorry, I am not a buyer.
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Disclaimer: I don’t own NIO shares or GM shares.
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