Things started out looking like a reckless bet, and as the cryptocurrency went progressively wilder, things looked more and more outrageous.
Earlier this year, Elon Musk used $1.5 billion of Tesla’s cash to buy bitcoin, sparking concern from all walks of life. As the price of the cryptocurrency bitcoin soared, the value of Tesla’s holdings rose more than $1.3 billion from when it was bought, and despite a recent pullback, Tesla is still making good profits on its books, only narrowing profits.
However, the financial press and Wall Street analysts have failed to notice certain disadvantages. Tesla has adopted a special accounting treatment for bitcoin, and while the investment is generally profitable, Tesla will have an “impairment” loss in the second quarter. If the price of bitcoin stays at its current level of around $38,000, the impact won’t be significant. But if it wants to offset the impairment, Tesla will have to sell a lot of bitcoin, and that could hit the bitcoin market. If bitcoin hits its recent lows, well below $30,000, Tesla would suffer a huge loss, and several quarters of profits from producing and selling electric cars would be wiped out.
Most importantly, the impairment for the fiscal quarter ending in June would remind investors that Musk’s buying actions amount to a wide publicity campaign for a highly volatile asset, thus elevating the risk that bitcoin has oscillated from highs to lows of 10% and higher in just eight days in mid-to-late May.
The general consensus before was, “Hey, the Bitcoin market looks crazy, but this guy is a genius – Tesla made billions of dollars on Bitcoin alone!” And now the opinion has become, “No one knows how the bitcoin market is going to develop, and if it crashes, it’s the equivalent of hiding a hand grenade at Tesla.”
The risk Bitcoin poses to Tesla has caused panic on Wall Street.
“A lot of investors would rather Musk never touched bitcoin.” Daniel Ives, an analyst at Wedbush Securities, said. “The focus should be on delivery, the global wave of electric cars and solving the chip shortage. Yet there is too much focus on bitcoin right now.” What’s particularly frustrating, he added, is that Musk’s recent major reversal of attitude toward bitcoin, which he had been raving about just a few months ago, has also hit Tesla’s stock price.
“It’s like lighting your own house on fire.” He said, “The Bitcoin incident has cast a cloud over the Tesla story. And it’s all asking for trouble.”
Let’s take a look at why the accounting rules for bitcoin will cause Tesla to lose money in the second quarter, and how bad the losses will be if bitcoin’s price plummets.
Tesla on Bitcoin
Tesla first announced a $1.5 billion investment in bitcoin in its 2020 annual report (10K), which was released on Feb. 8. It wasn’t until the 10Q report for the first quarter provided details that investors were able to figure out how much bitcoin the company had purchased, the average price of its purchases, and its holding gains.
The 10Q report said Tesla held $2.48 billion worth of bitcoin as of March 31. The closing price on the New York Stock Exchange that day was $58,919, so it can be estimated that Tesla held about 42,100,000 bitcoins.
From the beginning of February to the end of March, Tesla sold 10%, worth $268 million. Previously its cost was $140 million, resulting in a gain of $128 million. (A calculation shows that at most Tesla held about 46,800,000 bitcoins.)
It looks like the value of bitcoins on Tesla’s books plus the proceeds from the sale totaled $2.748 billion ($2.48 billion plus $258 million). As you know, it cost $1.5 billion to buy, and Tesla had realized and unrealized gains of more than $1.2 billion on March 31, or more than 80% of the investment in 11 weeks. Tesla bought Bitcoin at an average price of $32,000, with a price of nearly $59,000 by the end of the quarter.
Bitcoin’s Special Accounting Rules
At first, the plunge into bitcoin looked like a big success, with Tesla making a pre-tax profit of just $15 million in the quarter, excluding the sale of carbon credits to competitors. From that perspective, buying and selling bitcoin pulled up the company’s results.
