Tesla (NASDAQ:TSLA) is approaching what I have been expecting will be its most volatile moment in years, and this is the unveil of the Model 3, a $35,000 (and up) car that will meaningfully increase the addressable market for Tesla's car business. This article discusses what I believe to be the impact of this event on refundable deposits and their eventual conversion into actual sales.
Around the time of the Model 3 unveil at the end of March, there will be a day when refundable deposits are accepted in person at Tesla stores. After that, refundable deposits will be accepted online.
On this first day, when fans will be standing in line at the Tesla stores, it will be a little bit like those iPhone lines we saw in the early iPhone years. Or at least the particular store from which CNBC happens to be broadcasting, will have long lines. Someone will make sure of that.
Speaking of CNBC, am I the only one who has noticed CNBC has turned into what seems like an ongoing Tesla infomercial? For a whole day on February 16, I watched fawning coverage of extremely wealthy Tesla fan club members saying how much they love test-driving a car for which they put down $5,000 deposits as early as four years ago.
Considering this particular car is expected to sell no more than 15,000-35,000 units this year, one certainly wonders why it's the beneficiary of a whole day's worth of incessant one-sided bullish coverage on CNBC. Almost all other new car models launched in the market today will sell much more than 25,000 cars per year - some, more like a million cars globally - but they receive almost no fawning coverage, ever, on CNBC.
So clearly CNBC is deep in the tank for Tesla. If that's the coverage one can expect from a "ride and drive" event of a low-volume car in some random place near Chicago, surely CNBC will cover the Model 3 unveil event, with Elon Musk himself as the Master of Ceremonies, in an even more bullish fashion. The advertising value of that free CNBC round-the-clock infomercial could be very high.
Within hours of the Model 3 unveil event, it would be shocking if Tesla didn't Tweet some bullish commentary about the number of refundable $1,000 deposits it is receiving: "Off the hook" and "exponential" demand is to be expected. Perhaps the servers will crash, at least for a few hours while CNBC catches up for even more breathtaking commentary.
What is the market's consensus expectations for Model 3 refundable deposits anyway? I sure don't know. Over 100,000 Teslas have been sold since inception, although some households have more than one, and the average price has been close to $100,000. With a $35,000 headline price - even if the average selling price will clearly be higher, perhaps over $50,000 - why wouldn't half of those 100,000 households sign up for at least one refundable deposit on average? Especially if they are also stockholders.
The Tesla Motors Unofficial Podcast, in its latest episode from February 14, speculated just like me: 50,000 is the absolute minimum, as an initial baseline, right off the bat, in the first few days. But that's just from existing owners, and from "true" organic demand.
However, there are two other categories of "inorganic" demand boosters that could set that refundable deposit number a lot higher than the 50,000 one could otherwise have expected immediately in the first 48 hours of online reservations opening up:
Insurance against tax credit exhaustion
The Federal $7,500 tax credit starts to go away after the first 200,000 cars sold in the US from each manufacturer. We could have a lot of people placing reservations on a Tesla Model 3 in the hope of getting the car early enough to take advantage of this tax credit. We already saw what impact even a partial withdrawal of a tax credit had in Denmark last December, and that was for a far more expensive model, the Tesla Model S.
Of course, $7,500 will mean a lot more to a car that's $35,000 than one that is double - or more than double - the price. In other words, this could drive refundable deposits very hard on the first day or two this March 31 and April 1.
Speculators could place deposits themselves
Imagine that you own Tesla stock, whether as an outside investor or as an employee. Is there a way that you - or your friends - could help Tesla's stock price going higher?
Well, thanks to the Model 3 refundable deposit being only $1,000 - instead of $5,000 as on the Model X - you might be able to create the desired outcome all by yourself, maybe with a little help of your friends. I will provide an extreme scenario, and then you can figure out the multiple ways a group of like-minded people could get there.
Let's say you wanted to increase Tesla's ability to report refundable deposits in the first 30 days from 100,000 to 300,000. You would need to generate 200,000 additional deposits. At $1,000 apiece, that's $200 million.
Well, aren't there hedge funds that make $200 million bets all the time? Why not simply place 200,000 deposits online, at $1,000 each, so that Tesla can proudly Tweet out that it's received all those refundable deposits?
Assume that the impact of adding a few hundred thousand refundable deposits to the organic demand was to increase the stock price. When Tesla tweets out that they suddenly got 200,000 or 300,000 such refundable deposits right off the bat on April 1, that could cause the stock to go up. Those stockholders could then simply ask for their $200 million worth of deposits to be refunded a couple of weeks or months later, after pocketing their profit.
