We previously published our research report on how Tesla Motors (TSLA) was racking up losses, burning through cash as if it was an arsonist and its production difficulties. We recalled how the company was burning through so much money it had to seek fresh equity capital through the sale of nearly 8M shares of stock as part of a secondary stock offering at the end of Q3 2012. Fortunately for Tesla Motors' electric vehicle evangelists, Tesla Motors was able to raise $222M from its secondary offering which closed in early October and that helped the company recover about half of the cash that it burned through during the first nine months of 2012. We were surprised that Tesla's shares have held up during the recent bout of stock market volatility. We think that the financial model for Tesla Motors and Musk's other publicly traded company SolarCity (SCTY) is as innovative as its products. We think that the electric vehicle evangelists have bid up Tesla's shares by nearly 8.5% since Tesla announced its secondary offering on September 25th for the following reasons:
- Tesla's secondary offering only diluted existing shareholders by 7.5%
- Tesla's Co-Founder and CEO Elon Musk forecasted Tesla would be profitable in FY 2013
- Musk also chipped a staggering $1M to buy stock in Tesla's secondary offering. We think that was a real sporting move by Musk for buying $1M of the $222M secondary offering.
- According to Musk's Twitter feed, Tesla was narrowly cash flow positive for the week ending November 30th.
Source: Morningstar Direct
We are amazed that Tesla Motors has a market capitalization of $3.8B considering that it has yet to make a profit. The good news is that Tesla has raised $1.17B in equity capital from investors. The bad news is that it had burned through nearly $1B of its equity capital as of Q3 2012 and it is expected to burn through another $80M in Q4 2012. The worse news is that we think that expectations for Tesla may be a little too high considering that the US may be facing a potential recession in 2013 and we believe that may serve to dampen Tesla's expected revenues and profits for 2013. While Tesla may be targeting highly affluent individuals with its electric vehicles, we have concerns that Tesla will be able to get people willing to pay $50K and up for a car that that they would have to wait at least six months for if they were to make a $5K reservation for it today. The good news is that we believe that Tesla's reservation deposit system is one of the two reasons why we believe that Tesla Motors has an "innovative" financial model.
To buy a Tesla Motors automobile, a customer has to go to Tesla's website and agree to pay a reservation deposit payment in an amount ranging from $5K for the Model S and the Model X to $40K for the Model X Signature. As of Q3 2012, Tesla had $138.3M in reservation payment liabilities due to customers. This compares to Tesla's $54M in current portion of long-term debt and leases, $85.6M in unrestricted cash balances, $11.8M in vehicle operating leases and $27.5M in restricted cash. John Petersen recently published an article underscoring the importance of Tesla's reservation system and how it interconnects with Tesla's financial position. We think it bears repeating that Tesla's reservation agreement said it best when it states that "You understand that Tesla Motors, Inc. may not have completed the development of the Model X or begun manufacturing the Model X at the time of your reservation. You also acknowledge that, if you purchase a Model X, the Model X may not be delivered to you until 2014 or later. We will not hold your Reservation Payment separately or in an escrow or trust fund or pay any interest on Reservation Payments, except to the extent required by law."
Source: Tesla Motors' Q3 2012 10-Q
In short, people who are actually willing to buy a Tesla electric car are also providing an unsecured, interest free working capital loan to the company. We think that's absolutely remarkable that Tesla is able to get people to do this because a company with the risk profile of Tesla would probably have to pay 10%-15% annual interest on a regular loan or bond from the capital markets. Tesla's risk profile is that of a speculative, cash-burning startup and we don't believe that many banks would be willing to risk their own capital on a venture like Tesla. Tesla has 13,200 reservation holders as of Q3 2012 and we're wondering how many of Tesla's reservation holders are aware of the extent of their pecuniary relationship with Tesla. The reservation holders have paid an average of nearly $10.5K each and if the company goes bankrupt, the reservation holders may have to take a haircut to what Tesla would owe them.
The other reason why we believe that Tesla Motors has an "innovative" financial model is because it has borrowed $465M from the Federal Government at low interest rates ranging from 0.9%-3.4%. We don't believe that many traditional lenders would lend their capital to Tesla since it is a risky, speculative, cash-burning startup. We understand that Daimler AG (DDAIF.PK) has a 4.9M (4.6%) share position in Tesla even after it transferred 40% of its Tesla stock to an Abu Dhabi sovereign-wealth fund that owned 40% of Daimler's Blackstar Investco LLC investment subsidiary. We are aware that Elon Musk has over 31.5M shares of Tesla and this represents 28% of Tesla's shares. That still doesn't make the company any less risky.
