Dividend policy to disrupt shorts

[jhm]

Low-cost funds and brokers make money lending out shares held by their clients. Thus, shorting is an inherent part of these business models. They enable shorts and collect rent on shares.

Imagine collecting a few percent on the $10B in Tesla shares held short. This is a small industry.

The question for Musk is how to disrupt the shorting industry. Taking Tesla private is one strategy for shutting down the Short Tesla Industry. But I would suggest another way.

Tesla needs to define a forward-looking dividend policy. It should be clear in investor's minds what the future of Tesla dividends will look like even if Tesla is not currently prepared to pay any dividend.

Essentially a dividend forces shorts to pay rent to Tesla shareholders. This cuts into the rent that funds and brokers seek to obtain from shorts. A dividend policy changes the equilibrium that the shorting industry feeds industry. Dividends can reduce the total number of shares shorted. A policy outlining future dividends will start to challenge the sustainability of long-term shorting, even before those dividends are paid out. So this is something that Tesla can pursue now.

I have a few ideas about how construct a dividend policy, but I want to stop here so we can all digest the basic concept:

Dividends force shorts to pay rent to shareholders and changes the equilibrium feeding the shorting industry.

 

[jhm]

Yeah, I was always wondering how index funds are able to follow the indices with so little cost: "following" the price is almost always costly in the long run, as you always miss the biggest up-moves and the biggest down-moves...

But modern index funds have miraculously low maintenance costs. It appears, based on Elon's tweet, that this is so because they manipulate the price:

• price moves against them they mostly missed the big up-move (and no, HFT doesn't help them there)
• no problem, they buy shares too late, lend them out to shorts, who fade the biggest price movements to below the purchase price of index funds.
• index fund has now 'followed' the index by actually hurting the price (!), and earns a nice lump of money via the share lending interest
• because share prices are generally moving up, increasing volatility this way increases the income of index funds

If you think it through, this is true market manipulation and fraud in essence:

• the index funds knowingly lent out shares to help depress the price, to make it cheaper for them to "follow" the index,
• in the process the index fund not only hurts the income of their own customers (whose return is partially transferrred to the shorts), but hurts the income of every single long on the market,
• the shorts also measurably increase volatility, which is another cost and risk for the system.

Shorts are true anti-investors.

This is very helpful to this discussion. It shows other ways, beyond seeking rent on lending shares to shorts, that index funds participate in the shorting industry. In particular, controlling the supply of shares available to borrow enables players like this to manipulate the prices. This may be the mechanism behind what I have called "news nullification." After good news comes out, these funds can make available cheap shares to borrow. They can flood the market with supply, and this drives down the price. So it looks like shorts have colluded to do a bear attack, when in reality the actual short may simply be responding to incremental supply of shares available to short.

So we need to understand this business model better to formulate a counterstrategy.

 

[schonelucht]

Let's get some cash in the bank first before we start talking dividend. Mmmok?

 

[jhm]

Let's get some cash in the bank first before we start talking dividend. Mmmok?

You just missed the point altogether. It is not necessary to pay dividends now. What is helpful is to articulate a policy for dividends to be paid in the future. This changes expectations, which can alter the equilibrium well before dividends are paid.

 

[neroden]

I normally prefer dividends to stock buybacks.... but in the case of Tesla, stock buybacks are preferable to dividends. Here's why:
(1) High volatility. If Tesla did intelligent stock buybacks they could buy back at lows. (Most companies buy back stock at highs; this is documented.)
(2) Creates more trouble for short-sellers by reducing the supply of tradeable shares.
(3) Buys out weak short-term stockholders.

Dividends don't gain any of these benefits.

I don't think Tesla is in a position to do stock buybacks or dividends right now, but it wouldn't be crazy to issue a buyback policy; Berkshire Hathaway has an officially published buyback policy.

 

[cpa]

I think before Tesla takes the bold step of creating a plan for declaring dividends, Tesla needs to have retained earnings on its balance sheet instead of its current accumulated deficit. There is no telling how long it will take Tesla to flip the sign of the amount sitting in equity. With Tesla's ambition to produce the Model Y, pickup, and semi, the company will need to plow all its cash back into the company instead of paying out dividends and then having to borrow funds for working capital. Perhaps the banks and other lenders would not look favorably upon a company that has some sort of policy intent to pay dividends; doubtless any lending covenants would preclude any sort of consideration for dividends until a certain requirements are met.

