TSLA: Taxpayers Stuck with Lifeless Assets

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From my blog, http://huntingforcommoncents.wordpress.com, with thanks to BlackHat for the collaboration and review


Everybody loves a gimmick, whether it's the novelty of the high-flying social media companies run by twenty-somethings with nothing to lose but their oversize sweatshirts or the possibility of harnessing cold water fusion to create unlimited supplies of Clean Energy. The more ridiculous the idea, the more the Gen X'ers and the Millennials would love to embrace it. Being a Millennial myself, I naturally blame the Baby Boomers for instilling us all with the false sense of security and accomplishment they never had while growing up because their parents told it like it was.

Anyway, I'll stop myself from waxing poetic any further and get right to the point: the population of ambitious young men and women entering the workforce has been pushed further and further towards the belief that they're too special to simply take a job and work their way up the ladder anymore. No matter where they look, they see the Mark Zuckerbergs of the world and think their best bet is to create a job rather than going out and actually finding one. As you know, we've run into this before with brilliant pipe-dream businesses such as Zynga and Groupon in the past. They're new, they're exciting, they promise to change the world, people love them in the moment, and then, as quickly as you can say "laser hair removal" they disappear. Nobody seems to think about how the collapse could come so quick, but after it does, every single person you talk to will have saw it coming from a mile away. Spend a few minutes on the Apple message board on Yahoo! Finance and you'll get the idea.


Allow me to introduce to you our latest pipe-dream, Tesla Motors (TSLA).

For those unaware, Tesla is dedicated to building upper-end, high-performance automobiles that run entirely on electricity. They've been around since 2003, introduced their first and - until recently - only vehicle called the Tesla Roadster in 2008, and IPO'd in mid-2010 at $20.00 per share. After the launch of the Roadster, TSLA has moved forward in creating a second vehicle called the Model S, marketed as a luxury sedan aimed at a slightly more affordable price point. For reference, the base price on the Roadster was $109,000 while the Model S (with the cheapest battery, 40kW-hr) can be purchased at a base price of $59,900. Given their environmentally-friendly perception, the US government has agreed to extend a $7,500 tax credit to purchasers of the Model S, bringing that base price down to $52,400 for the time being. Not only that, but Tesla has additional support from the government in the form of a mid-$400M loan from the Department of Energy (DoE), which provides capital Tesla would be powerless without.

Further, TSLA has ended production of the Roadster and is currently delivering the Model S to customers exclusively, making it the only source of automobile sales. "Deliveries" of the Model S, which occur when the car is physically given to the customer either at a Tesla dealership or via shipment, began in June 2012. Customers who want a Model S typically must make a completely-refundable down payment of at least $5,000 to get in line for one, and delivery takes usually between 3 and 5 months, with more expensive versions getting priority and thus quicker delivery. [When the car is ready for production, Tesla demands confirmation from the customer, at which point the reservation payment becomes non-refundable.] This would suggest, as Founder and CEO Elon Musk likes to claim, they are supply constrained, not demand constrained... at least right now, that is. Also important to note is that Tesla uses these reservation payments as much needed working capital, though customers that cancel their reservation must receive immediate repayment.

TSLA also contracts with both Daimler and Toyota to manufacture powertrain components and electric vehicle (EV) batteries, providing it with a second revenue stream, though much smaller. Management implies this Development Services segment will trend towards zero over time. Lastly, Tesla receives regulatory credits as a result of being environmentally-responsible, which they have historically turn around and sold to other auto makers who actually need them. This virtually 100% margin activity is still included in Automotive Sales, and again I have to wonder what the chances are that selling automobiles alone would destroy this company in as quickly as a quarter or two.

So the general outline is that Tesla is at the cutting-edge of technology, looking to make one of the most environmentally-hazardous activities into one of the most environmentally-friendly, and the government is behind it. The question we must try and answer is simple: Will these "cars of the future" be embraced by the general public despite their high price tag and current lack of simplicity and infrastructure?


Who Buys a Tesla?

With the bare-bones price of the Roadster in the low six figures, the Tesla was seen as more of a toy for the car enthusiast or Hollywood celebrity with an environmentalist bent than the Midwestern soccer mom. Needless to say, that customer base isn't enormous, especially when you're trying to become a mass-manufacturing automobile company. Customers like George Clooney gave the brand some much-needed awareness, but that was never enough to sell Roadsters to the middle or even upper-middle class on a consistent basis. With the introduction of the Model S, Elon Musk and his gang at Tesla have aimed to capture the doctor, lawyer, and mid-level businessman who can afford the 60-70k the car may cost them with modest upgrades.

