September 27, 2020

Nikola: Assessing Defense Strategy And Potential Fallout From Shortseller Accusations (NASDAQ:NKLA)

Note: I have covered Nikola Corporation (NKLA) previously, so investors should view this as an update to my earlier articles on the company.

Just one day after the terms of zero emission transportation start-up Nikola Corporation’s recently announced strategic partnership with General Motors (GM) caused me to scrutinize Nikola’s bold proprietary technology claims, renowned shortseller outfit Hindenburg Research published a disturbing report calling the company of being “….built on dozens of lies over the course of its Founder and Executive Chairman Trevor Milton’s career.

I would urge investors to first read the Hindenburg report before continuing with this article.

Like basically every shortseller report, Hindenburg is utilizing a mixture of evidence and FUD to wreak havoc on Nikola’s elevated stock price.

At least in my opinion, a shortseller report should actually focus on a limited number of key issues and strictly avoid weaker or outright wrong claims as this provides the target a chance to turn the tables and attack the credibility of the entire report.

While Hindenburg does a good job providing evidence for key allegations like Nikola’s apparent lack of proprietary battery technology, the company faking a video of its early Nikola One prototype and a very bad case of nepotism, the report also contains some flaws.

For example, Hindenburg is raising questions about anchor customer U.S. Express’ ability to pay for roughly $3.5 billion in pre-orders because of its weak cash balance of just $1.3 million at the end of last quarter.

But Nikola’s proposed FCEV truck offering is actually based on an all-inclusive lease so customers won’t have to make upfront payments.

Photo: Nikola prototype on first zero-emission beer delivery for anchor customer Anheuser-Busch – Source: Company Website

In addition, Hindenburg is stating Bosch to be the manufacturing partner for the Nikola Tre truck in Ulm, Germany when in reality Iveco, a division of CNH Industrial (CNHI) will build the trucks at one of their legacy facilities which is currently undergoing required upgrades.

While Bosch will be providing the key electric powertrain and fuel cell system, it won’t manufacture the trucks.

In fact, Bosch has already disputed parts of the report:

Statements in the report that are attributed to a Bosch employee have been taken out of context and are not applicable.

The report also contains a myriad of minor claims (at least when compared to the key allegations), starting with founder Trevor Milton’s early business endeavors over the company’s niche NZT Off-Road vehicle to an exhausting discussion of solar panels not yet having been already installed on the roof of the company’s new headquarters in Phoenix, Arizona.

Despite the lack of focus and the flaws discussed above, I would rate the report a B- as Hindenburg provides good evidence for key allegiations.

That said, even a well-founded shortseller piece isn’t necessarily a guarantee for success as evidenced by Spruce Point Capital’s recent report on Plug Power (PLUG). Since the report was published in December 2019, the stock price has more than quadrupled at its recent peak, likely causing Spruce Point Capital to take a material hit on its short position.

Thankfully for Hindenburg, Trevor Milton has chosen what appears to be the least appropriate reaction to the report, by initially raging hard on his social media channels and touting a comprehensive rebuttal within hours and later not following through on his premature promises. Instead the company decided to retain outside counsel Kirkland & Ellis LLP and announced its intentions “to bring the actions of the activist short-seller, together with evidence and documentation, to the attention of the U.S. Securities and Exchange Commission.

Fellow contributor Mike Cutler recently published a great blog post in which he discussed Nikola’s options to respond to the Hindenburg report:

  1. Ignore the report. Deliver amazing EVs. Make incredible real EBITDA for investors. Prove Hindenburg wrong.
  2. Respond to the report line by line and try to prove Hindenburg wrong with facts that few people are checking anyway. (…)
  3. Grandstand, state summarily that all the accusations are wrong, focus on other ‘positive facts’, threaten to sue for defamation and fraudulent short seller price manipulation, complain to regulators that short sellers are evil maggots on society, and continue the playbook of selling great presentations and hype (and likely more stock).