Of course, there could be several investors like that. Couldn't you imagine five investors putting down 200,000 deposits each, either directly or through some automated script if a bulk deposit isn't accepted? That would be one million deposits right there.
Tesla employees are also shareholders, or perhaps have options, causing them to have vested interest in Tesla showing a big deposit number right out of the gate. Why couldn't 10,000 Tesla employees each put down five deposits? That's 50,000 right there. It would certainly help their employer raise equity from new investors from a more elevated stock price. And if their employer has more equity capital, it would reduce the probability of it going out of business in the near future.
When Tesla tweets out, or otherwise reports, how many refundable deposits it has received, will it disclose how many come from employees, investors or others with a stake in the company's ability to raise money on favorable terms? How would it even know to secure the identities from credit card deposits originating in Nigeria, China or Kazakhstan?
What is Tesla's reason for taking Model 3 refundable deposits this early?
Normally, an automaker wouldn't want to show a new car this far away from production, which Tesla itself says won't even begin until the end of 2017, almost two years from now. And that of course means that most people who aren't first in line probably will get the car in 2018 or even later. Mind you, the Model X was introduced in February 2012, promised for December 2013, but just started shipping recently, close to four years after it was shown.
The reason you don't show a new product too early is that you "Osborne" yourself. Usually, this is meant to replace an existing product with a newer version thereof. Case in point: Apple's (NASDAQ:AAPL) iPhone. When a new iPhone comes out, Apple doesn't want people to know two years in advance what the new model will be. Two weeks is more like it.
In the case of the Tesla Model 3, there is an even stronger case against showing this car any earlier than absolutely necessary. Why? Because this car is said to benefit from all new technology (battery and otherwise) and scale/volume efficiencies, that the price will be nothing short of HALF that of the existing Model S - $35,000 versus $70,000 (and up).
Clearly there are a few people who will still buy the more expensive car, perhaps because it's a little larger, but most likely the greater majority of people who would consider a Tesla, would rather get the newer, fresher, car for half the price - $35,000 instead of $70,000-$160,000. As such, sales of the existing model, selling for twice the price (and up) would be negatively impacted.
So why do it? Why would Tesla voluntarily shoot existing Model S demand in the foot?
There can be really only one answer: Tesla needs or wants to raise money NOW.
Yes, I know, something was said on the most recent earnings call to the effect that Tesla doesn't need to raise money this year. Strictly speaking, that may be right under some highly optimistic or narrow circumstances. Still, Tesla has raised money before very shortly after having said that there is no need to raise more money.
This exchange from the August 6, 2015, Tesla quarterly conference call is instructive:
John J. Murphy - Bank of America Merrill Lynch
So, Deepak, do you think as you go through the launch of the Model X and ultimately the Model 3, that you'll turn cash flow positive at the right point where you might not need to do a capital raise going forward, is that kind of how you're thinking about this with the credit lines on top?
Deepak Ahuja - Chief Financial Officer
Yeah, we are comfortable with the cash levels. I'll put it that way.
Elon Reeve Musk - Chairman & Chief Executive Officer
I don't think that there's not a need to raise equity capital. There may be some value in doing so as a risk reduction measure, but to be clear, we - what Deepak is saying is that even in the absence of any additional capital generation activity, we would have on the order of $1 billion through - basically that would be, our minimum cash position.
Of course, Tesla turned around right after that conference call and launched an equity offering, despite having just said that it's comfortable with its cash levels.
A huge refundable deposit number would provide for a convenient excuse to say something along these lines:
We have received an unexpectedly large number of refundable deposits for the Model 3. Clearly the world is demanding that we deliver a million cars, much faster than we had expected. In order to accelerate this process, we are hereby launching a $4 billion equity follow-on offering so that we can expand our production capability faster than we had previously planned.
In other words, this press release pretty much writes itself. Whether the refundable deposits are "organic" in nature, or "manufactured" by employees and other stockholders who simply want to see the stock to go up, the result would be that Tesla could walk home within a month or so with billions of dollars of fresh equity capital, raised at an elevated valuation.
After the inflation, comes the deflation
Even John Maynard Keynes could have predicted how this Tesla Model 3 refundable deposit saga ends up unfolding. There are three basic reasons why all of these many hundreds of thousands - or millions - of Model 3 refundable deposits will never convert into an actual sale, sometime after volume production eventually commences in 2018 or 2019:
Employees and stockholders get their money back quickly
All those people who could place hundreds of thousands of refundable deposits just to boost the stock price, will ask for a prompt refund once the stock has gone up, or in the case of employees after the company has raised fresh equity capital. Clearly those one million or whatever refundable deposits that would be made this first week of April will never convert into any sale of a car.
