What will happen to Tesla?
On May 2, Elon Musk and Tesla had their quarterly conference call, and to say it was interesting is an understatement. Now everything I am going to say from this point forward does not constitute a recommendation to buy, sell, or hold Tesla stock. These are purely my thoughts on a company that I have been asked hundreds of questions about over the past few years.
Tesla makes an amazing car. Anyone who has ever ridden in a Tesla knows that it is a pretty special driving experience. The first time I rode in a Model S four years ago, I was floored at the level of engineering and detail that had been put into the car. It was truly innovative. The responsiveness of the engine and the performance of the wheels and steering were exceptional… but I was in a car that retails for $125K. Buyers would and should expect an earth-shattering experience at that price.
Making a great product is only the first step in being a great company. It is certainly a foundational piece, but it is only one part. Historically, there have been many companies that have created great products but still managed to go under for various reasons (bigger and better-funded competition, mismanagement, production issues, and not evolving, just to name a few). Tesla has a visionary CEO in Elon Musk. No one is going to argue that Musk isn’t smart or that he doesn’t have brilliant engineers working for him. The products are amazing, and owners love their Teslas.
For bullish investors the first thing you need to truly believe is that Electric Vehicles are the future. That is the first step. Then you must believe that because Tesla only produces EVs that they have an advantage from a technology and focus perspective over the traditional US automakers and the Germans (BMW and Mercedes). From a technology perspective does Tesla’s relationship with Panasonic give it an advantage when it comes to producing the battery packs required to run the vehicles. Also Tesla having its own production facilities (gigafactories) for batteries is certainly an advantage currently over the other manufacturers.
Tesla has a charger network that is significant and pretty much connects the entire United States and a majority of Europe and some of Asia. This network certainly has value and is something that the traditional gas automakers do not have at their disposable. This was a smart investment by Tesla. They understood with the range issues that if they were going to become a mainstream success they were going to have to have a way for owners to charge while they were on the road.
Now that we have hit some of the positives of the company, let’s look at the challenges and opportunities.
Competition: The Moat Is Dry
When Elon Musk bought the assets and IP to create Tesla Motors in 2008, he had a significant first-mover advantage since GM, Ford, and all the other automakers were dealing with the aftermath of the financial crisis. None of the big automakers were giving electric vehicles more than a passing thought, because they had bigger problems to deal with. Unfortunately for Elon and Tesla, that has changed, and the established, well-capitalized competitors are charging hard after Tesla’s EV market dominance.
Over the next year there are going to be a ton of new competitors hitting the market – competitors that already know how to successfully manufacture cars. BMW, Mercedes, and others are going to have entrants into the high-end luxury electric vehicle market that the Tesla Model S currently dominates. Kia, Ford, and Hyundai are making entries into the small sedan market in which Tesla offers the Model 3. The point is that, while Tesla is currently making amazing cars, it is about to have major competitors join the electric vehicle revolution rapidly. These new entrants coming online this year will join GM (Volt) and Nissan (Leaf) who already make all-electric vehicles. And I believe that these competitors will be more price competitive than Tesla, which sells the Model 3 for between $55K and $80K and the Model S for between $100K and $125K depending on configurations.
Porsche’s EV is going to give Tesla a run for its money when it comes to high-end performance. Porsche announced that it is going to be investing $7.4B into its EV program by 2022. It also announced that it will have an all-electric vehicle on the market by 2019. This EV would go 0 to 62 mph in 3.5 seconds and have a 310-mile range battery, which is comparable to Tesla’s Model S (0 to 60 in 2.5 and 330-mile range). So Porsche is going to be a formidable competitor for the high-end performance car market with a brand that is known for quality engineering, performance, and loyalty.
— Porsche Newsroom (@PorscheNewsroom) June 9, 2018
When Elon Musk unveiled the Model 3, he portrayed it as a mainstream EV with an attainable price of around $35K. Now that Tesla has finally started to deliver Model 3s, they have not come anywhere near the $35K price point, with most of the cars selling for north of $60K. $60K is not a price that most people can afford. The average new car loan in 2016 was just over $30K, with an average monthly payment of $503 (CNBC). Thus borrowing $60K would be exceptionally difficult for most of the population to do.
@walalm Yes, my absolute goal w Tesla has always been mass market electric cars. Will finally get there with Gen3 program.
