It has been an exciting week for Chinese electric car vehicle maker Nio (NYSE:NIO). Over the weekend, it unveiled new products at the company’s annual Nio Day. Rival Tesla (NASDAQ:TSLA) started delivering vehicles in China, just a year after building its local production facility there. And on Monday, Nio dropped a bomb on short sellers, unveiling bad, but not quite as bad as expected, earnings.
That earnings report initially caused Nio stock to rally moderately. But soon a short squeeze of epic proportions kicked off. At one point, the stock was up 100% on the day before giving back some of its gains.
Despite ominous signs in the earnings report, including an official disclosure that they may go bust within the next year, Nio prevailed over the skeptics. For one day, at least. Don’t test your luck though. If you own Nio, now is the time to dump the stock.
Nio & Tesla Parallels
Nio and Tesla have a lot of similarities. Not only are their businesses somewhat related, their management styles have drawn some comparisons as well. It’s no surprise that Nio’s CEO once said that his company would be the Tesla-killer in China: Nio has clearly emulated some strategies from its American counterpart.
One of those is announcing big new things to help shift the conversation. With these deeply unappealing earnings — on a financial basis — Nio helped soften the blow by announcing a bunch of new products. This is quite like how Elon Musk has a knack for rolling out new Tesla features whenever short sellers start dictating the narrative around that stock. Nio’s decision to copy Tesla here seems to have worked, at least for now.
Nio premiered a new vehicle model, the EC 6, which appears designed to compete directly with Tesla’s Model Y. Nio also announced much higher-capacity battery packs that will allow its vehicles to travel more than 300 miles on a charge.
Don’t Confuse a Short Squeeze for Forward Progress
There were a couple of positive points in Nio’s earnings release Monday. For one, vehicle deliveries were up. Gross margins on their vehicle sales, however, fell even farther into negative territory. So don’t mistake increased vehicle deliveries for better financial results, but better deliveries are still preferable to a decline. Same goes for the improved demand guidance going forward. If you haven’t proven that you can make a profit selling cars, simply moving more units doesn’t fix everything, but it is a sign of increasing momentum.
Against those scant pluses, however, there was much to worry about. The falling profit margins show a business that isn’t anywhere near an inflection point. Also, there weren’t any breakthroughs on the company’s financial situation. It’s been more than half a year now that Nio has been searching for more outside funds. Shareholders have gotten the idea that salvation was close on several occasions, yet, apparently, there’s still nothing firmed up. The company merely says that it continues to try to raise funds.
Now, the Really Bad News
In fact, the fundraising situation appears to be reaching a critical level. The situation has gotten dire enough that in its official quarterly release, Nio had to include this sobering disclosure about its financial state:
The Company operates with continuous loss and negative equity. The Company’s cash balance is not adequate to provide the required working capital and liquidity for continuous operation in the next 12 months.
The company is still burning more than a quarter of a billion dollars every three months and has already extended its accounts payable to suppliers out to 120 days. With their cash supplies nearly exhausted, it’s hard to see how Nio will be able to remain operational unless their current fundraising efforts find some success.
Remember that Nio’s bonds are trading way down in the dumps, as they recently sold for less than 40 cents on the dollar. This means that the company’s creditors expect to take massive losses. Keep in mind that creditors get paid in full before common stockholders would get a penny in a bankruptcy or liquidation scenario.
Nio’s Bottom Line
Until Nio’s bonds trade up dramatically, there’s little reason to think the stock is worth much of anything. It’s going up for now as a trading vehicle, but once the short squeeze ends and the momentum folks move elsewhere, Nio will skid back down.
The good news, if you can call it that, is that with Nio’s stock price up, they can potentially raise money. The bond market seems closed to Nio for new issues, given the terrible trading of their existing paper. However, with the stock price up, Nio can potentially issue more shares to raise desperately-needed funds. This will help keep the lights on for 2020.
Of course, with Nio burning something like $300 million a quarter, they would have to issue 75 million shares of stock (at $4) just to raise enough money to keep going for one more quarter. You can probably guess what the impact on the market will be if Nio starts issuing blocks of stock in that magnitude with any regularity.
If you own the stock, you just had an incredible run-up in the stock price. But at this price, you own a business that the market is valuing at $4 billion which loses $1 billion a year and has a seemingly insolvent balance sheet. That’s not a great combination. Make sure to lock in your gains before they disappear.
At the time of this writing, Ian Bezek held no positions in any of the aforementioned securities. You can reach him on Twitter at @irbezek.