So far, that story has been one that we apparently cannot see in the financials, but Musk's most recent quarterly numbers indicated 6000 additional reservations in the fourth quarter of 2012, with deliveries of 2400 Model S vehicles. He goes on to tout that their backlog is so large that they could meet demand for their entire 2013 year goal of 20,000 Model S deliveries right now if they wanted to. Of course, we'll get around to why that's probably a bit of an exaggeration later. For what it's worth, they expect 4,500 of Model S deliveries to come in the first quarter... so we should assume the back half of 2013 will have to pick up the pace to meet their goal. For what it's also worth, TSLA has made 3,100 Model S sedans in its lifetime.

The Model S is technologically a great car and a pretty interesting concept. While I'm not a car enthusiast by any stretch of the imagination, those who are have agreed it has amazing torque, speed, and whatever else those kinds of people care about. On the other side of the coin, an all-electric car just doesn't meet the demands of the average Joe yet. As a controversial test-drive in the New York Times pointed out, someone who isn't experienced in driving the car can easily run out of juice on a road trip, particularly in cold climates that can hurt the lithium-ion battery's capacity. Coupled with limited charging stations nationwide that take upwards of 1h 30m for a full charge (or only an hour at one of the 6 or so "superchargers"), the car's gasoline savings are pretty quickly offset by the higher initial price and inconvenience of time spent charging. If you don't pay for the most expensive Model S battery, you'll unfortunately have to purchase an additional piece that allows you to use the Supercharger system, and you can't use it at all with the smallest pack... And for now, Tesla picks up the tab on all electricity used at the stations... but how long can they afford to do that if the number of Tesla drivers starts to spike?

The most recent conference call regarding Q4 2012 was held on February 20th, and it marked the first "major" selling period for Tesla and gave some information into what we can expect the rest of the year. As mentioned, about 2,400 Model S cars were delivered in the quarter - all of the 85kW-hr battery pack variety costing $79,900 before the tax credit given in the US, the largest and most expensive battery available - and the last of the Roadsters were delivered. Going forward, delivery of the 60kW-hr (base price $69,900 ex-tax credit) have recently started and 40kW-hr battery pack cars should be expected late this summer. As you'd imagine, these are cheaper cars to make, but basing battery costs off of other producers, we assume these will end up being lower margin sales, before even considering they are to stingier customers.


Show Me the Money

Having some cool cars for the rich and famous is all well and good until you're reminded that the taxpayers are footing the bill that not only keeps this company alive, but subsidizes Model S sales for already rich customers. Unfortunately for Tesla, they have yet to make any money on these things and that means an enormous cash burn until they can generate actual cash from operations. In the meantime they have to rob Peter to pay Paul, and unfortunately Peter happens to actually need the money.

As laid out in their 10-q for Q3 2012, "our Model S activities, as well as our capital investments in manufacturing infrastructure, continue to be funded by our sources of cash, including the final draw-downs under our Department of Energy Loan Facility, cash from the sales of the Model S and Tesla Roadster, cash received from refundable reservation payments for our Model S and Model X, and cash from the sales of powertrain components and systems. During the [3rd quarter 2012] we received $33.3M in draw-downs from the DOE Loan Facility, which completed our draw down of the $465M facility."

Based on what we know from the most recent quarter, we can rule out a few of these sources of cash already. The DoE loan is, for all intents and purposes, only a cash burn at this point thanks to required interest and principal payments, but let's just say it's a net zero cash producer going forward. The Tesla Roadster is no longer being produced or sold, so cash from those sales are also gone. Developmental Services cash from powertrain components is not a focus for management going forward, and was actually down about 50% year-over-year from 2011 to 2012. With a gross margin of almost 60%, these sales were very helpful cash generators, especially compared to automotive sales which were 3.6% for the full year and 5.3% for Q4, when Tesla enjoyed its highest production ramp-up (i.e. "economies of scale") to date. On the call, CEO Elon Musk chose to tout the 8% gross margin they achieved in Q4 with Developmental Services included, which inflates the margin to 7.3%... we don't round that up around here, Mr. Musk.

