Nikola faced fraud allegations upon announcing a $2 billion deal with General Motors, but GM doesn't seem worried

• Almost immediately after Nikola and GM announced a strategic partnership, with GM taking a stake in the startup, Nikola came under attack from short-sellers.
• Hindenburg Research alleged that Nikola is a fraud, but GM CEO Mary Barra stressed that GM had done its homework.
• Nikola is a high-risk venture that's trying to shed some execution risk by partnering with GM to build a pickup truck while Nikola focuses on semitrucks.
• Until Nikola starts selling vehicles, it's a good idea for investors to be wary, but GM doesn't seem concerned that the startup is all hot air.

Just days after announcing a big-time deal with General Motors, Nikola last week came under attack from a short seller, Hindenburg Research, who published a wide-ranging litany of allegations under the un-subtle title "How to Parlay An Ocean of Lies Into a Partnership With the Largest Auto OEM in America."

Hindenburg is Nate Anderson, and as far as I can discern, the firm is a one-man shop; this isn't exactly Bill Ackman going after Herbalife in 2012, similarly maintaining that the company was a financial fraud (an illegal pyramid scheme, in fact).

In his report, Anderson indicated that Hindenburg had taken a short position in Nikola, which went public earlier this year through a "blank check" SPAC deal and quickly minted a $3.3 billion market capitalization, generating a significant amount of chatter in the auto industry and on Wall Street.

It's not entirely clear that playing the market is Anderson's mission; he seems to have adventured in a few hedge funds before co-founding his own, then starting Hindenburg in 2018.

However, Anderson's research was quickly endorsed by another short-angled research firm, Citron Research, run by Andrew Left, who joined a chorus of Tesla naysayers a few years back before reversing course and turning bullish on the company. Left had already talked Nikola down in June.

GM's CEO stressed the automaker's diligence on the deal

According to S3 Analytics, a firm that tracks short-selling, Nikola is now the ninth most shorted stock in the auto and construction sectors; Tesla, after an epic rally that commenced at the beginning of 2020, is No. 1.

GM's deal with Nikola entails taking a roughly 10% equity stake, worth $2 billion, and becoming in effect a contract manufacturer for Nikola's forthcoming Badger pickup truck — producing the vehicle both in all-electric versions, using GM's new Ultium technology, and in a fuel-cell iteration.

But GM isn't putting any money into Nikola, so for the automaker, the deal looks almost completely risk-less, save for whatever reputation damage it might suffer if Nikola falls apart.

At an RBC event this week, GM CEO Mary briefly remarked on the Nikola deal and later fielded a question from Joe Spak, RBC's lead auto analyst, related to the dustup over the Hindenburg report.

"Our company has worked with a lot of different partners and we're a very capable team that has done the appropriate diligence," she said. "On the specific issues related to Nikola, I'll let you ... have that conversation with them. But on the strength of the deal we put together, it validates our technology, it allows us to have more people using the technology, which gives us the advantage of scale, which will help us drive costs down."

The translation is that GM did its due diligence on Nikola and isn't terribly concerned about research coming from a firm with a track record of going after relatively unknown growth companies. GM has also done deals with relatively unknown startups before; in 2016, it completed an acquisition of Cruise, which is now a stand-alone self-driving company that subsequent rounds of investment have taken to a valuation of nearly $20 billion.

The stock takes a hit

Following a sell-off on the Hindenburg announcement, Nikola and GM stock both slid and then recovered (Nikola had spiked almost 40% when the deal was announced). Nikola later produced a rebuttal to Anderson's allegations and said through a company spokesperson that "Nikola's legal counsel proactively contacted and briefed the US Securities and Exchange Commission regarding Nikola's concerns pertaining to the Hindenburg report."

On Monday, Bloomberg reported that the SEC had opened a probe of whether Nikola misled investors.

General Motors said it would be "subject to a staged lock-up provision beginning in one year and ending in June 2025" on its Nikola stake, so presumably, the company would be able to back out of the deal if the SEC inquiry amounts to anything.

But it doesn't sound like GM has any doubts about what it termed a "strategic partnership" with Nikola, and the deal is slated to close at the end of September, after the usual regulatory scrutiny.

So what's going on here? If you're troubled by short-selling, you see an effort to discredit a company whose SPAC-driven IPO led to a market cap that shot past Ford's, at one point, and continued to stand at over $10 billion, having never sold a vehicle nor generated revenue. Call it a short-seller's ATM, albeit a supremely risky one.

If you're troubled by the sudden rise of highly valued transportation startups selling no vehicles and following in Tesla's wake, touted as disruptors of business and usual, you see a comeuppance for Nikola's outspoken founder, Trevor Milton.

