Tesla: The Words Of The Prophet (And Lots More)

| About: Tesla Motors (TSLA)

Summary

Tesla to California: Drop Dead.

10-Q stealth changes: fewer Service Centers and Superchargers. Oh, and as the clock continues ticking, may I ask: Where are those other Gigfactory "partners"?

Message to Musk: if you want to tweet it when it's rising, you need to tweet it when it's falling.

My updated theory about the disappearance of the CPOs: it's all about the Growth Narrative.

Tesla's residual value guarantees to its leasing partners are material, and it's high time Tesla disclosed them.

The Model 3 discussion in Tesla's (NASDAQ:TSLA) latest quarterly report already has attracted plenty of attention, so I'm going to skip that part of the Q.

Any serious Tesla investor, however, will want to read the new detail (which appears at pages 23 & 32-37 of the report), both about the ambitious acceleration of production plans and the associated risks.

There are a few other curious features of the 10-Q that haven't been commented upon. I'll cover them quickly, and then move on to:

  • some thoughts about Elon Musk's selective tweeting,
  • my updated theory about why the CPOs have disappeared,
  • some negative news about Model S margins,
  • a call for Tesla to come clean about the residual value percentages it guarantees its leasing partners, and
  • deep thoughts from a latter day Jeremiah.

(Model X fit & finish)

Congratulations, California.

But first, some breaking news about how Tesla expresses its thanks to the State of California:

What has California given Tesla?

  • ZEV credits.
  • Buyer rebates.
  • Buyer HOV privileges.
  • More than $700 million in purchases qualifying for sales and use tax exclusions.

What was California promised in return? California jobs. Lots of California jobs. Including California jobs for refitting the Fremont plant.

How's that deal working out? Hmmmm.

Tesla has saved at least $129 million under the various sales and use tax exemptions that California granted.

Interestingly, most of the sales and use tax exclusions were specifically earmarked for manufacturing equipment.

Does anyone care to guess whether Tesla used part of that manufacturing equipment exclusion in expanding its paint shop?

No worries, Nevada. I'm sure things will work out better for you.

I. 10-Q STUFF

Farewell to 80 new Service Centers.

In its February 10, 2016 Shareholder Letter, Tesla promised 80 new retail stores and Service Centers in 2016. Three months later, though, in its most recent 10-Q, Tesla has dropped the number to 70.

Characteristically, Tesla does not acknowledge that it's reducing the number, never mind explain why it's doing so.

Someone please enlighten me about why reducing retail store and Service Center growth is a good idea at a time when the Service Centers are severely overtaxed, and when Tesla is promising as many as 350,000 new Teslas on the road by the end of next year.

And farewell to 300 new Superchargers.

Rinse and repeat. In its February 10 Shareholder Letter, Tesla promised 300 new Superchargers in 2016. That would require 75 new Superchargers each quarter.

In its May 5 Shareholder Letter, however, Tesla disclosed that it "energized" only 29 Supercharger locations. A few days later, in the quarterly report, it stated that it intended to build "approximately 250 new Supercharger locations" during 2016. (Page 24)

Again, Tesla neglected to acknowledge that the 250 figure in May represents a material reduction from its February promise.

Do Tesla investors enjoy being treated like boobs? Because Tesla, with its endless stealth reversals, certainly seems to treat them that way.

Gigafactory: Tesla is about to spend big (once it has your money).

More news from the 10-Q that's been overlooked: Tesla expects to spend a total of $520 million during 2016. (See 10-Q at page 28.)

Wow. That means Tesla will spend more on the Gigafactory during the balance of 2016 than it has spent to date.

Here are the numbers. Tesla spent $67 million in Gigafactory capital expenditures during Q1 2016, bringing the total Gigafactory capex as of March 31, 2016, to $380 million. Given the 10-Q forecast, that means Tesla will spend another $453 million during the final three quarters of 2016.

Obviously, Tesla doesn't have that kind of cash lying around. Tesla's further 2016 Gigafactory spending depends entirely on a capital raise.

By the way, Tesla has long said it will spend a total of $2 billion on the Gigafactory. So, even if Tesla spends the forecasted $520 million this year, it will still have another $1.1 billion of Gigafactory spending ahead of it.

Is it rude to continue asking where the other Gigafactory 'partners' are?