To add to that point, Tesla saw a huge spike in regulatory credit sales in 2012, which came from selling so many more cars than previous quarters. I don't like to talk about red flags so early, but I'm curious to see what the pattern will look like with these going forward, as they (along with the DoE) seem like they could be floating the entire company right now: "For the years ended December 31, 2012, 2011 and 2010, we earned revenue from the sale of ZEV and GHG credits of $40.5 million, $2.7 million and $2.8 million, respectively." For the record, that would mean in 2012, something a bit north of 11% of Tesla's revenue came from credits and inflated their margins dramatically. If we back out emissions credits, TSLA's Automotive unit has a gross margin that looks more like -7%. These guys sure do like the US government.

Tesla's emissions credits are a scary thing to rely on. More and more of the major players in actual automobile manufacturing have entered the electric market to satisfy regulations that a certain portion of their sales come from zero-emission vehicles. This poses a serious problem for Tesla because major car companies can afford to take a loss on these electric cars for a long, long time... Tesla cannot. Once these emissions credits are more easily obtained on their own, the majors will only be willing to pay much less for credits or may not purchase them at all.

Back to cash - Tesla ended the year with $220M in total cash available. About $18M of that is restricted/set aside to pay off DoE loan principal required in March, and $139M is down payments made by customers yet to receive their vehicles. That would imply that only a little over $60M is what I'll call "Tesla-generated cash" from selling cars and, you know, running their actual business. Most of that, however, comes from a mix of emissions credits, deferred payments to suppliers and stock-based compensation anyway. This mix isn't enough to offset their $396M loss for the year, obviously, and thus they continue to eat into reservation payments that can be redeemed in the near future.

[Update: Tesla filed their 2012 Annual Report right in the middle of this posting. They are now reporting about $202M in cash, along with $24.3M in restricted cash, for a total of about $226M in liquidity.]

Another peculiar change from the most recent 10-Q to the 10-k is the following line item: "We expect that our principal sources of liquidity will provide us adequate liquidity until we reach expected profitability in 2013, based on our current plans." That statement had typically been more along the lines of "for the foreseeable future," but the change in language causes me to suspect otherwise. Another equity raise is not out of the question for a variety of reasons, this being one of them.

Plenty of businesses have this problem, but it's scarier when the same company has seen this twice before. The DoE loan, of course, was a necessary lifeline for Tesla to continue developing their cars, with the promise that a home run from Roadster and Model S sales would help them pay back the loan at hyper speed. However, that wasn't enough. In mid 2011 they had an additional equity offering... And again, per the company:

"On September 25, 2012, we filed a registration statement on Form S-3 relating to a public offering of common stock. On October 3, 2012, we completed the offering and sold a total of 7,964,601 shares of our common stock for total cash proceeds of $222.1'' This ends up equating to about $27.89 per share.

The use of these proceeds, according to the aforementioned S-3 is simply "for general corporate purposes. We may temporarily invest funds that are not immediately needed for these purposes in short-term marketable securities." For reference, as of September 30th 2012, Tesla had no short-term marketable securities. As of December 31st, 2012, Tesla still had no short-term marketable securities. At the end of Q3, the company had about $107M in cash (including $23M restricted) after burning through around $170 in the first nine months of the year. Unfortunately, Tesla does not break out its cash flow statements by quarter... which would be extremely helpful/telling in this instance. I see you, Elon. Had Tesla not had their equity raise, the $92M in cash burn from operations and investing would have been enough to see them run completely out of cash. One particular covenant in the DoE loan required them to run a minimum cash balance, and a violation of that covenant would spell enormous trouble for Tesla... but this covenant has been mysteriously removed earlier in 2013. Nevertheless, given the economic and political climate we're in today, there won't be many happy legislators ready to sign off on cutting Tesla even more slack than they already have.

[Update: More peculiar changes from the Annual Report. While Tesla previously had a minimum cash balance covenant attached to the DoE loan, the new report conspicuously omits it while no other financial covenant has changed. "In addition, our DOE Loan Facility also contains a variety of customary financial covenants, including covenants related to current ratio, leverage ratio, interest coverage ratio and fixed charge coverage ratio. We modified certain of these covenants in February 2012, September 2012, and again in March 2013."] Another key change related to the DoE loan is that Tesla seems to have struck a deal with the DoE that pulls forward the maturity of the DoE loan to December 2017. I suspect this was a reasonable compromise for Tesla to get rid of that minimum cash balance.