But the 10Q report mentions what few people are paying attention to, foreshadowing the second quarter, and the possibility of bigger problems in subsequent quarters. Tesla was forced to include a $27 million “impairment” in its pre-tax earnings, despite making a huge profit from selling 10% of its bitcoin. (Net income was reduced from $128 million to $101 million.)
Here is a brief description of the accounting rules that caused the impairment and will create more losses in the coming quarters. According to the FASB’s classification, cryptocurrencies are “intangible assets with indefinite lives. But accounting experts tell Fortune that companies have a lot of freedom in how they treat crypto assets on their balance sheets. One option is to compare the purchase price, or “book value,” of bitcoin to the point of trade or “fair market value” at the end of the quarter.
If the price of bitcoin on June 30 is lower than the bid price of any portion of the coins on Tesla’s books, an “impairment” or write-down is recorded equal to the difference between the “book value” and the “fair market value,” which is the bid price minus the quarter-end market price.
Tesla apparently does not take an “end-of-quarter comparison” approach, but rather an anytime impairment approach, where an impairment is taken whenever the market price of bitcoin falls below the bid price of any portion of the coin held during the quarter. The company collects the impairment data, and at the end of the quarter it is collected and recorded in the “restructuring” line item.
In other words, if Tesla buys some bitcoins at $35,000 in early February, rises sharply, and then falls to $31,000 on May 19 (which it actually does), each bitcoin is impaired by $4,000. If Bitcoin rebounds back above $31,000, Tesla can’t recalculate the value of the coins and remove the impairment. The impairment will always be there. In fact, even if the market price of the entire portfolio is well above Tesla’s buy price for a sustained period of time, it cannot be counted as a profit.
That is, there are only two scenarios: if there is a gain on holding bitcoin, it is calculated at the cost of purchase; if there is an impairment, it is calculated at the latest lower “book value”.
Only when Tesla sells bitcoin can it be included in the profit. The gain equals the difference between the book value of the bitcoin and the higher selling price. Simply put, whenever the market price of a bitcoin on a cryptocurrency exchange is lower than Tesla’s buy price, Tesla takes a loss (or impairment) on the corresponding bitcoin, whether it is one or many. When the market price is higher than the book value, the only way to gain is to sell for cash.
In the first quarter, Tesla fell below its original cost after buying a small number of bitcoins, triggering a $27 million impairment. But as the price of most of the portfolio soared, Tesla sold 10% of it at a price well above the purchase price, resulting in a huge gain.
Robust and extremely conservative
It appears that Tesla has two paths to choose from, both of which would satisfy the FASB’s intangible asset rules. As mentioned before, one approach is to book a loss only if the average cost of buying bitcoin is below the market price at the end of the quarter, while the second approach is to impair any batch on the books if the purchase price exceeds the exchange’s quarterly closing price.
“Tesla was able to choose this primarily because the FASB has not issued guidance on bitcoin.” said Ed Cates, an accounting professor at Pennsylvania State University.
Albert Meyer, principal accounting expert at Bastiat Capital, noted that Tesla’s approach is prudent and follows two FASB principles, namely “timeliness” and “individual valuation.
Tesla calculated the impairment based on current prices rather than quarter-end prices, reflecting “timeliness. Write-downs are calculated every time the market price of a bitcoin falls below the bid price, which represents “individualized valuation. Meyer said, “Both the individual valuation and the immediate recognition of the impairment are very prudent and I don’t see a problem with that.”
However, it is worth noting that if Tesla had tested for impairment at the end of the quarter, it would not have incurred a $27 million loss in the first quarter and would have had a chance to avoid a write-down in the second quarter. In practical terms, however, Tesla keeps very prudent books, and thus could have warned about the dangers of investing in bitcoin.
This Time, the Losses Could Be Worse
In mid-May, Musk announced on Twitter that Tesla would no longer accept bitcoin as a payment method for electric car purchases due to its troubling carbon footprint. The announcement shocked the market. The market then became increasingly concerned that he was abandoning Bitcoin altogether, and Musk later announced that Tesla was not planning to sell its Bitcoin holdings.
