(Note: Information about the DOE loan has been updated since this article was originally posted.)
OK, I will get this out of the way first. I am not the biggest fan of Tesla (TSLA). I don't hate the company. I am not against new technology. I have examined the Model S in person and looked at the specs. The product has a great fan base, but the Model S is not the best-constructed car the world has seen, in my opinion. It has a very good product, not great, in a luxury market segment that is very crowded.
The question for Seeking Alpha readers is: Should I invest in the stock?
Tesla released some 2012 year-end information last week. They have yet to release their 10-K. Tesla does not have to release detail data to the SEC on the same day as their press release, but if you have bad news it helps to dribble information out over weeks.
On the revenue side, Tesla shows a huge increase since they essentially had not been selling any cars for 2Q and 3Q 2012. If they can sell their projected 20,000 vehicles at an average of $80,000 (not clear that is sustainable), total 2013 revenues will be $1,600 million. That seems impressive but the auto industry is a huge cash flow business. To put in perspective, Toyota (TM) had US sales of $233 Billion on 793,000 vehicles in 2011. (I converted from yen using xe.com so you may get different values for Toyota). So, Toyota revenue for the US is roughly one thousand times greater than Tesla. That pretty much defines a David and Goliath fight.
Basic business strategy in such a David v. Goliath fight would require good financing up front and quickly generating cash flow. CEO Elon Musk has shown he knows this by tweeting about cash flow and making many promises on conference calls. Tesla has not met many of these cash flow promises and that should raise a red flag to investors. A cash flow crunch is what brought General Motors to bankruptcy, not sales.
On the cost side, Mr. Musk admitted on his latest earnings conference call that Tesla was pushing the work force 70 hours/ week. At 66 hours workers are doubling their money, a significant cost increase over planned expense. Tesla is confident that they will have that under control by the end of 1Q. Expenses for parts were also much higher than planned due to the need to expedite parts. In an auto plant this is often indicative of a poor materials resource planning system. Materials planning (MRP) is such a critical part of auto manufacturing that all major manufacturers have proprietary software and processes to manage logistics. Tesla has not talked much about what strategy they have used for managing materials but it is critical to becoming a successful auto manufacturer. MRP is something Tesla cannot buy off the shelf.
Being caught with too much inventory almost brought down General Motors (GM) in 1980 and led to Just In Time inventory methods. This is just one more data point showing Tesla is struggling to learn the auto business on the fly. Many outside the auto industry think that the hardest part of the auto industry is good design. Design is only 5% of the cost of the vehicle and is important, but the money is made in efficiently moving 4,000 parts to an assembly line every 60 seconds in Toyota's case and every six to ten minutes in Tesla's case. For established manufacturers this is done through technology agreements and supplier partnerships developed over years. California is a lousy location for manufacturing logistics. Tesla touts a vendor neutral policy. How is that going to get Tesla suppliers to invest in IT interfaces with Tesla so they can solve their logistics problems? There is a reason traditional manufacturers work with their suppliers instead of dumping them. This is not the software business.
Accounts Payable and notes due are an interesting thing to look for in avoiding a cash crunch. Tesla owed $343 million to vendors. This is weighed against a little over $200 million in cash, and weighed down further by $268 M in inventory. That would indicate about 1 inventory turn/year (down from 2.99 in FY2011 with the Roadster). A good auto assembly plant goal would be 26 inventory turns, or even 52. It will be difficult to make money if Tesla does not improve inventory turns very quickly.
The really big item on the liabilities page is the long-term debt, most, if not all due to the Department of Energy-sponsored loan. Contrary to popular belief, Tesla is technically behind on this loan. Mr. Musk made headlines by paying the first quarterly installment early. I won't let the cynical side of me consider the fact that this was a government guaranteed loan in an election year. Then last September Mr. Musk very quietly renegotiated the Department of Energy loan. The loan payment schedule was modified so that instead of two payments in 2012, there was only one. A sliding schedule of eight payments were laid out for 2013 and 2014. Part of the September loan agreement states: "Borrower hereby agrees to submit to DOE a plan for the early repayment of all principal."
In the last year at least four confidential court orders have been filed with the SEC. Those could be anything, but two of them were filed on the same day as the two loan renegotiations. As an investor, I can only guess that there are a lot of discusssions in back rooms about how this loan is going to get paid off. For now, the loan payment terms are not entirely public and it is hard to accurately assess true profit potential this year without knowing what the payments will be.
The next scheduled DOE loan payment is March 15, 2013. Accounts payable are $343 million at the end of 2012 and there are four scheduled DOE loan payments. If Tesla wanted to get the loan paid in four years, 2013 payments might be in the $110 million range ($452 million/16 quarters = $28.25m + interest/quarter). And Tesla still has to make payroll for the rest of the year, so that could be $150 million.
It is really hard to take Mr. Musk's continued promise of 25% margins seriously. The main business model advantage Tesla has is their direct selling model. But General Motors only has selling and administrative expenses of around 10% with gross margins around 4%. To my knowledge Tesla has never said what their business advantage is that will enable them to achieve 600% margin increases over established manufacturers. Tesla numbers simply do not add up and the alternating chest thumping followed by silence does not help investors to understand how this is going to happen. The argument that Tesla is a new era and can't be compared to traditional manufacturers is nonsense. It may not be comparable on the sales side, but Tesla has already sold more than they can make. They are using very traditional manufacturing methods using the exact same stamping equipment that GM and Toyota have used in the Fremont plant. What is their manufacturing advantage?
Taking the questionable operating status of the Tesla business and the daunting expenses ahead, my advice is to avoid TSLA. Investors Business Daily has a Composite Rating of 35. Many have already seen the writing on the wall and have shorted the stock, 18 days worth currently. Shorting here is also a risky bet. And the drop from 30 days short interest to 18 days seems to show that others agree. There is almost 70% institutional ownership so they are not likely to stampede yet. Mr. Musk may not be very good at automotive operations, but he is a highly skilled marketer and financier. I suspect he may pull one more rabbit out of the hat and float stock or renegotiate his DOE loan again. In that case there could be a short squeeze in the near term, but Tesla's biggest problems are very difficult to solve and are longer term in nature.