The guest commentary below was written by written by Mitchel Krause. This piece does not necessarily reflect the opinions of Hedgeye.
After 22 years on Wall Street, Other Side Asset Management opened our doors in early 2018 with the goal to contribute, lead and help restore certain fundamental principles we believed the industry to be lacking. With honestly and integrity at the heart of our core values, given our unique path – and in turn, perspective – it was imperative to tell investors exactly what we would want to know should the roles be reversed. Simply put, we wanted investors to understand the “other side” of the investing story, good or bad, that’s often conveniently omitted when working with larger firms.
As much as we’d like things to always be bullish, unfortunately, that’s not how the world or economic cycles work.
Per FactSet, as of March 16, 2023, there were 10,966 ratings on stocks in the S&P 500. Of those ratings, 53.5% were Buy ratings, 40.3% were Hold ratings, and 6.2% were Sell ratings. Over the course of our 27 years in this industry, at any given time, equities covered by Wall Street analysts have been rated either a buy or hold roughly 90% to 94% of the time … which might lead one to wonder how this could be.
Nearly 40% of small cap companies in the Russell 2000, alone have negative earnings. Numerous companies in the “Profitless Tech” basket, which is a real thing, are cash-flow negative; and many will be bankrupt as we describe below. But it’s not just small cap companies that are hemorrhaging cash and receive Buy or Hold ratings. Larger cap names like $TSLA went 18 years before reporting a profitable quarter.
In May 2019, we walked readers through prospectus data and statements CEO Elon Musk made on earnings calls as to how $TSLA was a handful of days away from having a zero balance just before their bankers bailed themselves out of multi-billion-dollar revolving credit lines by aiding them in raising some $1.6 billion. Clearly, they didn’t outright admit this … nor did the analysts who covered the name, but if you read the documents and listened to Musk it was clear. As we wrote then:
“More disturbing is Tesla CEO Elon Musk freely admitting, almost bragging to investors on their earnings conference call: ‘Overseas volume strained our logistics operation and resulted in over half of our global deliveries occurring in the final 10 days of Q1.’
Delivering these cars in the final 10 days of the quarter represents nearly $2 billion in cash flows! Why is this so important to understand? Per the most recent prospectus, Tesla ended the first quarter with just under $2.2 billion in cash! See below…”
$2 billion coming through the doors in the last 10 days of a quarter is akin to someone who is living paycheck-to-paycheck, finally getting paid and 'hoping' their check clears so they don’t bounce the check they just wrote to their dry cleaner; only Tesla’s 'drycleaners' are their parts suppliers (without parts, cars can’t be built). These admissions coupled with the numbers from the prospectus put this company as dangerously close to 'cash strapped' (pre capital raise) as it gets."
We all know where we currently are in this story: bankers were successful, everyone’s bullish, happy ending for all … right?! We’d contend that this specific story is far from over, though we digress…
Last month, we informed readers that nearly 90% of those small cap companies required to refinance their debt between now and the end of 2024, at current interest rates, will no longer be cash flow positive … and yet, 94% Buy/Hold recommendations remain.
The Other Side of this story is that if an analyst cuts a stock from a “Buy” or “Hold” rating to a “SELL,” that investment bank is likely to lose up to 6 revenue streams on that downgrade:
- Institutional “nickel” business
- Corporate buyback business
- Mergers and acquisitions business (representing either side, buy or sell side)
- Future capital markets business
- Equity/debt/preferred offerings, etc. (or any indirect benefits like being paid just because your name sits on the prospectus … yeah, that’s a thing, too)
- Insiders cashless options exercise
- Analyst votes
You may or may not understand what these all mean, but we do and can explain what they and how/why these revenue streams are lost (This note is not the time or place. However, should you have interest, never hesitate to reach out to discuss.)
At the end of the day, you’re never being told the full story by most of Wall Street and/or the financial media – be it:
a.) They truly don’t understand how things really work (most don’t); or
b.) Those who do understand will never say anything due to “career risk” (they make too much money and don’t want to lose their jobs).
I know the above to be true. I lived it, watching all of the above happen in real time for over 20 years on both the retail and institutional side of the business.
This business isn’t designed for the average broker or investor to understand how it works. It’s complicated by design – siloed, segmented and disorganized – and unless you’ve experienced each facet of the game, you’re likely to have a poor understanding of how it works. The more confusing it is, the more individual investors feel lost, tethered to their guide (broker).
Saying things that completely contradict what the vast majority of an industry is by no means easy. I could only imagine this is what a salmon swimming upstream to spawn feels like. I just pray we’re of the Atlantic salmon variety, not Pacific. (Pacific salmon always die after spawning, while Atlantic salmon often survive with the opportunity to spawn another day).
We don’t sell readers a narrative, we provide empirical facts via the data; stating that the data probabilistically wins in the end as we did last month isn’t narrative, it’s historical fact. At the same time, markets don’t always trade in lock step with the data but most frequently mean revert as the reality of the economic cycle unfolds, which is happening.
This month, we’ll update readers on the current economic cycle, by way of the data which corroborates what we’ve been describing for readers for nearly 20 months now.
Click here to read Mitchel's note in its entirety on the Other Side Asset Management website.
This is a Hedgeye guest contributor piece written by Mitchel Krause and reposted from his most recent monthly report. Krause is an industry veteran of nearly 28 years, where he’s seen the industry from the inside out. Nearly a decade of private wealth service, followed by just under seven years with an institutional group focused on banks and thrift stocks. He’s been managing discretionary money since 2015. His career began at, Ryan, Beck & Company in 1996, a boutique firm specializing in financials and municipal bonds, which was later bought by Stifel Financial Corp in 2007. He opened the doors to Other Side Asset Management in 2018 in an effort to tell the “other side” of the investing story to those willing to listen. He continues to manage discretionary assets while publishing these notes monthly. His archives are open to the public. Currently, he both works and resides in Raleigh, North Carolina.
Twitter handle: @OtherSide_AM
LinkedIn: Mitchel Krause