Is Bitcoin a “bomb” hidden inside Tesla?

The beginning of the matter seemed like a reckless bet, and as the trend of cryptocurrencies became crazy, the situation seemed more and more outrageous.

Earlier this year, Elon Musk used Tesla’s $1.5 billion in cash to buy Bitcoin, which aroused the attention of all walks of life. With the soaring price of the cryptocurrency Bitcoin, Tesla’s holdings have increased by more than $1.3 billion from the time of purchase. Despite the recent decline, Tesla’s book profits are still good, but profits have narrowed.

However, neither the financial media nor Wall Street analysts have noticed certain unfavorable factors. Tesla has adopted a special accounting treatment for Bitcoin. Although the investment is generally profitable, Tesla will experience “impairment” losses in the second quarter. If the price of Bitcoin stays at the current $38,000, the impact will not be great. But if it wants to offset the impairment, Tesla will have to sell a lot of Bitcoin, which may impact the Bitcoin market. If Bitcoin hits its recent low, well below $30,000, Tesla will suffer huge losses, and the profits from the production and sales of electric cars for several quarters will be wiped out.

Most importantly, the impairment of the fiscal quarter as of the end of June will remind investors that Musk’s buying behavior is equivalent to widely advertised for extremely volatile assets, thereby increasing the risk, only in the eight days of mid-to-late May. Here, the amplitude of Bitcoin from high to low is as high as 10% or even higher.

Before, people generally thought: “Hey, the Bitcoin market looks crazy, but this guy is a genius-Tesla made billions of dollars on Bitcoin!” Now the public opinion has become “No one Knowing how the Bitcoin market develops, if it collapses, it is equivalent to hiding a grenade in Tesla.”

Bitcoin’s risk to Tesla caused panic on Wall Street.

“Many investors would rather Musk have never touched Bitcoin.” Wedbush Securities analyst Daniel Ives said. “The focus should be on delivery, the global wave of electric vehicles, and solving the problem of chip shortages. But now people are paying too much attention to Bitcoin.” He added that what is particularly frustrating is that Musk has been very aggressive in recent months. The attitude of praised Bitcoin has been reversed, and it has also impacted Tesla’s stock price.

“It’s like setting fire to your own house,” he said. “The Bitcoin incident has clouded the story of Tesla. And it’s all asking for trouble.”

Let’s take a look at why Bitcoin’s accounting rules in the second quarter will cause Tesla to lose money, and how severe the loss will be if the price of Bitcoin falls sharply.

Tesla on Bitcoin

Huge gains

In the 2020 annual report (10K) released on February 8th, Tesla announced for the first time that it would spend 1.5 billion US dollars to invest in Bitcoin. Until the first quarter 10Q report provides details, investors will be able to figure out how many bitcoins the company bought, the average purchase price, and the holding income.

The 10Q report stated that as of March 31, Tesla held Bitcoin worth $2.48 billion. The closing price of the New York Stock Exchange that day was $58,919, so it can be estimated that Tesla holds about 42,100 bitcoins.

From the beginning of February to the end of March, Tesla sold 10%, valued at $268 million. Previously, its cost was 140 million U.S. dollars, so the revenue was 128 million U.S. dollars. (By calculation, Tesla holds about 46,800 Bitcoins at most.)

It seems that the value of Bitcoin on Tesla’s books plus the proceeds from the sale totals $2.748 billion ($2.48 billion plus $258 million). As we all know, the purchase cost 1.5 billion U.S. dollars, and Tesla’s realized and unrealized gains exceeded 1.2 billion U.S. dollars on March 31, which means that the investment income in 11 weeks exceeded 80%. Tesla bought bitcoin at an average price of 32,000 US dollars, and by the end of the first quarter the price was nearly 59,000 US dollars.

Tesla’s troubles:

Bitcoin special accounting rules

At the beginning, it seemed like a big success to invest in Bitcoin. Excluding the sale of carbon credits to competitors during the season, Tesla’s pre-tax profit was only $15 million. From this perspective, buying and selling Bitcoin boosted company performance.

However, the 10Q report mentioned content that few people paid attention to, indicating the situation in the second quarter and the possibility of greater problems in the subsequent quarters. Although Tesla made a huge profit by selling 10% of Bitcoin, it was forced to include a $27 million “impairment” in its pre-tax profit. (Net income decreased from US$128 million to US$101 million.)