Since market strategy is not in my wheelhouse, it seems to me that any cash dividend declared reduces the share price by the amount of the dividend. Moreover, if the company does not have any retained earnings, any dividend paid would just serve to reduce the shareholder's basis in the stock. It would not be considered income--whether for income taxes or for accounting purposes.

Yeah, maybe shorts might be less inclined if there were such a policy in place. But the conditions that would permit a dividend are so far into the future that they might as well be non-existent.

A few consecutive quarters of net income, and a profit for 2019 will do more to scare off the shorts than a planned dividend policy for 6-8 years down the road.

 

[jhm]

I normally prefer dividends to stock buybacks.... but in the case of Tesla, stock buybacks are preferable to dividends. Here's why:
(1) High volatility. If Tesla did intelligent stock buybacks they could buy back at lows. (Most companies buy back stock at highs; this is documented.)
(2) Creates more trouble for short-sellers by reducing the supply of tradeable shares.
(3) Buys out weak short-term stockholders.

Dividends don't gain any of these benefits.

I don't think Tesla is in a position to do stock buybacks or dividends right now, but it wouldn't be crazy to issue a buyback policy; Berkshire Hathaway has an officially published buyback policy.

Right, stock buybacks can accomplish some things. I don't see these as exclusive. In fact, I would want to see a dividend policy include a DRIP (dividend reinvestment program). Many growth oriented investors would prefer accumulate shares in lieu of cash dividends. If Tesla funds the DRIP with cash, it can buy the shares off the market and create some anti-dilution. So I think this covers (2).

Item (1) is more about preserving share value when it drops low. Dividends (with optional DRIP) also support the share price when it drops low. The dividend is denominated in dollars, so as the share price falls the dividend yield increase. This makes the shares more attractive to income investors when the stock is undervalued.

But for our purpose here, we're more interested in what the impact on shorting is. So specifically, when the yield goes up, this increases the total cost of borrowing for shorts at just the time the stock becomes more attractive to income investors. So this creates incentives for shorts to close their positions after driving the share price down.

The key advantage that I see in a dividend approach over buyback is that it impacts the funds and brokers that are collecting rent on lending shares. The dividend cuts directly into the total cost to borrow that shorts are willing to pay. I don't see a stock buyback really having any impact on stock lenders. In fact, decreasing the total number of share would seem to support higher interest rates on borrowing shares. So the lenders may actually benefit from shares being harder to borrow. So a dividend says, sure you can borrow the stock, but you'll have to pay rent to all the shareholder for the privilege of doing so.

Regardless, shares will be lent out to shorts. The question is who is collecting rent on these shares. Currently, brokers and funds get to collect all that rent. But if shareholder increase the rent by demanding dividends, it might just reduce demand for shares borrowed.

So Shorts are sitting on about $10B in Tesla shares. If Tesla paid a 1% dividend, shorts would have to pay $100M per year to shareholders. A stock buyback does not really force shorts to pony up cash. Meanwhile, whether a stock has a dividend or not really does not make much a difference to the total return to shareholders, nor does it impact growth. So I see it as roughly neutral to shareholders, but taxing on shorts. If this drives shorts away, then they will have to buy out weak short-term shareholders (3).

 

[jhm]

I think before Tesla takes the bold step of creating a plan for declaring dividends, Tesla needs to have retained earnings on its balance sheet instead of its current accumulated deficit. There is no telling how long it will take Tesla to flip the sign of the amount sitting in equity. With Tesla's ambition to produce the Model Y, pickup, and semi, the company will need to plow all its cash back into the company instead of paying out dividends and then having to borrow funds for working capital. Perhaps the banks and other lenders would not look favorably upon a company that has some sort of policy intent to pay dividends; doubtless any lending covenants would preclude any sort of consideration for dividends until a certain requirements are met.