Anyway, with $107M in total cash, $222M incoming from an equity raise in October, and about $220M at year-end, Tesla clearly issued $222M in common stock to satisfy a very significant lack of cash they (for one reason or another) were unable to anticipate. Why hadn't they done this in the $30s months earlier... or found other financing? For what it's worth, however, Tesla did mention on the call that while free cash flow (defined by them as Cash from Operations less Capex) for the quarter was -$102M, they were FCF positive in December. We'll come back to this later, as it isn't unthinkable that Elon Musk knowingly misled his investors on Tesla's earnings call.


Flakers and Fakers

There's a Ponzi-ish smell coming from the Tesla Factory, legal for now, but not ethical in all jurisdictions it seems. The use of reservation payments as working capital is somewhat risky but apparently necessary for Tesla to continue doing business. Cancellations have become an increasing problem for Tesla, and even Chief Cheerleading Officer Elon Musk has admitted that cancellations have increased and may accelerate in Q1 2013 as more people are prompted to make the firm commitment to purchasing their Model S. Tesla confirmed that it had 15,000 reservations outstanding at the end of 2012 (representing a minimum of $75M in down payments, for reference), with a fourth quarter that had 6,000 new reservations and 1,500 cancellations, according to Tesla IR. That would mean a cancellation rate of 20% for Q4. [Update: And from the 10-K, First quarter 2013 cancellations are likely to remain elevated as the remaining older reservation holders are invited to configure their vehicles within a set time frame or pay the higher price just like new reservation holders."]

At the end of Q3, reservation payments amounted to $138.3M, and after a net increase of 2,100 reservations (4,500 - 2,400 deliveries) the reservation payments at year end were $138.8M, representing only a $500,000 increase, or 100 reservations at most. So how does this make sense that reservation payments wouldn't increase by more? One possible explanation is deliveries of the Model S Signature Edition, which requires a $40,000 down payment rather than a $5,000 for a normal Model S. If Q4 was overweight with Signature deliveries, it could offset the addition of 2,100 normal reservations enough to keep reservation payments rather flat. For what it's worth, the math implies this means the average reservation payment for each of the 2,400 deliveries was between $9300 and $9400, meaning about 300 Signature Editions delivered and 2100 regular Model S deliveries.

A stroke of beautiful and conniving genius at the expense of those who don't understand the concept of modern finance, Tesla held on to enormous chunks of cash from "Sig" reservation holders that kept them from doing even more additional financing than they've already had to. As one writer on Green Car Reports put it...

"In the end, the Signature program has proven to be a good deal for Tesla. It got the company $40 million cash up front, and assured that the first 1,000 cars out the door would be maxed out with options, bringing in nearly $100,000 each. (That's $100 million in badly needed cash.) Tesla clearly could have done a better job making its Signature buyers feel special. But all 1,000-odd available Sig cars have sold out."

As Sig owners were supposed to be given heavy preference in line to receive their cars, we can expect most of them have been delivered but not quite all. If there really are more Signature Editions to be sold, this will be yet another heavy cash drain on the company. Sounds a bit counterintuitive, doesn't it? Well, let's pretend Elon Musk's ultra-ambitious 25% gross margin is accurate as early as the current quarter and see what happens when a Sig gets sold. At their top end, Sigs sell for $110,000 and cost Tesla $82,500 to make (75% of the sale price), giving them a gross profit of $27,500. However, they already have $40,000 from the Sig reservation holder, meaning Tesla loses $12,500 per Signature Edition Model S sold, and the cash burn is even higher when the gross margin is lower than 25%.

That all being said, the past is the past and it's time to look at what the future holds for Elon and his band of electro-cowboys.


Taking the Training Wheels Off

Looking ahead to 2013, Elon Musk had some very ambitious goals set out for the company on the recent earnings call. The biggest of all, which the market will take the most seriously, is his virtual guarantee of 20,000 Model S deliveries this year. In 2012, Elon had forecast 5,000 deliveries before dropping it suddenly to a range of 2,500 to 3,000 late in the year, and ultimately grazing the bottom of that range with 2,400 in the fourth quarter. Elon boasted about Tesla reaching a run rate of 400 cars per week in the quarter for 3 consecutive weeks in December, but attributed much of the wider-than-expected Q4 loss Tesla incurred to a significant amount of overtime wages being paid to meet this rate. As previously mentioned, at its best run rate ever, Tesla's automobile sales yielded a gross margin of 3.7% for Q4. Musk, however, expects a gross margin in the mid-teens for Q1 2013 and a 25% margin for the entire year. That's one hell of a move up for a company that expects to maintain 400 cars per week for three straight months to meet its 4500 quota (less one work week that Musk says he gave his employees off for a "job well done" in 2012)... all while somehow avoiding that enormous overtime expense they needed in Q4 to hit it just for three weeks.