In this brief introduction, the accounting rules that cause impairment and more losses will be formed in the next few quarters. According to the classification of the Financial Accounting Standards Board of the United States, cryptocurrencies are classified as “intangible assets with uncertain maturity.” However, accounting experts told Fortune that companies have a lot of freedom in how companies handle crypto assets in their balance sheets. One option is to compare the purchase price or “book value” of Bitcoin with the point of transaction or the “fair market value” at the end of the quarter.

If the price of Bitcoin on June 30 is lower than the purchase price of any part of the currency on Tesla’s book, it will be included in the “impairment” or write-down, and the amount of impairment is equal to the “book value” and the “fair market value” “The difference is the purchase price minus the market price at the end of the quarter.

Obviously, Tesla did not adopt the method of “comparison at the end of the quarter”, but the method of devaluation at any time. As long as the market price of Bitcoin is lower than the purchase price of any part of the currency during the quarter, it will be devalued. The company collects impairment data, and the collection at the end of the quarter is included in the “restructuring” item.

In other words, if Tesla bought some bitcoins at the beginning of February for 35,000 U.S. dollars, and then fell to 31,000 U.S. dollars on May 19 (in fact) after a sharp increase, each Bitcoin would cost 4,000 U.S. dollars. Impairment. If Bitcoin bounces back to more than $31,000, Tesla will not be able to recalculate the currency value and eliminate the impairment. The impairment will always exist. In fact, even if the market price of the entire portfolio is much higher than Tesla’s purchase price for a period of time, it cannot be considered profitable.

In other words, there are only two situations: if there is a benefit from holding Bitcoin, it must be calculated at the cost of purchase; if there is an impairment, it will be calculated at the latest lower “book value”.

Only when Tesla sells Bitcoin can it be included in the profit. The gain is equivalent to the difference between the book value of Bitcoin and the higher selling price. Simply put, no matter it is one or many, as long as the market price of bitcoin on the cryptocurrency exchange is lower than Tesla’s purchase price, Tesla will calculate a loss (or depreciation) on the corresponding bitcoin. When the market price is higher than the book value, the only way to obtain income can be through selling for cash.

In the first quarter, Tesla fell below the original cost after buying a small portion of Bitcoin, causing $27 million in impairment. However, due to the soaring prices of most of the portfolio, Tesla sold 10% at a price much higher than the purchase price, thus making huge gains.

Tesla’s approach

Robust and very conservative

It seems that Tesla has two options, both of which can meet the intangible asset regulations of the US Financial Accounting Standards Board. As mentioned before, one method is to lose the book only when the average cost of buying bitcoins is lower than the market price at the end of the quarter; the second method is that any batch of purchase prices on the book exceeds the exchange quarterly The closing price is impaired.

“Tesla was able to choose mainly because the Financial Accounting Standards Board of the United States did not issue guidance on Bitcoin.” said Ed Katz, a professor of accounting at Pennsylvania State University.

Albert Meyer, chief accounting expert at Bastiat Capital, pointed out that Tesla’s approach is quite cautious and follows the two principles of the American Financial Accounting Standards Board, namely “timeliness” and “individual valuation.”

Tesla calculates the impairment based on the current price rather than the quarter-end price, which reflects “timeliness.” Whenever the market price of Bitcoin is lower than the purchase price, it is calculated to write down, which reflects the “individual pricing”. Meyer said: “Individual pricing and immediate confirmation of impairment are very cautious, I think there is no problem.”

However, it is worth noting that if Tesla conducts an impairment test at the end of the quarter, there will be no loss of $27 million in the first quarter, and there will be a chance to avoid write-downs in the second quarter. However, from a practical point of view, Tesla’s bookkeeping is very prudent, which can remind people of the dangers of investing in Bitcoin.

This time, the loss may be more serious

In mid-May, Musk announced on Twitter that due to the disturbing carbon footprint of Bitcoin, Tesla would no longer accept Bitcoin as a payment method for purchasing electric cars. This remark shocked the market. Subsequently, the market became more and more worried that he would completely abandon Bitcoin. Later Musk announced that Tesla did not intend to sell the Bitcoin he held.

