From Seeking Alpha
Jan. 25, 2019 4:09 PM ET About: Tesla, Inc. (TSLA)
- Tesla is seeing an implosion of demand – not just in US but also internationally. European Model 3 demand is below even bear expectations.
- The company has several major cash calls from maturing debt and organizational changes and does not have the cash to cover these.
- Without a capital raise or favorable vendor terms, Tesla faces solvency risk in Q1.
- This idea was discussed in more depth with members of my private investing community, Beyond The Hype. Start your free trial today »
Fears of a cash crunch at Tesla (TSLA) are not new. Bears have raised these concerns in the past, and bulls have pooh-poohed them. The bear arguments were vindicated when CEO Elon Musk recently admitted that Tesla was within single-digit weeks of going bankrupt in 2018 as it struggled to ramp Model 3. Think about this: In one of the earnings calls in 2018, although there were no disclosures, Mr. Musk felt the Company may not survive until the next earnings call!
In the past, Tesla has been able to pull itself out of cash crunch situations through capital raises based on overly optimistic projections of Tesla’s prospects – and Tesla has largely failed to deliver on the investor expectation set during these raises. Management projections from the most recent quarter are also crumbling as we predicted in October. All of the major predictions from the previous article have come true. Per the article:
– In Q4, Tesla has introduced a lower priced Model 3 as demand for the higher priced version dried out.
– As US demand collapses, Tesla is starting earlier-than-expected shipments to Europe and China in Q1
-And, Tesla has laid off 7% of its employees. (note that Tesla is not disclosing the extent of contractor terminations and performance firings which will likely put the overall termination numbers much higher than 7%).
Unfortunately, for Tesla, the going is likely to get much worse. As they have done in 2018, Tesla management seems to be playing a game of chicken with investors on cash needs and capital raise. The Company continues to deny the need for a capital raise, although fundamentals point to exactly the opposite.
Elon Musk’s recent missive about the challenges that Tesla faces makes for an interesting read. After promising rosy future and sustained profitability about two months back, Mr. Musk did an about face and painted a dire picture of Tesla’s prospects. To quote a few choice paragraphs from the note:
“In Q3 last year, we were able to make a 4% profit. While small by most standards, I would still consider this our first meaningful profit in the 15 years since we created Tesla. However, that was in part the result of preferentially selling higher priced Model 3 variants in North America. In Q4, preliminary, unaudited results indicate that we again made a GAAP profit, but less than Q3. This quarter, as with Q3, shipment of higher priced Model 3 variants (this time to Europe and Asia) will hopefully allow us, with great difficulty, effort and some luck, to target a tiny profit.”
“However, starting around May, we will need to deliver at least the mid-range Model 3 variant in all markets, as we need to reach more customers who can afford our vehicles. Moreover, we need to continue making progress towards lower priced variants of Model 3. Right now, our most affordable offering is the mid-range (264 mile) Model 3 with premium sound and interior at $44k. The need for a lower priced variants of Model 3 becomes even greater on July 1, when the US tax credit again drops in half, making our car $1,875 more expensive, and again at the end of the year when it goes away entirely.”
“As a result of the above, we unfortunately have no choice but to reduce full-time employee headcount by approximately 7% (we grew by 30% last year, which is more than we can support) and retain only the most critical temps and contractors. Tesla will need to make these cuts while increasing the Model 3 production rate and making many manufacturing engineering improvements in the coming months. Higher volume and manufacturing design improvements are crucial for Tesla to achieve the economies of scale required to manufacture the standard range (220 mile), standard interior Model 3 at $35k and still be a viable company. There isn’t any other way.”
The problem is that Mr. Musk’s narrative, as usual, is not credible.
Note that Model 3 has been in “production” for over a year now and has gone through many fixes and tweaks. The production line has also been improved considerably in the same time period. Most of the easy cost improvements in parts and manufacturing process have already been made. In the near term, it is extremely difficult to squeeze another 20% or so in costs necessary to make the $35K Model 3 profitable at a net profit level. The 7% workforce employee layoffs will help but will not a big difference as direct and indirect labor is only a small fraction of Model 3 cost structure. Our assessment is that the situation is much direr than the CEO is predicting, and the solutions being proposed do not come close to solving Tesla’s problems. If, as Mr. Musk says, “there isn’t any other way”, then Tesla will die.