The original PowerPoint "Gigafactory Projected Timeline" slide in Tesla's 2014 presentation showed "Partner Discussions" occurring between February and November 2014.

Click to enlarge

With only Panasonic announced as a Gigafactory participant, here's what the 2014 Tesla annual report (filed with the SEC on February 26, 2015) promised:

We are developing the Tesla Gigafactory as a facility where we work together with our suppliers to integrate battery precursor material, cell, module and battery pack production in one location....

We believe that the Gigafactory will allow us to achieve a major reduction in the cost of our battery packs of greater than 30% on a per kWh basis by the end of the first year of volume production of Model 3… We expect to announce other partners as construction progresses.

We anticipate bringing on additional partners for the Gigafactory to create a fully integrated industrial complex. Although planning discussions with production and supply chain partners continue to progress well, to date we have not formalized any agreements with any other partners.

(Tesla 2014 Annual Report, filed with the SEC on February 26, 2015, at p. 11, emphasis added)

Here we are, almost 15 months later, and still no "other partners" (sub-suppliers) in sight.

And, of course, the "precursor" language disappeared several months ago.

So much for a "fully integrated" battery manufacturing process. And so much for the on-site processing of depleted cells for re-use of the valuable metals.

(Hey, wait. Wasn't the 30% cost savings supposed to come from the full integration and the recycling?)

Explain again about that warranty reserve?

The May 5 Shareholder Letter states:

Our warranty accrual rate on all new vehicles declined from Q4, based on projected warranty costs, as vehicle reliability continues to improve.

I'll ignore the temptation to wonder whether Model X owners would agree about an improvement in vehicle reliability, and go straight to the numbers.

In Q4 2015, Tesla delivered 17,478 cars and accrued as "Provision for warranty" $23.679 million, which works out to $1,355 per delivery. The Q1 2016 numbers are $30.271 million for 14,810 deliveries, or $2,044 per delivery.

So, warranty accrual per car went from $1,355 to $2,044, which works out to a 51% increase. Someone tell me what I did wrong, because I'm not seeing that decline in the numbers.

(And, yes, I'm aware that Tesla has no warranty reserve at all for leased cars; instead, it expenses warranty costs as incurred. Tesla has quietly discontinued reporting details of how many deliveries during each quarter were subject to resale value guarantees and how many were third party leases with residual value guarantees; only direct leases are still reported.)

II. DEAR ELON: IF YOU START TWEETING, YOU NEED TO CONTINUE TWEETING.

Beginning March 31, CEO Elon Musk tweeted continuously about Model 3 reservations. I count 17 tweets between March 31 and April 7 concerning Model 3 demand. Examples:

Since then, crickets.

Here's how it works, Elon. If you want to be the first automobile manufacturer CEO in history to endlessly take to social media to promote your products, that's fine. But you're not free to use misleading language and you're not free to tell only part of the story.

What do I mean by misleading language? I mean calling refundable deposits "orders" when the Tesla contract explicitly warns:

  • They are not orders.
  • They do not guarantee a car.
  • They do not guarantee a price.
  • They do not even guarantee a place in line.

Tesla can cancel those "pre-orders" whenever it wishes. Go read the agreement.

What do I mean about telling part of the story?

I mean that you can't simply tweet about growing numbers of deposits, and then have your Vice President of Business Development, Diarmuid O'Connell, announce that those deposits are "approaching 400,000" without continuing to keep investors apprised of what the reservation number is.

Will Tesla dare to go to market for more capital without disclosing the then-current number of Model 3 deposits?

Isn't there a phrase for that somewhere? Something about omitting to state a material fact necessary in order to make other statements made not misleading. You could look it up.

Yes, Elon, I realize you think you got away with this on the Model X deposits, boasting about them in the 2014 Annual Report when they hit 20,000, and then clamming up in the latest annual report after (I believe) a material percentage of those deposits had been cancelled.

But here's some unsolicited advice: Don't push your luck. In the eyes of the SEC, Twitter is no different from other means of disclosing key information.

III. THEORIES ABOUT THE DISAPPEARANCE OF THE CPOs

Three weeks have passed since first I wrote about the mysterious disappearance of CPOs for sale, and still not a single CPO listing at the Tesla EV-CPO Consolidator.