So it can be assumed that currently Tesla still holds 90% of the purchase, or 42,100 bitcoins.

However, the value of Bitcoin held by Tesla is much lower than a few weeks ago. In mid-April this year, Bitcoin hit a record high of $64,863. At that time, the market value of Tesla’s currency holdings was as high as 2.73 billion U.S. dollars, and the total unrealized and realized income was approximately 1.36 billion U.S. dollars, an increase of 150 million U.S. dollars from the end of the first quarter.

As of the afternoon of May 25, Bitcoin has fallen 41% to 38,000 US dollars, and Tesla’s revenue of 1.36 billion US dollars has been reduced to 378 million US dollars.

As for the first quarter, Tesla revealed that the “book value” of the remaining 42,100 bitcoins was $1.33 billion. This means that the average “base price” of each coin is $31,600, but the average price is not important when calculating the impairment loss, and it cannot be considered as the overall “profit” of Tesla. The key is the lowest price on the exchange during the quarter. As long as Tesla buys above this price, it must be devalued at the lowest price. The amount of impairment is the difference between the low price and Tesla’s purchase price.

So far, the lowest price of Bitcoin in the second quarter appeared on May 19, falling to $30,682. On that day, the Chinese government banned banks and payment providers from accepting cryptocurrencies. However, trouble also appeared. We don’t know exactly how much Tesla bought Bitcoin from January 1st to February 8th. If the average price is US$31,600, some part of the purchase price is definitely higher than US$30,682. During Tesla’s purchase, there were only a dozen days below that price.

In order to estimate the scale of future impairment, a simple assumption can be made here, that is, half of the bitcoins bought by Tesla are higher than the average price of $31,600, and the other half are lower than this number. Suppose Tesla bought 21,500 “cheap coins” for $29,500, and the purchase price of the other 21,500 was $33,700 (calculated with an average price of $31,600).

In this case, Tesla’s average devaluation per bitcoin is about $3,018 (each $33,700 minus the quarterly low of $30,682). Impairment expenses in the second quarter will reach 65 million U.S. dollars.

This doesn’t sound that serious. But even from an accounting point of view, it would be very embarrassing that Tesla’s previously touted Bitcoin investment lost money. In order to avoid losses, Musk may break his promise to sell Bitcoin to fill in the hole. The problem is that the price has fallen so much that to fill the $65 million gap, you have to sell a lot. According to my estimation, if the price stays at the current level of 38,000 US dollars, Tesla needs to sell 10,000, which is a quarter of the Bitcoin holdings to tie it.

Since Musk is an opinion leader in the Bitcoin circle, a large-scale sell-off may trigger panic among fans, which will further promote Bitcoin’s dive. Imagine that the price returned to $25,000 in early December, and Tesla’s loss would amount to $278 million. What if it falls to $20,000? At that time, Tesla’s once “profitable” investment of US$1.3 billion will lose US$484 million.

Keep in mind that in the past four quarters, after deducting sales of carbon credits, Tesla suffered a pre-tax loss of US$127 million. Musk also admitted that sales of carbon credits will rapidly decrease. If Bitcoin suffers a huge loss, it may wipe out all the profits from selling cars and batteries in 2021 or even longer.

However, the real problem is that Bitcoin’s price trend has always been ups and downs and extremely difficult to judge, and Tesla’s already unpredictable future earnings are becoming more and more suspicious. The most indispensable thing for Tesla today is uncertainty. Musk chooses to bet on today’s most varied assets and can only add variables to the variables.

Musk used the $1.5 billion of Tesla shareholders to play Bitcoin before, and he was very lucky at the beginning. Now, his luck is getting worse and worse. Who knows if he will have more chips next month than when he started?

Shareholders have not dared to ask, after all, since Tesla’s stock price peaked in January, shareholders’ holdings have shrunk by a third.

Author/ Translator: Jamie Kim
Bio: Jamie Kim is a technology journalist. Raised in Hong Kong and always vocal at heart. She aims to share her expertise with the readers at Kim is a Bitcoin maximalist who believes with unwavering conviction that Bitcoin is the only cryptocurrency – in fact, currency – worth caring about.