A brief aside - I failed to mention this yet since I want to remain conservative, but Tesla also has another car planned to begin production and delivery sometime in 2014 called the "Model X," which has been reported to have at least "$40M worth of reservations" as of February 2012 and according to a Tesla owners forum, over 1500 reservations as of July 2012. I'll speak to this in a future installment of this post, digging through the Annual Report is more important right now.

Back to business, and assuming all reservations are for the Model S only, Tesla has a backlog of 15,000 cars and projects 4500 deliveries in the first quarter. That means they would have to deliver an average of just under 5200 cars in the next three quarters, representing a run-rate of about 430 cars per week. And even though Elon Musk admits cancellations will likely accelerate, if we assign this backlog of reservations a 15% cancel rate, ready-to-buy demand would be 12,750 cars, or 8250 after the first quarter's deliveries but before counting new reservations over that time. That means Tesla will need to see 11,750 new Model S reservations in 2013 to hit their goal, while producing cars at a rate almost 10% faster than their production-on-steroids December run rate. Can they really hit those numbers and still keep costs under control so certainly as to justify the kind of hype we see in the stock price?

[Update: Strangely enough, the Annual Report thinks overtime and labor will be down significantly as early as this quarter... "We expect first quarter material, labor and overhead costs to be substantially lower than the fourth quarter of 2012, and for this trend to continue throughout 2013."]

All these numbers give us a good idea of what the problem is, sure. But the real problem for Tesla is much simpler: a Model S is really a toy, not a mass-production automobile for every American household to consider. Most people that wanted a Tesla have already gotten their place in line. Some of them will change their minds at the last second because nobody needs this car the way they need a Ford Fusion or a Chevy Malibu. The "coolness" of seeing your neighbor get his Model S delivered can certainly help demand, but there's already enough of these cars on the road such that if you were interested in one you'd already have looked into it. Envy is a much better motivator than legitimate interest, of course, and it's possible that might be the one big thing TSLA has going for it in 2013.


The Man[ager] Who Wasn't [Mentally] There

As the entrepreneurial drive behind the company, Founder and CEO Elon Musk plays an enormous part in how Tesla operates and how it's stock is perceived in the market. People like to listen to billionaires, but billionaires can be wrong sometimes... perhaps even all the time. Musk is known for being a co-founder of PayPal, the CEO of SpaceX (a company that sends rockets to the International Space Station), and Chairman of SolarCity. This doesn't exactly lend itself to being 100% focused on any one single company, even though this is definitely the one Musk is most attached to from what I've been able to collect about him. Nevertheless, he is seen as a visionary and wildly successful serial entrepreneur, a reputation he leverages to get Tesla brand awareness and stay in the headlines. He is a very vocal guy when it comes to Tesla and he has on several occasions attacked news outlets and other media sources for saying anything remotely bad about Tesla's products, even going as far as to sue BBC over a British car enthusiast show called Top Gear that showed their Roadster failing under the stress of high performance driving tests. That lawsuit was dismissed and the subsequent appeal dismissed again. Tesla has suggested the possibility of taking similar action against the New York Times for their review, but this is not the best time for Tesla to be spending too much money in court.

Musk doesn't seem to care very much about shareholders given all his equity raises, not to mention his conference calls are very scattered and lacking any prepared remarks. With the call going straight to Q&A, you'd hope Elon would at least be prepared for analysts' questions, but on the most recent call he wasn't even able to pull up simple figures on the spot. When I say simple, I mean really, really simple. When asked if reservations had accelerated or decelerated since Q3 2012, Musk was unable to even give a yes or no answer, opting instead to pump the future that TSLA desperately needs Wall Street to buy into:

"Actually, I'm not sure what I recall offhand what our third quarter numbers were. The key point to bear in mind is like, as mentioned earlier is like, we have enough reservations right now to fill out the year, -- and just on sheer momentum sell every car we make, even if we closed every store we have got."