So it can be assumed that Tesla currently still holds 90% of what it bought, or 42,100,000 bitcoins.
However, Tesla’s bitcoin holdings are worth far less than they were a few weeks ago. In mid-April of this year, Bitcoin hit an all-time high of $64,863. At that time, the market value of Tesla’s coin holdings was $2.73 billion, with total unrealized and realized gains of about $1.36 billion, an increase of $150 million from the end of the first quarter.
As of late afternoon on May 25, Bitcoin had fallen 41% to $38,000, reducing Tesla’s once-high $1.36 billion in gains to about $378 million.
As for the quarter, Tesla revealed that the remaining 42,100 bitcoins had a “book value” of $1.33 billion. That means an average “basis price” of $31,600 per coin, although the average price is not important in calculating impairment losses, nor does it count toward Tesla’s overall “profit. What matters is the lowest price on the exchange in the quarter. Whenever Tesla buys above that price, the impairment must be calculated at the lowest price. The amount of the impairment is the difference between the low price and Tesla’s buy price.
By far the lowest price for bitcoin in the second quarter occurred on May 19, when it fell to $30,682. On that day, the Chinese government banned banks and payment providers from accepting cryptocurrencies. Yet trouble also emerged. We don’t know exactly what price Tesla paid for bitcoin when it bought it between Jan. 1 and Feb. 8. If the average price was $31,600, some of the buy-in price must have been higher than $30,682. And there were only ten days during Tesla’s buying period when it was below that price.
To estimate the size of future impairments, here’s a simple assumption that half of the bitcoins Tesla bought were above the average price of $31,600, and the other half were priced below that number. Let’s say Tesla bought 21,500 “cheap coins” for $29,500, and another 21,500 for $33,700 (which works out to an average price of $31,600).
In this case, Tesla impaired an average of about $3,018 per bitcoin ($33,700 per coin minus the quarterly low of $30,682). The impairment charge would have been $65 million in the second quarter.
This doesn’t sound that serious. But even from an accounting standpoint alone, it would be very embarrassing for Tesla to actually lose money on its previously touted bitcoin investment. Musk may have broken his promise to sell bitcoin to fill the hole in order to avoid losing money. The problem is that the price has fallen so much that trying to fill the $65 million gap would require a massive sell-off. By my estimate, if the price stays at its current $38,000 level, Tesla would need to sell off 10,000, or a quarter of its bitcoin holdings, to break even.
Since Musk is an opinion leader in the Bitcoin community, a massive sell-off could trigger a panic among a group of fans, which would further drive Bitcoin to dive. Imagine a price return to $25,000 in early December, and Tesla’s losses would be $278 million. What if it falls to $20,000? Tesla’s once “profitable” $1.3 billion investment would then lose $484 million.
Remember, Tesla has lost $127 million before taxes over the past four quarters, net of carbon credit sales, and Musk has acknowledged that carbon credit sales revenue will diminish rapidly. If Bitcoin posts a huge loss, it could wipe out all the profits from selling cars and batteries for the rest of 2021 and beyond.
The real problem, however, is that bitcoin’s price has always been volatile and difficult to judge, and Tesla’s already unpredictable future earnings are increasingly in doubt. Uncertainty is the least of Tesla’s problems today, and Musk’s choice to bet on today’s most volatile asset only adds to the variables.
Musk, who previously played Bitcoin with $1.5 billion of Tesla shareholders’ money, was very lucky at first. Now, his luck is getting worse. Who knows if he’ll have more chips in his hand next month than when he started?
Shareholders have been afraid to ask for the exit, after all, since Tesla’s stock price peaked in January, the amount of money shareholders hold has shrunk by a third.
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/bitcoin-is-the-bomb-hidden-inside-tesla/
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