According to Mike, option one is “by far the smartest response to drama short sellers, assuming you have a strong case, are confident in the promises you have made, and have not inappropriately over-hyped your product, company and prospects.”

But companies that don’t have a strong case, have over-hyped its products or prospects, and maybe even told some ‘white lies’ usually tend to choose option two or three with the latter having also been the preferred choice of proven frauds like Wirecard (OTCPK:WRCDF, OTCPK:WCAGY) or Luckin Coffee (OTCPK:LKNCY).

Nikola’s response is exactly what a shortseller like Hindenburg wants:

More more press time, more attention, and a fighting CEO and company who only dig a deeper hole for themselves while turning attention away from their primary mission of building great products.

On Saturday, Bloomberg added fuel to the fire by, among other things, scrutinizing the company’s claims regarding the construction progress of its new factory in Coolidge, Arizona, its Bosch relationship, battery technology and contract with anchor customer Anheuser-Busch (BUD). Bloomberg also raised additional questions regarding the status and configuration of the Nikola Tre protoypes in Ulm, Germany shown on photos posted by Trevor Milton on Twitter on Friday.

Assessing potential impact on Nikola

While the company and its chairman likely made a bad choice with their approach to tackling Hindenburg’s acccusations, the main question for investors is the potential fallout from the report.

The bad news is pretty obvious as both the General Motors agreement and Hindenburg report provide evidence for an apparent lack of proprietary technology at Nikola.

The good news is that both General Motors and Bosch appear to have no intent of backing out of their respective commitments, at least for now. European manufacturing partner Iveco hasn’t yet commented on the allegiations but just like GM and Bosch they also own a substantial number of Nikola shares and carry only limited financial risk as per the terms of their agreement so I would expect them to stay course, too.

That said, the General Motors transaction hasn’t closed yet and might very well require renegotiation due to the precipitous fall in Nikola’s share price in light of Hindenburg’s accusations.

Given the highly advantageous terms of the agreement for General Motors, I firmly expect the automaker to honor the deal but likely demand a reduction of the underlying Nikola share price from $41.93 to a number closer to the trading price shortly before the transaction will be finalized.

Unfortunately, the Hindenburg accusations might very well have an impact on Nikola’s ability to raise the approximately $3 billion in additional capital required until 2024 and securing a potential partner for the planned network of large-scale hydrogen fueling stations in the U.S.

Looking at the comment sections, some Seeking Alpha members apparently expect nothing less than apocalypse for Nikola and the SEC anticipated to suspend trading in the company’s stock or bankruptcy allegedly being just days away.

Frankly speaking, I don’t expect this to be the case as the SEC will likely require more evidence to suspend the stock from trading for the permitted maximum of ten days.

In addition, the company had close to $700 million in cash and no meaningful debt at the end of June, so bankruptcy clearly won’t be an issue for the next couple of quarters.

Bottom Line:

While certainly not flawless, the Hindenburg Research report appears to provide evidence for some of its key accusations, particularly the alleged lack of proprietary battery technology is concerning.

Unfortunately for investors, Nikola and its founder and chairman Trevor Milton seem to have chosen the most inappropriate approach to deal with the accusations. In fact, the Nikola defense closely resembles Wirecard’s course of action when the German fintech company was initially hit by accusations of cooking the books by the Financial Times.

That said, I would expect short-term damage to Nikola’s business to be limited as key strategic partners like Bosch, Iveco und General Motors are likely to stay course, particularly given their large shareholdings in the company.

I don’t expect the stock to be suspended from trading either and certainly Nikola won’t file for bankruptcy anytime soon.

On the flipside, the issues discussed in the Hindenburg report could very well impair Nikola’s ability to close new strategic partnerships and raise the $3 billion in additional capital required by the company’s business plan until 2024.

Given the added uncertainty and still elevated valuation, investors should remain on the sidelines, particularly given the giant December lock-up expiration as discussed by me previously.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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