Tesla's Car Financing - What I Think Happened

| About: Tesla Motors (TSLA)

Now we know what Tesla's (NASDAQ:TSLA) big announcement was and how it involves Elon Musk putting his money where his mouth is "in v major way." Let's recap what Tesla has on offer and think a little about what this involves for the company, for the banks, for Elon Musk, why it has turned out as it has, and what it all may mean for shareholders.

Here is what Tesla has on offer if you strip away all the 'showmanship and hype':

Tesla's Bank Financing Scheme

Feature Description
Coverage 10% down
Term 66 Months
Rate 2.95%
Residual Guarantee
Tesla + Musk
Like MB S-Class
~43% @ 36 months
Click to enlarge

It's a fairly conventional bank supplied financing deal for a luxury car, except for the Residual Guarantee. What this guarantee does for the customer is to make the financed purchase effectively convertible to a walk-away lease that the buyer may terminate at 36 months. It's a great way for Tesla to assure buyers that their touch screen won't fail and their battery will keep charging. Customers who would like a new Tesla and are either concerned about the company, the car or the battery, or are unable to write Tesla a six-figure check will love this deal.

What the availability of bank financing does for Tesla of course is to open up its market beyond the very well-heeled or very earnestly committed first adopters that have been buying every Model S just as fast as they roll off the bamboo inspection platform. It also, and very importantly, opens up access to conventional sources of financing money, backed by Tesla owners that flows into Tesla's business model. Practically speaking, the bulk of Tesla's gross income going forward is likely to flow through this, or a similar consumer financing facility. After all, no one who actually thinks the matter through can envision a sustainable car company business model in which the customers actually pay for the cars they buy...

For the participating banks, Wells Fargo (WFC) and U.S. Bancorp (USB), the residual guarantee from Tesla, backed up by Elon Musk, provides assurance that these Model S cars will retain value sufficient to collateralize the loans they will be making. My guess is that the banks required this type of guarantee - a guarantee from the company, backed personally by their largest shareholder - before they were prepared to participate. Welcome to the world of Silicon Valley start-ups.

It appears the ever-optimistic Mr. Musk saw the bank's demand for a residual value guarantee as an opportunity. By offering its customers the same guarantee it is probably having to offer to the banks, Tesla isn't assuming much risk that it didn't have to already. Setting the guaranteed residual at par with an S-Class Mercedes, not only projects confidence to the market, it does two other very important things for Tesla. A high guaranteed residual encourages the banks to supply at lower interest rates, reducing a customer's payment and thus as a practical matter allowing Tesla to charge a higher price or sell the customer more options. It also places a floor under the market price for used Teslas which is good for Tesla's brand image and also sets up Tesla to be in the 'certified, previously owned' resale market. (The hopping mad car dealers in Texas will just love this.)

Obtaining an outside financing facility for Tesla customers to support future, expanded sales was essential. Banks requiring a residual guarantee was, in the case of a new company with a 'new' technology, inevitable. The necessity for an Elon Musk personal guarantee, given the financial condition of Tesla was unavoidable. Turning the required residual guarantee into an asset for Tesla customers was brilliant.

Today's announcement contained a whole lot of hype - mostly centered on the idea that the electric car tax credit makes the down payment, and savings from low cost energy to time saved using the HOV lane make owning your $80k+ Tesla, well, cheaper than you can imagine. They even put up a nice "Cost of Ownership" page to help customers rationalize purchasing the Model S of their dreams.

What was not hyped enough was the significance of today's announcement for Tesla shareholders. Tesla's announcement Sunday night that it will be profitable, both non-GAAP and GAAP in Q1 sparked a huge rally in the stock on 10x normal volume. But, today's announcement is actually far more significant because this consumer finance facility will allow Tesla to go on selling cars and making profits for many quarters to come.

Disclosure: I am long TSLA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.