— Elon Musk (@elonmusk) July 27, 2012
I believe that if the Model 3 had been released for $35K like originally promised, then Tesla would not only be dominating the market but would also have such a significant advantage that it would be hard for competitors to catch up. I was a reservation holder, but, like most people, I will not pay $60K for a car. However, it appears that I have a better chance of finding Godot than I do of ever getting a $35K Model 3. Recently Elon Musk said that a $35K model will be delayed again, probably into 2019. As this date continues to move further and further out, Tesla is opening a window for other competitors to create mass market EVs, and, as previously mentioned, the competition is coming.
Financials: Bad and Getting Worse
Tesla supporters are constantly talking about the future and Elon Musk’s ability to innovate. That is certainly important, but so are the current financials and trends. The Q1 2018 GAAP (Generally Accepted Accounting Principles) excluding zero-emission vehicle credit sales was negative $760M. That is a loss of over $25K per car sold. The zero-emission vehicle credits are tax credits Tesla gets from the government that it can sell to other companies in states like California which have laws around carbon output. In comparison, Tesla lost $219M in the first quarter of 2017. The free cash flow for the quarter also accelerated to negative $277M. Why is free cash flow important? Well, the capital-intensive dynamics of the auto industry means every dollar counts – especially for a young, fast-growing automaker like Tesla.
Here’s the exchange where Elon Musk cut off two analysts on the Q1 earnings call to go to crowd-sourced questions on YouTube. Shares fell 4.7%, or about $2.4 billion, in after-hours trading pic.twitter.com/uBP4UtaYAW
— Tom Randall (@tsrandall) May 2, 2018
It takes billions of dollars to build out vehicle production capacity. In the fourth quarter of 2017, for instance, the company spent $787M in capital expenditures, the majority of which went to Model 3 and Gigafactory production capacity increases. Furthermore, capital expenditures for the full year were $3.4B – more than double the automaker’s $1.3B in capital expenditures in 2016. And Tesla expects capital expenditures to be “slightly” higher in 2018.
With so much spending, the automaker has unsurprisingly burned through billions of dollars. Tesla’s free cash flow in 2017 was negative $3.5B – worse than its negative free cash flow of $1.4B in 2016.
So far, Tesla has turned to equity and debt markets to raise capital to help sustain its aggressive expansion. Recently Moody’s downgraded Tesla’s debt rating from junk stable to junk negative. This may not seem like a big deal, but, despite Elon Musk’s repeated comments about not needing to raise additional capital, it is fairly evident that Tesla is going to need to raise billions this year to refinance current debts and to continue to build out production capabilities and capex for future manufacturing facilities for the Semi and Roadster (which the company has already begun taking deposits on).
Elon Musk has been adamant that Tesla will not need to raise additional debt or equity to fund the continued expansion of the business and has gone even further to say that it will be Cash Flow positive by Q3 and Q4 of this year. Goldman Sachs estimates that it will need to raise between $2.5B and $3B later this year to meet obligations and continue the expansion and increased production demands. Goldman Sachs goes on to say that Tesla is going to need to raise $10B over the next two years.
With increasingly poor cash flow and an already debt-ridden balance sheet, how will Tesla be able to raise that kind of capital? And how much will it cost them to do it? It already has a significant debt service payment annually of $596M for interest in 2017 and currently have almost $10B in long term debt on the books.
Blast from the past:
2018Q2: So, you’re going to incur incremental dilution, right?@elonmusk: No. I specifically don’t want to.
So, what changed? pic.twitter.com/rSq346nfHJ
— skabooshka (@skabooshka) June 8, 2018
— BossHogg (@BossHoggHazzard) June 6, 2018
You tell me – would you lend money to a company with current significant debts, negative free cash flow (that is getting worse), and limited asset base for collateral security? And, if you would lend said company money, what would you charge them for the risk? What is funny is that, in February 2012, Elon Musk stated that the company would not have to raise another round of funding again, but then Tesla proceeded to raise the following in subsequent debt and equity:
- September 2012: $195M
- May 2013: $913M
- February 2014: $2B
- August 2015: $652M
- May 2016: $2B
- March 2017: $1.4B
- August 2017: $1.8B
Does that sound like someone whose word investors should trust?
An additional concern for the almost 500,000 people and companies who have placed deposits with Tesla is that if the company goes bankrupt then their deposits (totaling almost $1B at the end of 2017) would most likely be gone. Deposit holders would get in line as general creditors, and, if I were a betting man, I would say that there would be nothing left to pay them back.