Since market strategy is not in my wheelhouse, it seems to me that any cash dividend declared reduces the share price by the amount of the dividend. Moreover, if the company does not have any retained earnings, any dividend paid would just serve to reduce the shareholder's basis in the stock. It would not be considered income--whether for income taxes or for accounting purposes.

Yeah, maybe shorts might be less inclined if there were such a policy in place. But the conditions that would permit a dividend are so far into the future that they might as well be non-existent.

A few consecutive quarters of net income, and a profit for 2019 will do more to scare off the shorts than a planned dividend policy for 6-8 years down the road.

Actually, I think lenders like companies that pay a dividend. Debt always gets serviced before a dividend can be paid. So the dividend is a buffer to debt. The lender knows the borrower wants to pay the dividend and is generally able to do so, but in a pinch dividend payments will be curtailed to assure that debt is performing.

Also if a dividend paying company needs to raise capital, it can demonstrate its ability to go to the equity market with a plan for growth and be well received. Basically, management needs to prove to equity markets that it has a strong plan for growth. Compare that to situation where a company has be accumulating cash for quite awhile and then embarks on some growth ambition. If it is just using cash in house, it does not need to prove the merits of the growth investment to equity investors. This is one of the basic reasons why investors like Buffet prefer dividend paying companies. You don't want management to squander retained earnings on second rate investments. Now this is not at all the risk that Tesla is presently in. I'm well convinced that every growth ambition of Tesla is inclined to support higher than stock market rates of return. But from the perspective of debt investors, it is comforting to see a borrower have to tap some fresh equity to confirm that equity investors really believe the growth plan has merits.

So basically, I view paying a modest dividend as a gesture that will enhance the creditworthiness of Tesla in the eyes of debt investors. This is critical to address because shorts like Chanos have worked hard to poison the relationship between Tesla and the debt markets.

 

[durkie]

So Shorts are sitting on about $10B in Tesla shares. If Tesla paid a 1% dividend, shorts would have to pay $100M per year to shareholders. A stock buyback does not really force shorts to pony up cash. Meanwhile, whether a stock has a dividend or not really does not make much a difference to the total return to shareholders, nor does it impact growth. So I see it as roughly neutral to shareholders, but taxing on shorts. If this drives shorts away, then they will have to buy out weak short-term shareholders (3).

This is the part I wonder about: the potential size of the dividend. Borrowing prices (instituted by brokers) have often exceeded 1% (by many percentage points) in the past and regularly hang out somewhere between 0% and 1%. It seems that many short sellers are fine with fees of this magnitude and my concern would be that the dividend would have to be quite large in order to deter short selling activity significantly.

 

[Brando]

So glad Elon focus is on improving the product and not improving the stock.
Want to help Tesla?
How about starting Tesla vehicle rentals? Tesla Limo Services? Tesla Taxi Company?
rent to Uber and Lyft drivers? or taxi drivers?
That would increase demand. Always a good thing, right?

Didn't Elon say something like: "if you don't like volatility then Tesla stock probably isn't good for you"

 

[Brando]

The Rise In Anonymous Online Short Attacks, + Stale & Fresh Attacks On Tesla | CleanTechnica

For those stock holders/traders that want to actively "help" with stocks.
A Field Guide To Potential Securities Violations By Tesla's Foes — In Depth | CleanTechnica

 

[jhm]

This is the part I wonder about: the potential size of the dividend. Borrowing prices (instituted by brokers) have often exceeded 1% (by many percentage points) in the past and regularly hang out somewhere between 0% and 1%. It seems that many short sellers are fine with fees of this magnitude and my concern would be that the dividend would have to be quite large in order to deter short selling activity significantly.

Sure, but it also matters who that interest is going to. The dividend is a direct transfer from shorts to shareholder. So it works to enhance the value of the share while increasing the cost of shorting.

Remember also that the yield is a function of share price. Suppose you start with a share price of $500 and dividend $5. That's just a 1% yield. But suppose shorts attack the price all the way back to $250. Now the yield is 2%. Pushed far enough, the stock becomes increasingly attractive to dividend oriented investors, while increasingly expensive for shorts to keep holding on. So at some level the dividend puts the skids on the bear run.