There are, however, plenty of new Tesla (Inventory) cars listed. As of this weekend, there were 375 of them in the U.S. alone. From the VIN numbers, it's clear that cars are being built specifically to add to the inventory list.

The new cars listed on the Consolidator are surely only a small part of Tesla's total inventory. The latest Tesla guidance for Q2 deliveries implied an inventory build of about 3,000 cars.

So, what's going on here?

jim15936 and neroden have theories…

Several Seeking Alpha members have offered possible explanations.

jim15936, for instance, wondered whether Tesla is dismantling the CPO cars to build a stock of spare parts.

neroden insisted that Tesla needs the CPOs as loaners because it "needs to open an average of 10 new locations each month, and that's a lot of loaners they need. It'll be sucking up all the CPO supply for a year."

I'm grateful for the ideas, guys, but I'm not biting. As for jim's theory, I think Tesla is too busy trying to assemble Model X cars to have time to disassemble Model Ss. And the economics make no sense.

And, memo to neroden: Tesla is not opening 10 new locations a month. As noted earlier in this article, the average is now guided for fewer than 6 per month (with every indication that most of the new locations will be back-loaded in 2016).

... but I'm hanging with bubslug & Cygnus3000 (& Socrates).

What's my theory? I believe Seeking Alpha member bubslug may be on to something:

I think they are simply trying to force used car shoppers into a new car.

Why do I find bubslug's theory so appealing? Let's use the Socratic method of asking questions to get to the deeper truths.

  • First question: What are the two most important "metrics" to Tesla?

Well, that was easy, wasn't it? You all got the correct answers: "gross margin" and "deliveries" (which includes only new cars).

  • Next, why is gross margin so important?

Another obvious one. Tesla loves talking about gross margin because it deflects attention from Tesla's perpetually negative net margin. Gross margin promises there are better days ahead if only we increase our production, which we're always promising to do.

  • Question number three: Why are deliveries so important? Because deliveries are central to Tesla's Growth Narrative.

With a capital raise desperately needed, the Growth Narrative is more crucial than ever. So, we would expect deliveries to be emphasized above all else.

  • Final question: What recent development eclipses the importance of even deliveries in the Growth Narrative?

Why, of course, the Model 3 deposits. They are incredible, astounding, unexpected, record-setting, disruptive, paradigm-changing, and colossal, and they justify the immense capital raise that we are trying hard to put together even as you read these words.

Developing bubslug's thesis, and knitting together the answers in our Socratic dialogue, here's a perceptive commentary by Cygnus3000:

If one thing's clear, it's that Musk et al. are astute at managing their equity valuation as a growth story (as opposed to a profit story). If they see new deliveries flattening, and a growing surge of used cars coming off lease, they risk flooding their own market.

"Destroying" this supply by turning it into loaner fleets, or simply scrapping these cars, would be the same strategy dairy farmers used during the Depression -- dumping milk to support milk prices. Because Tesla has a monopoly on granting CPO status (and one would have to be pretty adventurous to buy a non-CPO Tesla given all the new expensive tech, and the utter void of third party repair and service shops), this would be easy enough to do.

If destroying 500 used cars allows Tesla to sell 500 more new cars, thereby enabling it to hit its sales guidance for the quarter, it's well worth the expense.

After all, Tesla is valued as a growth company, so who cares about Profit & Loss? And this strategy wouldn't just defend/promote new Model S sales; as the price of a used S comes down, it may start to appear as a better value prop than waiting for a new Model 3, so these used cars could also erode deposits on the 3. Better to take them out of circulation than risk a plateau (or possibly cancellations) of those Model 3 deposits.

Now, to be clear, I'm not ready to go nearly as far as Cygnus3000. I don't believe Tesla has any intention of destroying used Model S cars.

But I do believe Tesla is hanging on to all the used Teslas it's accepting as trade-ins. It's storing those cars somewhere, probably at locations around the country.

Two Predictions: A Deliveries 'Beat' & A Used Car Flood

It's crucial for Tesla to keep the CPOs off the market. I'll make two predictions:

  • First, Tesla will exceed Q2 guidance (17,000) by 500 to 1,000 cars. Even though the delivery total won't come close to the 21,730 deliveries to stay "on track" for meeting low-end annual guidance of 80,000, the usual suspects at Motley Fool, Business Insider, and CNBC will celebrate the Q2 figure as a surprising and positive "beat."
  • Second, shortly after the capital raise is completed, a flood of used Model Ss will hit the market, most likely via auctions or as CPOs, or both.