Mr. Musk does not come across as much of a car guy either, or at least not the way you'd think of Chrysler or Ford CEOs knowing how to manage an auto manufacturer. Sure, he should be expected to be pretty green on the subject, but he's been doing this for 10 years now. I'm concerned that a genuine lack of understanding of the auto industry and an ego that thinks it can change things so quickly are a major part of what is holding this company back.

"I mean, I'd say generally speaking, the car business is a pretty cost efficient business. I mean, it may not be great at a lot of things, sort of breakthrough technology and that kind of things, but it is pretty good at cost optimization." Autos have been trying to efficiently cut costs since the '50s and still can't figure it out, so I'm not sure exactly what Musk was thinking when he went with this answer in regards to how he is going to mitigate overtime pay going forward. And if he thinks breakthrough technology isn't something the car business is very good with, yet he runs a car business that essentially sells breakthrough technology... well, I don't know what to make of that. On top of all that, his overly-enthusiastic guidance with very little transparency for his shareholders makes it a nightmare to figure out what's actually going on with supply constraints and future demand.

Lastly, he's improperly compensated by his Board of Directors. His CEO Grant plan, which gives him about 5.3M shares via options for hitting certain goals, is incredibly shareholder-unfriendly. All of his incentive is in pushing production as quickly as possible while continuing to develop new cars. His only issue is having the cash to sustain the company while he tries to accomplish all this. Among his remaining goals are awards based on producing 100K, 200K, and 300K cars, getting the Model X into production, and introducing a 3rd generation Tesla vehicle prototype and eventually put it into production as well. Compensation plans like this make me question the legitimacy of the company's Board of Directors as well... so there is not much for me to like here.


Key Takeaways

I cannot think of a short that makes as much sense as this one, with catalysts being events like equity follow-ons and other indicators of cash deficit, continued revisions on overly-hyped production goals, etc. The stock currently trades in the mid-$38 range, giving it a market cap of about $4.4B, a shade over 11x sales. That makes it an unbelievably expensive car company to begin with, and the market is essentially already pricing in a lot of the 20,000 Model S sales, as TSLA would trade at a little over 3x sales if they were able to deliver 20,000 cars at an average price of about $69,900 (which is generous, of course). It is somewhat unimaginable they could get so much credit in the market with very little proof of being accurate forecasters or efficient manufacturers.

Given the characteristics of the company and where it's positioned in the automobile landscape, it wouldn't be the worst thing in the world for a large car company to scoop Tesla up at the right price. This company could be an amazing asset in the hands of another business that is already established, has the ability to sustain losses in the short-term, can ramp up production geometrically faster, and most importantly, is free of Elon Musk. However, Musk and his affiliates hold 65% of the common stock and it's very unlikely he would ever leave the company without an offer so compelling that no rational buyer would ever make it. So ignoring the acquisition road, Tesla could head down the more familiar path for government-funded pipe dreams: bankruptcy protection. There really is no middle ground where the company can sputter along doing just well enough to survive and keep shareholders happy, given the nature of the automotive industry and the way that Tesla has had to finance itself. This business simply cannot survive without universal acceptance of their cars leading to a major spike in growth that allows them to finance via their own operations, so it truly is a boom or bust asset.

Again, to quickly summarize this long and winding stream of thought:

Tesla relies on a very small audience with dozens of comparable products without the same risks and inconveniences of the Tesla Model S, or any other all-electric vehicle for that matter.
The company is completely dependent on new customer down payments and equity sales to fund its operations now that the entirety of their $465M loan from the Department of Energy is drawn down.

Tesla has essentially run out of cash on multiple occasions, and would be poised to do so again in the next two quarters if it doesn't see a healthy inflow of cash from emissions credit sales and net reservation payments.
Despite an obvious habit of over-promising and under-delivering, the market is giving Tesla credit for being able to take their Model S deliveries from around 2,600 to 20,000... all while turning a profit and becoming cash flow positive.

Their gross margin on cars is continually misrepresented and is, in fact, still negative and likely to stay that way for a while.
I apologize for being very bad at bullet point summaries, as there is simply an exhausting laundry list of concerns this business has that could cripple it as it crawls through 2013 and beyond.

Comments (10)

Mar 9, 2013

Awesome post. Very thorough and convincing.