There is a reason that most successful CEOs lead only one company: it requires tremendous focus and attention to detail for a company the size of Tesla to succeed. Elon Musk is not only the CEO of Tesla, he is also the CEO of SpaceX (which purportedly has a larger market cap than Tesla) and the Boring Company (which makes tunnels). He also has dreams of building a high-speed rail, dubbed the Hyperloop, and recently talked about creating a company that looks at the honesty and credibility of media reporting. This is not a hyper-focused CEO.
“he’s really little more than an unusually accomplished B.S. artist. His legions of devotees are fanatics and, let’s face it, a bit stupid.” https://t.co/faMaMpOr8W
— scepticalblonde (@omniamea) May 26, 2018
He has recently shown signs of instability on Twitter. If people want to go off the rails about Trump’s mental stability based on his tweets, then, as a public CEO, Elon Musk should be subjected to the same scrutiny. He has tweeted jokes about Tesla going “Bankwupt” and the fact that he is sleeping at the factory (which, if he is doing, is deeply disturbing).
Elon was found passed out against a Tesla Model 3, surrounded by “Teslaquilla” bottles, the tracks of dried tears still visible on his cheeks.
This is not a forward-looking statement, because, obviously, what’s the point?
Happy New Month! pic.twitter.com/YcouvFz6Y1
— Elon Musk (@elonmusk) April 1, 2018
He has attacked legitimate reporters over their reporting without providing facts to the contrary. He created a Twitter poll about whether people trusted the media and then proceeded to tweet about it for hours. Again, this is not an engaged leader.
Going to create a site where the public can rate the core truth of any article & track the credibility score over time of each journalist, editor & publication. Thinking of calling it Pravda …
— Elon Musk (@elonmusk) May 23, 2018
One the most disturbing tweets though is one that could end up getting him and the company in trouble – when Musk tweeted that workers would lose their stock grants if they unionized. Now I am not a believer in unions, but what he did is a direct threat to his workers and their rights. While it is debatable how much influence his comments would have if there was a vote to unionize at Tesla, it is still an issue.
New: Musk’s tweet about losing stock options by unionizing could be grounds for Labor Board charges, former NLRB chair tells me: https://t.co/FAJcXXnjha “The employee is going to hear it as, ‘If I vote to unionize, stock options will no longer be an option.”’ https://t.co/zaBaHvejc7
— Josh Eidelson (@josheidelson) May 23, 2018
Elon Musk also uses Twitter to tease things that for many other companies would be considered material disclosures, like his most recent statement that Tesla will unveil the Model Y on March 15, 2019. Later, he admitted that he just made up the date because it sounded good. He also picked a fight with the National Highway Traffic Safety Board about their investigations into crashes involving Tesla Auto Pilot feature. In general, picking fights with government agencies like the NHTSB and the SEC is not a good long-term strategy. Being pulled away to deal with investigations will continue to consume Musk’s time and will ultimately prevent him from fixing company issues.
Musk also has a history of overpromising, underdelivering, and missing deadlines for delivery, ramp-ups, and margins, among other things. It is hard to know if he believes what he is saying or if he is just saying things that sound good. In 2012, he said that his ultimate goal was to make an affordable mass-market EV. In 2016 at the Model 3 unveil, he said that you will not be able to find a better car for $35K even with no options on it. Now he is saying that Tesla can’t make the $35K car without losing a ton of money and ultimately killing the company. So… which is it? Eventually people will stop believing, and it will play out like the boy who cried wolf.
Legal Issues Are Percolating
If you are in business, there are always legal issues to navigate, and a business the size of Tesla is no different. But there is a disturbing trend developing of exaggerating and obfuscation. Tesla is currently under investigation by at least 4 government regulators:
- OSHA: Tesla has held its Fremont Factory as this ultra-modern safe facility where it is revolutionizing car making as we know it. Based on some investigative journalism by Reveal OSHA has opened an investigation into claims that Tesla underreported injuries. Why does this matter? Well besides the obvious worker safety issues it plays into an overall portrayal of an image that is almost too good to be true.
- National Traffic Safety Board (NTSB): While it’s not unusual for an automaker to be in investigations related to crashes and safety issues of their automobiles what is different for Tesla is the number of crashes that are occurring related to their Autopilot feature. Autopilot has been touted by Musk and Tesla as being a revolutionary game changing safety feature. So the fact that there have been several fatal crashes where Autopilot has been properly engaged is certainly concerning. It is also an issue because Tesla charges buyers for the Autopilot feature and many buyers purchase it because it is being sold as an increased safety feature. If it hasn’t been fully tested to show an increase in safety and worse may be dangerous then Tesla may have a big issue to deal with. There is already a class action lawsuit being pursued by some owners related to the Autopilot issue. It’s something to keep an eye on. By itself it is not a huge issue, but it portrays a bigger pattern of deceit.
