Tesla's (TSLA) stock has been moving lately after the news erupted that the company is under an investigation conducted by the Immigration and Customs Enforcement (ICE). The probe is centered on whether or not the company used its foreign zone status to bypass the DOE loan requirements. According to the federal loan requirements, ICE believes that Tesla cannot use foreign-made parts in manufacturing its vehicles and it should only buy from local (American) suppliers (discussed in detail below). This news has sent bearish signals to the market and has not helped the stock price to climb, despite the fact that Elon recently claimed that the company was narrowly cash flow positive in the last week. The stock is 2% down since the news of a potential loan fraud by Tesla hit the headlines.
Is It Really Loan Fraud?
Tesla investors have been taking the DOE loan issues quite seriously. The main reason for this has been the intense liquidity crunch that the company has been going through for quite some time. I mentioned in my previous article on Tesla how the DOE waived the penalty on the company (for violating the loan covenants) on the condition that it would repay the loan before the scheduled time of repayment. The recent news of a "potential" loan fraud has enhanced investors' anxiety.
Tesla closed a $465 million federal loan with the DOE in 2010. According to the loan documents, the loan was given to Tesla to:
- reopen an auto manufacturing plant in Fremont, Calif., to produce specially designed, all-electric plug-in vehicles; and
- develop a manufacturing facility to produce battery packs, electric motors, and other powertrain components that will power all-electric vehicles manufactured by TSLA and other original equipment manufacturers like Daimler (OTCPK:DDAIF) and Toyota Motors (TM).
A year earlier, ICE requested the DOE to assist it in obtaining the DOE loan documents signed between the DOE and Tesla. ICE told the DOE that it was looking into whether TSLA was using the foreign-made parts rather than the U.S.-made parts in its cars. According to the Buy American provision in the American Recovery and Reinvestment Act of 2009, if a recipient of financial assistance funded by the Recovery Act is using Recovery Act funds for a project, all of the iron, steel, and manufactured goods used in that project should be made in the U.S. Therefore, under this regulation, Tesla cannot use foreign-made parts in its cars. However, the DOE Loan Guarantee Program claims that the loan was appropriated through Public Law 110-329 and not through the Recovery Act. Therefore, the Buy American requirements do not apply to Tesla.
However, ICE is still proactively investigating whether Tesla is using its foreign trade zone status to bypass the so-called "loan requirements." A foreign trade zone facilitates the creation of certain areas at or near customs port of entry where products can be imported without standard import duties and customs entry procedures. Tesla's application for a "subzone" within San Jose's foreign trade zone was approved in September. ICE is neither affirming nor denying an investigation. Also, Tesla has made no mention of this investigation in its SEC disclosures.
Based on my understanding of the inquiry, I have limited concerns about the potential impact of the federal probe at this juncture. First and foremost, according to the article published in The Washington Times, the DOE's own office (Office of the Inspector General) ultimately decided not to join the investigation. According to the DOE, the federal loan to Tesla came through a federal appropriations bill, and thus is not subject to a "buy American" clause. Moreover, I believe that both the DOE and the broader market is well aware of the fact that Tesla sources certain components from foreign manufacturers -- most notably, batteries from Panasonic (PC) in Japan, something it has been doing for some time. In fact, investors still remember that the company made an investment in Tesla in 2010. Therefore, there are minimal chances that the DOE would structure the loan (and Tesla would agree to terms) that would prevent Tesla from working with a trusted supplier of one of the critical components of its vehicles.
Positive Cash Flows
Tesla investors were quite happy to read a tweet from Elon Musk indicating that the company was narrowly cash flow positive last week. The post also stated that Tesla expects a continued improvement in cash flows through year-end. Investors have been deeply concerned about the cash resources (as already mentioned) at Tesla as the company needs strong financial resources to uplift its production rate in order to meet its target of producing 400 cars per week in 2013. Barclays believes that Tesla's ability to achieve consistent cash flow generation would be viewed as a critical milestone for the company, helping to transition it from an upstart innovator to a sustainable operating entity.
Currently, 44% of the stock has been shorted. In my previous article on Tesla, I showed how the price of Tesla can reach $42 if it meets its target of producing 20,000 cars in 2013. The company lost $110.1 million of cash in this year's third quarter, which was $40 million more than the cash lost in 2011. The news of positive cash flows has sent bullish signals to the market. Barclays expects the company to announce some more data points in the future that will support the company's ability to ramp-up its production (e.g., improved profitability). I believe that the current dip of 2% in the stock price has given investors an ideal entry point in the stock.