Nikola Goes Bust: What Can Investors Learn?
Video: Why most stocks like Nikola fail, and what to look for instead.
Transcript
Back in May 2023, I made a video detailing why Nikola, the hydrogen and battery truck manufacturer, was an extremely risky investment.
At the time, I received some of the standard comments about how if I talk negatively about a stock… I must be a short seller. Even though I never short stocks.
One person even implied that I sounded scared in the video, and that I should cover so I don’t financially ruin my family.
And of course, about two years later, we just got news of Nikola filing for Chapter 11 bankruptcy.
The point of this video is not to dunk on investors that lost money on this stock, but to point out the obvious flaws of a company like Nikola.
Avoiding companies that are likely to go bankrupt like this is not rocket science.
When investing in stocks, we are playing a game of probabilities.
What is the probability of success or failure, depending on a variety of factors. The opportunities that most people tend to focus on are profitable and growing companies, but depending on the situation, those have lower reward potential.
I am not against buying unprofitable companies… most of the companies I own are unprofitable. But we can dramatically increase our odds of success if we avoid buying unprofitable companies that require high capex spend.
That is the ultimate question, if a company is unprofitable… we need to have a good sense of how long it will take them to reach profitability. And how much it will ultimately cost.
Just over the span of 2022 and 2023, that cost Nikola around $1.3 billion. The company also never earned a positive gross profit. So, even when they began to sell vehicles, they were losing money on every sale.
Obviously, that is an unsustainable situation. It’s no surprise they went bust.
If you have been following the stock market over the last few years, you could see how most capex-intensive investments are ultimately going to fail.
We have seen this happen time and time again, especially in the electric vehicle industry.
In many cases, it takes billions of dollars just to get a manufacturing facility up and running. All of the hiring, all of the design work, all of the equipment required… scaling these plants is incredibly expensive to do.
This requires increasing levels of stock dilution, which destroys your ability as an equity holder to even get back to breakeven. Every new share issued makes your initial stock purchases less valuable.
Not even including more recent dilution, Nikola 3.5x the outstanding share count from February 2021 to February 2024. From 391 million shares to 1.3 billion shares.
Anyone that bought the stock in 2021 could consider their investment a zero. Even if Nikola was a success, it would be incredibly difficult, if not impossible for you to make your money back with that level of dilution.
The company was able to ramp up production of trucks relatively fast after the debacle with the company’s founder Trevor Milton. Who lied about basically everything the company was doing, and there wasn’t even an actual working prototype back in 2020. But like we mentioned before, if you can’t even turn a gross profit on those truck sales then selling trucks doesn’t even matter.
Profitability issues were exacerbated by operational issues with production. Nikola acquired Romeo Power, a battery pack manufacturer, and later sold the assets to Mullen Automotive for pennies on the dollar.
Mullen’s initial purchase of some Romeo Power assets was for only $3.5 million, and the rest was acquired from Nikola later on for an undisclosed amount. This is a far cry from what Nikola originally bought the assets for through a $144 million deal in shares.
The sale of those assets was likely spurred on by the recurring battery fires in Nikola trucks. This led to the recall of 209 battery-electric vehicles. Which only made the company’s financial situation even more dire.
And this is probably only the tip of the iceberg on their operational issues.
It’s not surprising that the company encountered these problems, because again, this happens all of the time in these industries. There are better industries than others when it comes to investing. EVs, and even regular combustion engine vehicles are one of the bad ones.
On screen you can see a list of all of the failed auto manufacturers in just the United States alone. It’s not a good sign to see that there is this level of competition, and especially that this many companies have gone out of business over the last century.
The reality is, while the total addressable market (TAM) can be large in industries like this… an extremely low amount of companies will survive the massive spending cycles they need to make to increase production of new vehicles.
And with so many competitors, profit margins are razor thin. That is why, as an investor, you want to find companies that can dominate industries with an outsized portion of the total market share. It’s unlikely you will pick the winner in such a disputed industry like EVs.
Large amounts of competition are good for consumers, and bad for the producers of goods.
Another problem for the larger EV space, not just Nikola, has been the absolute lack of demand for electrification after the peak back in 2021.
All of the early adopters of electric vehicles are in, and then it’ll take a long time, if ever to see the average consumer buying an EV.
Basically every large-scale legacy manufacturer in the automotive space has delayed plans to focus on EVs. They can see that consumer sentiment is just not there yet for them to make the complete swap to electric models.
Even with the significant competition, prices are still too high with how resource intensive it is to produce electric batteries and hydrogen fuel cells.
So going over all of the issues here, Nikola operates with:
A capex-intensive sector which requires significant investments and time requirements to produce new vehicles.
An industry prone to operational challenges, which they did encounter.
Total addressable market in the hundreds of billions, if not trillions as time goes on.
Because of that TAM, they have a nearly endless level of competition from both new manufacturers focused on EVs only, and the legacy manufacturers who have a vast operational advantage with existing production facilities and resources.
Hardly any differentiation between one auto manufacturer and the next, they are price takers.
None of this sounds great to me as an investor. The risk is simply not worth the potential reward. That you are unlikely to even receive. Most of these companies will go bankrupt, as Nikola has.
Instead, what we should be looking for in a industry or opportunity is:
Ideally, low levels of competition.
Capex-light expansion options, keeping costs relatively similar while still growing.
The low levels of investment required often lead to a quicker path to first revenues, and ultimately profitability.
Barriers to entry that lead a company to have a moat (patents, network effects, etc).
These are some of the factors that will dramatically increase our chances of success, especially if we’re buying unprofitable companies.
And these are some of the factors that I prioritize when researching new investments.