Tax credit "insurance" will evaporate
Once it becomes clear who made the cut to be eligible for the $7,500 tax credit, many of those who didn't make the cut will ask for their deposit refunds too. You have to understand that other manufacturers will be selling EVs in 2018 and 2019 that will be eligible for the $7,500 tax credit, so why not just get your car from them instead? This would include Ford (NYSE:F), Chrysler, Honda (NYSE:HMC), Volkswagen (OTCPK:VLKAY), Audi, Volvo, Jaguar, Kia, Hyundai and probably many others as well.
Competition: Seen versus unseen
Most of Tesla's competition for 2018 and 2019 has not yet been unveiled. Really the only two cars of consequence that have been shown are the Chevrolet (NYSE:GM) Bolt and the Audi (OTCPK:AUDVF) eTron Quattro, and the latter one of those two only in concept car form.
It's not easy for the consumer to imagine what the Nissan (OTCPK:NSANY) LEAF 2.0 will look like, what the range will be, how it will perform, how reliable it will be, and so forth. The same goes for the electric car offerings from all the other automakers who may have 200-300 mile range competitors in the 2018-2019 timeframe - again including Ford, Chrysler, Honda, Volkswagen, Volvo and many others.
However, those automakers are not soliciting deposits on their 2018 EVs right now. Not even the Chevrolet Bolt, which goes into production just a few short months from now, in the fourth quarter of 2016, is taking deposits - even though it will be available at least one year before the Tesla Model 3.
Therefore, it's easy to compare something against nothing. Tesla will have what I am sure to be a most impressive unveil and overall product pitch in late March 2016, for the Model 3. The comparison? Well, all those other automakers - except for GM - have not unveiled their Tesla competitors yet. So if you are the consumer, why not place a refundable deposit on the Model 3? This of course boomerangs once the other automakers start selling their EVs at various points in 2017, 2018 and so forth.
As you can see, the boom in Model 3 refundable deposits that I expect to happen in the immediate wake of the March 31 reveal will likely deflate in the following months, quarters and years, as most of these refundable deposits never convert into the sale of a car. Meanwhile, Tesla could be billions of dollars richer having sold stock at elevated prices in April or May of this year.
Deposits 101: The experience of Model X
The Model X has had a slow start. In the third quarter of 2015, only approximately ten cars were delivered, including one to Elon Musk himself (Did Tesla actually count that as revenue? If so, when did he place a deposit and did he place a deposit for only one car?). In the fourth quarter of 2015, Tesla delivered 208 Model X cars. Surely there will be more in the first quarter of 2016 and even more in the following quarters.
Tesla has not provided any audited or otherwise reliable numbers for how many of the Model X deposits were cancelled or did not convert into orders. Come to think of it, we don't even have a recent reliable number for how many Model X deposits were placed to begin with.
If you just do a quick search, you'll see plenty of estimates not too far from the 30,000 point, some above, some below. How many of them are being converted into actual sales? Mind you, those deposits were no less than $5,000 apiece - not $1,000 as with the Model 3.
Perhaps CNBC's incessant telethon infomercial for the Model X will help these conversions from refundable deposits to actual orders and eventually deliveries. Still, we do not have any audited or otherwise reliable statistics from Tesla as to how the Model X refundable deposits have developed over time, including the number and timing of cancellations/refunds, from quarter to quarter.
Bottom line: Boom followed by bust. In the meantime, likely capital raise.
It seems obvious to me that Tesla will get at least many hundreds of thousands - maybe even millions - of refundable deposits for the Model 3, with most of those inflated for temporary reasons, including from stock speculators and employees who just want to pump up the stock value. Assuming that the stock shoots up because of high refundable deposit numbers, I believe Tesla will take this opportunity to raise fresh equity at an elevated valuation.
Then, in the end, come 2018 or 2019, the vast majority of the Model 3 refundable deposits will never convert into a sale, either because no sale was ever intended in the first place, or because the $7,500 Federal tax credits expired, or because people switch to the competitor products closer to the Model 3's volume availability in 2018 at best.
For these reasons, I think Tesla stock has a good probability of outperforming in the near term, barring some other unrelated problem, but face a far more difficult time starting in May 2016 and beyond.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in TSLA over the next 72 hours.
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.
Additional disclosure: At the time of submitting this article for publication, the author did not have a position in any of the companies mentioned. However, positions can change at any time. The author regularly attends press conferences, vehicle launch events and similar things, often hosted in whole or in part by the automakers.