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Why short-sellers met a painful end with Tesla

A customer drives a Model S out of Tesla’s factory in Fremont, Calif., June 22, 2012.

© Noah Berger/REUTERS

The denouement of the short sellers betting against Tesla Motors Inc. has been awesome to witness. The shares have nearly tripled since the beginning of the year, and vaulted up in nearly vertical fashion last week to nearly $95, as the shorts, facing the prospect of unlimited losses, capitulated by purchasing stock and closing out their positions.

But the story of Tesla's dramatic rise has more implications, in my view, than just the financial pain it inflicted on the hapless short sellers.

Investors have to ask themselves why there was a successful short squeeze, a rare event on financial markets. Pros who short, or sell borrowed shares in the hopes of profiting by buying them back later at a lower price, are usually among the sharpest minds on the Street. The shorts thought Tesla, an obviously overvalued company, was such a slam dunk that at the end of April they'd sold nearly 40 per cent of the publicly available shares.

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The huge size of the short interest did leave these sellers vulnerable to a rush for the exits, should the stock begin to rise. But then Tesla, on the surface, had all the makings of a perfect candidate to slide. Although it eked out a small profit in the first quarter, it's been losing money for a decade.

Despite not having much of an earnings record and being essentially a start up, the company sported a stupendous market capitalization of nearly $10-billion (U.S.), comfortably exceeding even an established player like Fiat that's been in business for decades. In terms of sales, Tesla is hoping to move about 20,000 cars this year, compared with millions for the big car companies. Another knock: Tesla been a serial stock issuer, most recently last week when it diluted existing holders yet again by floating more shares and a convertible bond issue.

With everything seeming to be going for them, the shorts were vanquished. Why did they fail?

A plausible explanation is that the rise of Tesla and its Model S luxury sedan is a sign that many investors have become believers in the idea that a disruptive technology – the switch to electric cars – has a chance of emerging in the auto sector.

If it happens, this development would obviously have a huge impact, not only on vehicle manufacturers but on electric utilities and the oil industry. The obvious call is that it would mean great things for power utilities, hardship for the oil patch, and doom for car makers who aren't riding the electric wave. To be sure, the electric car business is in its early days and still risky. Competitor Coda Holdings filed for bankruptcy recently. A report from the International Energy Agency last month pointed out there are only 180,000 e-cars in the world, a mere 0.02 per cent of the total.

Yet when a new technology reaches a tipping point, it can move with astonishing alacrity. Electric vehicle sales more than doubled between 2011 and 2012, for example, suggesting momentum gathering behind the trend. The fact that using electricity as fuel costs only about a third the price of gasoline, also helps. The IEA report said there could be as many as 20 million electric cars on the roads by 2020. The development of quick charge installations using direct current is also overcoming one of the traditional drawbacks of electric cars, that they take hours for a fill up.

Tesla remains a risky way to play the electric car trend, given that the shorts aren't wrong in viewing it as way overpriced. Other car companies have electric offerings diluted in their larger operations, so they're not ideal investments either.The safest way to play the trend, when it emerges, will likely be in the power market. Electric utilities and merchant power producers are going to become the equivalent of gasoline stations and oil refineries, if electric cars take off. Merchant power producers, or companies that own generating stations and sell their juice into the grid, have the added advantage of being out of favour. Long-term trends also suggest electricity could become pricier with any big increase in demand because of promising developments on the supply side. Dirty coal fired plants are being shuttered.

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The U.S. nuclear fleet is also getting older. Many plants will be shut in the years ahead rather than having costly refurbishments. And natural gas, currently a cheap power plant fuel, won't stay cheap forever.

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About the Author
Investment Reporter

Martin Mittelstaedt has had a varied reporting career at the Globe and Mail, covering politics, the environment and business. He opened up the Globe's New York bureau for the Report on Business, and has also been on the banking and capital markets beats. He's written extensively on investing themes. More

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