At best, it would be a venture-stage investment and if it was to borrow money from venture capitalists, we believe it would be lucky to pay 10%-15% annual effective interest rate for the debt. However, Tesla is able to pay a much lower interest rate on its borrowings because it is borrowing the money from the taxpayers. In Massachusetts, we call this a "public-private partnership". We the public risk $500M of our capital with no real choice in the matter and if it is successful, we get the return of our money plus a few kopecks of interest while Elon Musk (private special interest) rakes in millions and billions of dollars. If it isn't successful, we're out $500M and Elon Musk is still a billionaire. Tesla's shareholders and reservation holders are holding out hope that Tesla's cars will be an automotive game-changer and we're wondering how many businesses with try to repeat Tesla's innovative financial model of customer provided financing and government loans. Although we have expressed our displeasure at Ford Motor (F) for taking government loans as well, at least Ford's government loans only account for 6.4% of its debt versus 98% for Tesla.
Source: Ford's Q3 2012 10-Q
SolarCity issued its Initial Public Offering earlier this month and we can see that SolarCity's financial performance has been anything but sunny. SolarCity has been losing money since its 2006 inception even though it has enjoyed strong revenue growth. The good news is that SCTY's revenue has increased from $23M in 2007 to nearly $140M annualized in 2012 and its gross margin has increased from (-$119K) in 2007 to over $49M annualized in 2012. The bad news is that its operating expenses have increased from $10.9M in 2007 to nearly $109.2M annualized expenses for 2012. The ugly news is that its interest expense has increased from $233K in 2007 to nearly $20M annualized in 2012 and its net other income and expenses worsened from $291K in net other income in 2007 to $24M in annualized net other expense in 2012. At least SolarCity shares the same innovative financing model of relying on customer deposits and government aid that Tesla relies on, though it has a greater portion of non-government and non-customer related borrowings than Tesla.
Source: Morningstar Direct
The good news for everyone is that SolarCity did not receive any government loans like Tesla has. Unfortunately for everyone except SolarCity stockholders, Solar City received nearly $287M in government grants from the 2009 stimulus bill and the benefit of the U.S. Treasury grants is recorded as deferred income and is amortized on a straight-line basis over the estimated useful lives of the related solar energy systems of 30 years. The amortization of the deferred income is recorded as a reduction to depreciation expense which is a component of the cost of revenue of operating leases in the consolidated statement of operations. SolarCity has amortized $13.4M of its grants as a reduction to depreciation expense and has $273.3M in unamortized grants remaining on its balance sheet. The company also has $106.4M in outstanding debt from various banks and other financial institutions.
SolarCity's customer-oriented financing consists of $10M in customer deposits and nearly $205.5M in deferred revenue. The deferred revenue comes from customer payments on SolarCity's solar energy systems as well as the portion of rebates and incentives received from utility companies and municipal government agencies. The primary reason for utilities to be involved with SolarCity's solar energy systems is because utilities are forced by law to generate a portion of its energy through approved "renewable energy sources" and these requirements range from a low of 10% in Wisconsin to 33% in California and 40% in Hawaii. SolarCity also owes $162M on lease pass-through and sale and leaseback obligations. At least with the owed on its lease pass-through deals and its sale and leaseback deals it relies on investor funding arranged from Goldman Sachs, which is the same bank that Solyndra tapped for its proposed IPO.
Source: Morningstar Direct
In conclusion, we're still not fans of Tesla, SolarCity or its biggest backer Elon Musk. We believe that Elon Musk is what Ayn Rand's John Galt would be if Galt was willing to work under the orders of Dr. Floyd Ferris from the State Science Institute. We are impressed with the innovative financing models that each firm utilizes, its absolutely remarkable that Musk has been able to get the government and his customers to provide nearly 65%-100% of the debt financing for these companies. However, we are not impressed with the idea of investing in Tesla and SolarCity considering that electric cars and solar energy are extremely uneconomical relative to the proven models for automobiles and energy generation. Furthermore, electric cars and solar energy are yesterday's answers to automotive technology and energy generation. In short, we can see why Obama donor Whitney Tilson has shorted Tesla Motors and we're surprised that he hasn't shorted SolarCity yet.
Additional disclosure: This article was written by an analyst at Saibus Research. Saibus Research has not received compensation directly or indirectly for expressing the recommendation in this article. We have no business relationship with any company whose stock is mentioned in this article. Under no circumstances must this report be considered an offer to buy, sell, subscribe for or trade securities or other instruments.