If you're looking at the situation more dispassionately, from the GM side, you realize that GM took a $500-million stake in Lyft 2016 and saw that investment double after the ride-sharing startup's IPO in 2019. The Cruise acquisition added up to about $1 billion, once long-term expansion plans were baked into the deal, and that wager is now 20 times the initial stake.

GM has also been shedding entire divisions — as it did with Opel in 2017, selling it to France's PSA Group — to free up capital to invest in an ambitious plan for electrification and autonomy over the next 10 years.

How did it become possible to short Nikola in the first place?

One also has to examine how a company like Nikola got to the point where it even had any public equity for GM to obtain, as well as how Nikola can be shorted in the first place. Nikola went public because it was bought by a "special purpose acquisition company," or SPAC, in this case, a firm called VectoIQ Acquisition Corp., which had raised money from institutional investors, including Fidelity, to buy ... somebody.

The reverse merger created a Nasdaq-listed company with the new ticker NKLA, but without a traditional "roadshow" to gin up investor enthusiasm or the usual public scrutiny of financials, the merger more closely resembled a private-equity takeover. By that logic, the SPAC likely has a private-equity timeline to see the deal yield results, at least five years, maybe 10.

In that context, Hindenburg's Anderson is David to GM's Goliath, except that GM has access to an army of lawyers, accountants, and financial experts to vet its deals. So the analogy is more like David to 50 Goliaths. That was implicit in Barra's RBC comments, which I read as putting the matter to rest for the automaker.

There's a larger debate around the proper role of short-selling. The virtue of shorting stocks is that the practice provides an opportunity to rationalize markets, adjusting for misperceptions about value; shorting also opens the opportunity for investors to balance their portfolios, achieving a positive return in up as well as down markets, although it's possible to argue that "bad" companies could simply be ignored and that investors would be better served to support long positions, buying and selling as needed to manage a good return.

The focus with Nikola is actually incidental as far as the investment thesis goes, given that the company has been listed for only a few months. Instead, the story has been driven by research, although the premise of that research is to allege fraud without the documentation of the type of editorial process that would be evident if Nikola had been investigated by journalists.

For that, anybody interested can turn to Bloomberg's Edward Ludlow, who has drawn the ire of Milton.

Ultimately, what most interested observers might conclude from this fracas with Nikola — like Tesla and many other entrepreneur-driven auto startups, dating to the Ford Motor Company in the early 20th century — is that although more than 100 years of car making and the creation of vast global conglomerates selling millions of vehicles annually has smoothed the inherently rough edges of the business, creating a car company demands some bare knuckles and doesn't attract low-key personality types.

We've seen this with Elon Musk and now we're seeing it with Milton, whose deal with GM in some respects resembles the equity stakes that Daimler and Toyota took in Tesla a number of years ago, which enabled the company to survive a challenging period when it wasn't selling very many vehicles.

To fraud or not to fraud

What about Anderson's fraud allegations?

Hindenburg's dive into Nikola is premised by the assessment that the "real 'value' for GM seems to be branding."

The report adds: "We believe the legacy automaker simply seeks to latch General Motors' storied name onto Nikola's charismatic Founder and Executive Chairman, Trevor Milton. Trevor is perceived by many as a forward-thinking, fresh, visionary entrepreneur capable of rivaling Elon Musk's allure."

This is nonsense. The branding opportunity is less for Nikola, a company whose brand is currently a financial phenomenon — a work in progress — and more for GM's Ultium technology, which the company unveiled at the beginning of 2020, and that underpins its entire EV strategy.

The report evokes Tesla along with Theranos, the biotech startup founded by Elizabeth Holmes that collapsed in 2018 in a scandal after an SEC investigation concluded that the company was a sham. The report also covers a vast amount of ground, from well before Milton founded Nikola, giving skittish investors ample justification for selling shares.

However, a good rule in the auto industry is to avoid investing in anything until you can see product; by far the toughest challenge for a new carmaker is to actually build a car — and then sell it. As a practical matter, Nikola is now concentrating on building semitrucks, hiring GM to take care of the Badger pickup and engineer the drivetrains.

GM manages risk all the time — from whether it will be able to get enough steel to construct vehicles, to what could sink its investment-grade credit rating, to how many US sales it could lose and continue to remain profitable — so it's safe to assume a level of maturity as far its evaluation of Nikola goes.

For everybody else, Nikola is best ignored until it starts selling something tangible.

But doesn't that mean missing out on the next Tesla? Not really. Tesla shares were flat for several years after its 2010 IPO, and prior its latest rally, the stock peaked at about $300 before retreating into a realm of volatility that presented adventurous investors with many buying and selling opportunities.

But GM's stake is a strong indication that Nikola should survive, despite the understandable obsession of short-sellers with this overnight success.