18 Sep 2020 Nikola and Startup Investing

“The short seller said a 2018 promotional video showing a prototype of a Nikola semi-truck traveling down the road was staged and that the truck was rolling down a hill rather than propelling itself….Nikola said the video, titled as showing the truck ‘in motion,’ never stated the prototype was driving under its own power.”

The above comes from a Wednesday article in the Wall Street Journal about Nikola—if you’re unfamiliar with this company, think of it as the Tesla of semi-trucks, just without having actually sold any trucks—and a short seller’s report that the startup company overstated the level of technological progress it’s made in its bid to produce and sell trucks.

Of course Nikola and its executive chair Trevor Milton staunchly deny there’s anything to this report, saying that the short seller is simply trying to drive down the price in order to profit from being short the stock (which, of course it is). The SEC and the Feds are examining the allegations, and who knows what they will find. Maybe there’s a smoking gun à la Theranos, or maybe this is just another of countless examples of the vast grey area between marketing and auditable statements.

I don’t have a dog in this race, by the way. If you’ve read more than about three articles coming from the collective Beacon brain trust you will have seen that we generally do not recommend investing in individual stocks, whether they are startups who haven’t seen a single dollar of revenue or companies that make so much money they often return some of it to shareholders in the form of dividends and share buybacks. On the other hand, I’m rooting for Nikola, because it seems like it could be a really cool technology, a plus for the climate, and ultimately a boost to the economy.

The point is either way, this is a fascinating little insight into just how risky individual stock plays can be, especially in the startup space. Startups are incentivized constantly to flirt with and often cross the line between marketing their capabilities and marketing their perhaps unrealizable hopes, and there is precious little clarity for investors of any size to parse out which is which. In this case, Nikola showed a video of a semi-truck moving, and any semi-reasonable person would assume it was of its own battery-operated volition, but of course Nikola never explicitly said that, and therefore it’s at this point a bit of a tossup. Think about the razor thin edge of that. A truck company may or may not be able to actually make trucks that can move without being gravity-fed down a hill, and investors have to decide whether they read the tea leaves in favor of profitable self-propulsion (and therefore buy the stock) or gravity propulsion (and therefore do nothing, or in this case, short it).

But how does an investor “read the tea leaves”? If you’ve spent any time reading 10-Ks, the sheer amount of disclosure required of public companies (and therefore the sheer amount of work required by auditors to give an opinion on those financial statements), well, it’s dizzying and bordering on the absurd. But even with all of that disclosure, at the end of the day, the video on the screen of the truck “in motion”–gravity fed or not!–carries such an outsized weight in even the professional investor’s mind relative to balance sheets and income statements. Again, this is especially true of startups, because like in the case of Nikola, there’s often not much else to see! Nikola reported $36,000 of revenue in their most recent quarterly filing, and oh by the way it was for installing solar panels at their founder’s house. On the strength of $36,000 in revenue and a grand, incredible vision with hopefully some substance, they currently have about $700,000,000 in cash on hand from investors, after having already burned through $300,000,000 cumulative dollars to date.

If all of this sounds insane to you, it’s because it is! It is. Even if the short-seller report is totally fabricated and Nikola is vindicated, it’s still insane that a company with basically zero revenue can raise hundreds of millions of dollars with some prototypes and great videos. But sometimes the prototypes become real live products, and sometimes those products sell a whole lot, and then it seems in hindsight that the millions of dollars ponied up by early investors was a bargain. And therein lies the rub: the very thing that makes investing in startups so potentially, gobsmackingly lucrative is exactly what makes them functionally the same as playing high stakes roulette. If the audited financial statements don’t really have much in them, then investors are forced to make a call on whether a founder’s hopes and dreams are realizable (and eventually profitable!), and that’s not a position in which people who are investing for individual and family goals should ever put themselves.

So Nikola is really cool, and by definition so are most of the other startups you’ve heard of, but investing in them at early stages is not something we would recommend unless you are absolutely nailing all of your other financial goals and have a small pile of cash you’d like to burn. Eventually, if Nikola starts producing and selling battery-powered semis and proves to be a viable competitor, you will by definition be investing in them by simply investing in the whole index of US stocks. Until then, enjoy the hype responsibly!