Mar 9, 2013

great post, insightful analysis and I agree. As much as I want the Model S to succeed the electric car market is still very niche and as a cool car not as an essential. Plus in this price range there are a ton of other options. We were thinking about a Model S but then realized that charging is a PITA, BMW, Merc, and even a Mas QP were just as expensive, nicer, and easier to live with

Mar 9, 2013

Excellent post! I find your investment thesis very convincing, but allow me to play devil's advocate:
- Your catalysts include equity follow-ons and cash deficits, but what if the market ignore those fundamentals indicators? The market has similarly ignored fundamentals such as these during the internet bubble, instead using illogical metrics such as website hits/month to justify internet company valuations. These illogical metrics are very similar to Tesla's opinion that they are supply constrained and therefore use their production rate as a measure of performance.
- What if Tesla can continue to receive government funding to the point where they can create an economical(and proprietary) vehicle? Wouldn't the barriers to entry be incredibly high, and therefore Tesla could actually increase their margins to desired rate?

Overall I agree with your underlying thesis, but these things popped in to my head while I was reading this.

Mar 9, 2013

Excellent post! I find your investment thesis very convincing, but allow me to play devil's advocate:
- Your catalysts include equity follow-ons and cash deficits, but what if the market ignore those fundamentals indicators? The market has similarly ignored fundamentals such as these during the internet bubble, instead using illogical metrics such as website hits/month to justify internet company valuations. These illogical metrics are very similar to Tesla's opinion that they are supply constrained and therefore use their production rate as a measure of performance.
- What if Tesla can continue to receive government funding to the point where they can create an economical(and proprietary) vehicle? Wouldn't the barriers to entry be incredibly high, and therefore Tesla could actually increase their margins to desired rate?

Overall I agree with your underlying thesis, but these things popped in to my head while I was reading this.

-Well, luckily for us any additional equity follow-ons will continually dilute the stock held by Elon Musk and his affiliates unless they are bought exclusively by them. Over time this could dilute their stake to a level violating the DOE covenant threshold of 65%. That's just one possibility but more of an unlikely one in my eyes. Cash deficits and violations of financial covenants as a result of too many illiquid assets would be more likely violations for the DOE to have a problem with. If we exclude the market having a negative impact on these (it really should, 9 times out of 10, given we've seen this a handful of times before, but nevertheless) then these covenants become increasingly risky. And on metrics, Elon has decided it's time to move past that now... with his main goals highlighted as profitability in Q1 and deliveries per quarter... and to a lesser extent, reservations as of Q1 end. We are past the "production rate" metric now that Elon has waxed on about it long enough for people to start believing they're doing it. I still suspect they totally are not.

-That's one hell of a what-if. And if it is the case, government funding would naturally cut back as Tesla more easily funds its own operations. And no, barriers cannot be incredibly high, as deep-pocketed companies like Daimler can easily eat losses for several cycles to develop an economical car that can compete with anything Tesla can come up with. Their infrastructure and cash flows in all other areas of car production are more than enough to give them the tools to float the ship until they can make up ground on Tesla... if there's even any ground to make up at that time.

Thanks again for enjoying the analysis. Looking forward to more dialogue. We are short quite a large amount so I want to continue to hear more and more from all directions, though at this point I have great conviction in this investment thesis.

Mar 9, 2013

Thanks! Also will be updating the Tesla saga as I gather more information and maintain our short position over the course of the whole ordeal on my blog. Already done some number crunching to try and arrive at Q1 profitability and it's very difficult to do without some very serious optimistic tweaking and pull-forward/push-back on smaller battery packs to maximize Q1 regulatory credits.

Anyway, a link included to that follow-on (no pun intended) post is here as well:

Mar 9, 2013

I thank you for your short position, it has paid for another year of tuition for me :) Long position from $34 with a mix of calls, all closed up Friday.

But I do agree that in the long term, Tesla is going to fail. No doubt in my mind, and your post only strengthen this idea. In 20 years Tesla will either be dead, or at $200 a share. Most likely, failure is what awaits Tesla.

Great stuff WH.

Mar 9, 2013

Nice write-up WH! Will check back on this thread.

Short TSLA @$38.47.

Please don't quote Patrick Bateman.

Mar 9, 2013

What's the borrow?

Mar 9, 2013

What's the borrow?

All-in-all we're getting in the 8 to 12% range, with the full position spread out between different expiration spreads and strikes, mostly for 2015. Paying at 9-10% I feel ok for the short term and don't think we'll need full years short the stock to see the depreciation we're looking for. I try to not take the borrow into account so long as it's not absurd Facebook borrow rates like 40% where you basically sign away the entire thinng you just borrowed to begin with

Mar 10, 2013