Of course this is premised on the dividend being reliably paid. So if Tesla is fundamentally sound, the dividend is not at risk and it will serve to reinforce stock price through bearish sentiment.

But there is another trick here. Tesla really is a growth company. Revenue and income should keep growing, even when market sentiment is sour on Tesla. I think Tesla could have a dividend policy that credibly aims to increase the dividend 41% every year. The dividend would double every two years. So that $5 dividend in 2020 looks to hit $10 in 2022, $20 in 2024, and so on to $160 in 2030. So what would you pay today for a share that could ramp the dividend to $160 by 2030?

Divendend growth investors would be all over this. What this does is force investors today to take seriously today what Tesla is doing to become a huge cash engine capable of a $160 dividend in 2030. I think dividend growth investing really has the right sort of focus on long-term sustainable growth.

So Tesla can start out with a very small dividend once it is FCF positive. If they double that dividend in pace with revenue or earning growth, then eventually you get to a high enough yield that the dividend forces the share price to grow with the dividend. Imagine the folly of long-term short forced to double their dividend payments every two years. How long would they want to hang on for that?

 

[jhm]

Dividend discount model - Wikipedia

I would encourage people to refresh their memory on the Gordon Growth Model. Pay attention to what happens when the dividend growth rate is really high.

 

[jcasetnl]

You just missed the point altogether. It is not necessary to pay dividends now. What is helpful is to articulate a policy for dividends to be paid in the future. This changes expectations, which can alter the equilibrium well before dividends are paid.

Market would 1) not be fooled by the promise of dividends absent some sort of a track record of profitability or, at the very minimum, a strong cash surplus on-hand. 2) Would more likely be seen as desperate (hail mary-like), and draw in more negative attention and speculation.

 

[DrKenneth]

You need profits to pay dividends (reliably). Might as well say that Tesla should start making a profit to hurt shorts. What a revelation.

There's nothing about dividends that hurt shorts more than the profit required to fund them.

 

[EinSV]

I think Tesla’s business plan should stay laser-focused on what is needed to implement its product roadmap and achieve its mission of accelerating the transition to clean energy.

Consistently generating significant free cash flow and at least a modest GAAP profit while growing 50% per year should be enough to crush the short sellers. Instituting or pre-committing to financial engineering or gimmicks such as buybacks or dividends that might restrict cash available to accelerate growth seems like a mistake.

I have no doubt that short sellers are damaging Tesla. But the way for Tesla to win is to keep focused on its compelling product roadmap and business plan. Completing Model 3 ramp, then Model Y, Semi, Pickup, Solar Roof, Full Self Driving, Megacharger Network, virtual power plants, Powerpack, less expensive car, Gigafactories in China and Europe followed by many more Gigafactories around the world will require significant investments for years to come. Investing in these projects as well as the next generation of Tesla products is a much better use of cash flow than dividends IMO.

The growth bulldozer will eventually crush the short selling cockroaches. Elon has allowed short sellers to distract him too much already. Committing to plans that might limit growth in the hope they might hurt short sellers would be the tail wagging the dog.

Execution on Tesla’s plans should be a financial execution squad for Tesla shorts. Tesla and Elon need to stay focused on that plan, not get overly distracted by short sellers. Eyes on the prize.

 

[jcasetnl]

I have no doubt that short sellers are damaging Tesla.

Shorts are helping Tesla. As are auto haulers, body shops, the Swedish government, the SEC, big oil and big auto. All of these groups of people have been scape-goated for various Tesla shortcomings and create (for some) a convincing "us vs them" narrative of being on the righteous side of "the fight".

As someone else said, all Tesla has to do to shut up the shorts is make money.

 

[EinSV]

Shorts are helping Tesla. As are ... the SEC, big oil and big auto.

That’s false. If you look anywhere on social media there are tons of shorts and trolls of various persuasions doing their best to harm Tesla. The regular media is happy to play along.

Tesla is already performing extraordinarily well — it is the fastest growing large US tech company by far and the Model 3 is crushing the competiton from Mercedes, BMW and Audi. Earning consistent cash flow and profits will help reduce the attacks although they are not going to end any time soon.

I do agree that Tesla should focus on execution rather than get overly distracted by all of the noise from short sellers and other bashers.