Let us first consider the near-term challenges that Tesla faces.
Demand Has Evaporated
As Mr. Musk himself acknowledged, the US demand is low. However, the situation appears much more dire than indicated. Anecdotal evidence gathered by Tesla watchers suggests Q1 demand is running at less than 10% of the Q4 level. Even the largest volume Tesla sales center in Southern California is seeing zero sales on many days. Other sites are also showing very low demand.
European demand is far less than even bear expectations. Sum of all orders in the largest European markets is only about 16,000 units. This level of demand may not be sufficient to tide Tesla over for even a single quarter.
Cash Is A Big Problem
Consider Tesla’s balance sheet (from the Company’s Q3 shareholder letter)
We do not yet have the Q4 financials, and we do not know if the balance sheet during Q4 has gotten better or worse or stayed about the same. However, as discussed in an earlier article, Tesla had two significant cash calls in Q4:
- $230M Convert due 11/2018.
- $157M Non-recourse Term Loan due 12/2018.
In the balance sheet above, note the large line items: Account Payable, Customer deposits, and Current portion of long-term debt. These items, at the end of Q3 were $3.6B, $906M, and $2.1B, respectively.
In addition to the convert and term loan needs, the latter two line items discussed above are likely to move against Tesla. In other words, cash needs will increase, and cash is likely to go down than up.
To offset this burn, Tesla may have generated some cash during the quarter. While it is unlikely to be substantial, for the sake of discussion, let us assume that the cash position has stayed the same since Q3.
Now consider that, with the stock below conversion price, the $920M convert due 3/2019 will likely have to be paid out in cash. This event alone reduces Tesla cash position to $2B.
Layoffs Have Direct And Indirect Costs
7% layoffs, along with contractor retrenchments, and other retrenchments through performance reviews, will have their own costs. While it is difficult to estimate this amount accurately, we believe Tesla will incur about $100M in cash costs and an additional amount in write-offs and other non-cash costs.
This brings the cash down to $1.9B
It is difficult to estimate how much Tesla will be spending in capex. The Company has significant control over its spending although the control comes with trade-offs. Tesla has dramatically scaled back capex in the last several quarters leading to major underinvestment in Superchargers, Service Centers, Sales Centers, etc. The result is that the Supercharger network is overburdened, and there are regular stories of customers facing long delays and descending into arguments. Similarly, service centers are overburdened, and customers have faced long delays and quality has suffered.
Note that in addition to the maintenance capex, CEO Musk sets lofty expectations on new projects. Mr. Musk, for example, promises that the Company will deliver a truck in 2019, a Model Y in 2020, and a China factory in 2019/2020. These efforts will need billions of dollars of investment today if Tesla were to have any chance of meeting the timelines promised by Mr. Musk.
For this discussion, we will assume that, for cash conservation, all these projects will be delayed, and only about $300M in maintenance capex will be spent in Q1.
This brings the cash balance down to $1.6B.
Items Not Being Considered
This cash flow analysis is ignoring a myriad of cash expenses such as:
- Deposit refunds which could be several tens, or even hundreds, of millions of dollars.
- Refund of $5,000 for Model 3 “P” version purchasers in Q3 (due to Tesla adjusting price on the version in Q3).
- Tens of thousands of cars which may not qualify for the $7,500 Federal tax credit because Tesla has not registered the cars before the end of the quarter. Given that Elon Musk has promised to make customers whole if the FTC deadline is missed, Tesla may owe customers $3,750 for many of these tens of thousands of unregistered cars (chart below from Twitter user @TeslaCharts)
It is questionable if investors should trust Tesla Q4 balance sheet when it is released. The cash numbers may be artificially inflated by Tesla not registering several tens of thousands of cars as of the end of Q4. That likely means Tesla has collected the customer cash but may not have paid sales taxes on the cars or paid off ABL vendors on the sold cars.