Sure, at some point, Tesla will have to pay the piper. Tesla will have suffered depreciation costs from keeping the cars off the market so long. It may have overpaid for the cars just to sell a new Model S.

But it will all have been in service of propping up new car deliveries and thereby forwarding the Growth Narrative.

Because at Tesla, the Growth Narrative is everything, and there is no such thing as a Profit Narrative.

Author's Update (May 17, 2016 @ 8:23 a.m. EST):

Lo and behold, since this article was published yesterday, 70 additional new Model S cars and 70 CPOs have hit the U.S. listings in EV-CPO Consolidator.

Thanks to Bonaire for alerting me to this development.

I doubt Atlanta needs 25 inventory cars. And I'm sure Cleveland does not need 30. Tesla is producing more new cars than it can sell.

As for the CPOs, it's clear they're not being soaked up by the loaner pool. My guess: there are plenty more CPOs where these came from.

Now, back to the original article...

Tesla Pattern: Broadcast the Happy News; Whisper the Sad News.

Pending the capital raise, the much-celebrated Tesla CPO program has succumbed to the familiar pattern: ostentatious introduction followed by silent disappearance. Other examples:

IV. A TESLA GRAB-BAG OF NEWS & VIEWS

How is Model S demand holding up?

As noted, the CPO Consolidator site listed 375 U.S. cars this weekend, all of them inventory. From the VIN numbers, it's clear that cars are being built specifically to add to the inventory list.

And how are inventory sales going? Of those 375 cars, 144 have been lowered by at least $5,000. And 48 of those have had their price lowered by at least $10,000.

Tesla said it expects to produce 20,000 vehicles in Q2, but deliver only 17,000. That makes for a Q2 increase in inventory cars of 3000.

Does anyone believe this bodes well for resale value or for gross margin?

Dear Tesla: Time to come clean about residual guarantees.

Everyone knows the details of the Tesla's resale value guarantee program. Buy a car from Tesla under the program, and three years later, Tesla will buy it back for 50% of the base price plus 43% of what you paid for extras.

No one, though, knows a crucial detail about the residual value guarantee that Tesla offers its leasing partners: the percentage of purchase price promised by Tesla.

The details about the residual program for lessors is much more important than the resale program for buyers. About two and one-half times as many cars are covered by the residual value guarantee as by the resale value guarantee.

Not only are more cars covered by the residual VG than by the resale VG (with the proportion of leased cars growing larger every day), but the third party lessors are far more likely to exercise their put options.

Why? Whereas private buyers with a resale VG must pay off their loans, it's just business for the third party lessors. If the residual value is marginally close to the guarantee, it simplifies the lessors' disposition of dated vehicles.

Tesla assures its investors: "Based on current market demand for our cars, we estimate resale prices for our vehicles will continue to be above our resale value guarantee amounts." (10-Q at p. 25)

Guess what Tesla says about the residual guarantee amounts?

That's right. Nothing.

And the sign said: "The words of the prophet are written on the subway walls…"

... and conference calls, and transcribed in the links at SA:

There are many ways to skin a cat, and it's remarkable how you can achieve a single objective with a hugely varying degree of difficulty. You can sort of take the analogy and say, if you wanted to kill a fly, you can kill a fly with a thermonuclear weapon, you can with a MOAB, with a cruise missile, with a machine gun, or a fly swatter.

So the end result is the same, but the difficulty is considerably more significant from one to the other and the collateral damages is considerably more significant.

So having production be really fundamental to the design of the Model 3 I think is very important and then making sure we're not adding extraneous features to the 3 that aren't necessary to achieve the production volume is also extremely important.

Presented without further comment.

A Note About My Contributors

As always, I've poached freely from the good ideas of others.

This time, big shout-outs to bubslug, investor.gator, and Cygnus3000, on this board. And even though I didn't agree with them, I was intrigued by the comments of jim15936 and neroden.

Over at the Yahoo Tesla message board, lots of help, as usual, from temagami, n0m0renancy, rusty_wallace_fans, easygoingnala, and cgc.meaden.

Disclosure: I am/we are short TSLA VIA LONG-DATED PUTS.

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.