- Securities Exchange Commission (SEC): The SEC is looking into Tesla’s sales practices around the Model 3. Why does that matter? The SEC was investigating its practice of taking deposits for promises of certain types of cars to be delivered at a future date. Using this deposit system has a huge impact on Tesla’s cash flow as it brings in large sums of cash to help fund operations while it takes years to deliver the actual product to the customers paying deposits. While the practice may be legal, the fact that the SEC is looking at it more closely could have an impact on Tesla in the future.
- Department of Labor: In relation to Elon Musk’s series of tweets related to stock options and unionization, the Department of Labor is investigating the company. Picking fights with the government generally does not end well especially when there are consumers and workers that are potentially getting hurt by the CEO’s comments and actions.
Executive Departures: Rats Off the Titanic, Normal Turnover, or Something In Between?
While executive turnover happens at every company, it doesn’t usually happen in such a rapid fashion and with such a high number of important positions in a company. Many of the company’s important engineering heads have left in some cases to go to competitors like Waymo. It has also lost many important people on the corporate finance side such as the Chief Accounting Officer, The Corporate Treasurer, and the CFO. Below is the full list of employees who have appeared in annual reports and have left in the last two years (this list, compiled by Rueters, can be found here):
- Matthew Schwall, Director of Field Performance Engineering, exits to join Alphabet Inc’s self-driving unit, Waymo. rs/2rIFnxb
- Jim Keller, head of Autopilot Hardware Engineering, leaves for Intel to lead its silicon engineering team. rs/2rIZknr
- Georg Ell, Director of Tesla’s Western Europe Operations, leaves to head UK-based Smoothwall. ly/2rJEKCt
- Chief Accounting Officer Eric Branderiz exits after joining in October 2016. rs/2rI6OXD
- Susan Repo, Corporate Treasurer and Vice President of Finance, exits to become chief financial officer at another company. bg/2FFA4HB
- Jon McNeill, President of Global Sales and Services, leaves to join ride-hailing company Lyft as chief operating officer. rs/2GgaLr6
- Jason Mendez, Director of Manufacturing Engineering, leaves after more than 12 years. ly/2InKIQO
- Will McColl, Manager of Equipment Engineering, leaves after seven years. ly/2InKIQO
- Jon Wagner, Director of Battery Engineering, who joined in 2013 exits to launch a battery and powertrain startup in California. rs/2L3CFu4
- Diarmuid O’Connell, Vice President of Business Development, departs. rs/2KpjeuJ
- Kurt Kelty, Director of Battery Technology and one of the longest serving company executives, exits. He led negotiations with Panasonic on the company’s gigafactory in Nevada. bg/2vhrcSD
- SolarCity co-founder Peter Rive leaves the company, eight months after Tesla bought the biggest U.S. residential solar panel maker. rs/2Krcnkh
- Chris Lattner, Vice President of Autopilot leaves within six months of joining. rs/2rL6l6e
- SolarCity founder Lyndon Rive leaves the electric vehicle maker. rs/2rJnY6u
- Arnnon Geshuri, who led HR at Tesla for more than eight years, departs. ly/2IGwKg8
- Chief Financial Officer Jason Wheeler leaves to pursue public policy projects; replaced by Deepak Ahuja, who served as CFO before Wheeler. bi/2wI4Zir
- Mark Lipscomb, Vice President of Human Resources, departs to join streaming service provider Netflix
- Satish Jeyachandran, Director of Hardware Engineering, leaves after seven years with the company; later joins Waymo. ly/2IloGSs
- David Nister, Vice President of Autopilot Vision, departs to join chipmaker Nvidia. bi/2jWtteA
- Klaus Grohmann ousted after a clash with CEO Elon Musk over the strategy at Grohmann’s firm, which Tesla had acquired in November. Grohmann Engineering helped companies design highly automated factories. rs/2wJjbYF
- JLM Energy says Ardes Johnson, who worked as Director of Sales at Tesla Energy, joins as a Vice President. ly/2rJUqWh
- Sterling Anderson, head of Tesla’s Autopilot System, leaves company. Tesla sued him for trying to recruit company engineers for his new venture while still with Tesla, and in April withdrew the lawsuit after a settlement.
- Mateo Jaramillo, Vice President of Tesla Energy, leaves after seven years. ly/2wHbGBs
- Rich Heley, Vice President of Product Technology, departs to join Facebook. ly/2rJnXjb
- Josh Ensign, Vice President of Manufacturing, leaves; joins startup Proterra as chief operating officer. bi/2IHq4hS
- Greg Reichow, Vice President of Production, leaves as the company prepares to launch Model 3, and sharply ramp up production. rs/2InGIQi
- James Chen, Vice President of Regulatory Affairs and Deputy General Counsel, leaves to join rival Faraday Future. bi/2rI1P8P
- Ricardo Reyes, Vice President of Global Communications, leaves. bg/2ImDzUY
- Michael Zanoni, Vice President of Finance and Worldwide Controller, departs to join Amazon. ly/2rHW9eU
- Chief Information Officer Jay Vijayan leaves Tesla to create his own startup.
Ownership has its Privileges and Big Costs
All cars have costs more than just the purchase price. You have things like maintenance, fuel, insurance, etc. Theses things are called the costs of ownership. With a Tesla these costs are significant. While you don’t have gas which is a significant savings you still have electricity costs. I have a couple of clients that own Tesla’s so I asked them specifically for their costs of ownership.
One client owns a 2017 Model S P100D which cost $123,000 upfront after-tax credits and savings for paying cash for the car. They added the Maintenance plan because of the issues they had heard about with the cars in general. That cost him an additional $3000 and covers the car for 4 years. Insuring their Model S costs them $3800 a year. They drive about 1200 miles a month which costs them about $400 for the year in electricity. The total cost of owning the Tesla for 5 years is approximately $147,000 and that is with paying cash for the car purchase which is something that most people could not do easily.
If you purchased anything that cost $140,000+ to own it for 5 years you would expect it to work as close to 100% of the time. They have owned the car since January 2018 and it has had to go into the Tesla Service Center 3 times for various problems. The first one was the heater in the car was turning on by itself. The second one was related to not being able to unlock the doors and the last one was related to the battery not keeping charge. The first two issues were fixed with some software update and the last one they ended up replacing the battery. While they love the car they are a little frustrated with having 3 issues so soon into their ownership experience. I understand that this is one persons ownership experience but a simple online search would show hundreds of similar experiences.
Subsidies and What They Mean to Tesla
According to a 2015 LA Times report, Elon Musk and his companies (Tesla, Solar City and SpaceX) have received more than $4.9B in government support. This support has come in the form of grants, subsidies, tax credits, and inexpensive loans. Getting government support when you are starting a business in a new field is not unusual. Many biotech companies have spun out of research that was funded through National Institutes of Health or Center for Disease Control grants.
Now Elon Musk says that the subsidies are not a big deal and that the big oil makers receive significantly more in subsidies than his companies do. This is true on an absolute basis that traditional fossil fuels receive more government assistance than renewable energy but when you normalize for industry size the renewable energy space is getting significantly more assistance.
In my opinion, the most important subsidy for all automakers is the $7,500 tax credit for EVs buyers. I’m not going to debate whether the policy of offering tax credits for different industries is appropriate. It is what it is, and the government has decided that energy independence and alternative energy is an important thing to invest in. Let’s instead explore the $7,500 tax credit: how the new tax law will impact it, and what it means for Tesla and GM in particular.
Currently, the $7,500 tax credit begins to be phased out once a manufacturer reaches 200,000 cars sold in the United States. Why does this matter to Tesla and GM? Because the two companies are very close to hitting the 200,000 EV units sold, while competitors like BMW, Ford, Kia, and Hyundai are just beginning to sell. In the very near future, possibly as soon as Q3 2018, Tesla will reach the 200,000-unit mark, and Tesla buyers will begin to lose the tax credit that buyers of other EVs will still receive. I don’t think this tax credit matters very much for Tesla’s higher-end Model S and X buyers, but it could have an impact on Model 3 sales, since the tax credits benefit lower-priced car buyers more than higher-priced ones.
Tesla will be an amazing case study one day because there is no in between from a success or failure perspective. They will either become a huge success that dominates the EV market of the future or they will implode in a financial train wreck that goes bankrupt under the weight of production issues and tremendous debt. I will leave it to you the investor to decide whether Tesla will be the revolutionary technology company that changes energy and transportation forever or if it will join the other automakers that have been forced to declare bankruptcy under the financial strains of too much debt and little to no profit margin.
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