On Tesla Not Needing Profits

| About: Tesla Motors (TSLA)

Summary

It's often thought that once Tesla gets the scale, the profits will come.

It's also thought that if things get ugly, Tesla can always rely on being acquired.

This article comments on both issues and shows why both are misleading.

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Jaguar XJ. Tesla isn't the only one that's able to design beautiful cars

As always, Tesla (NASDAQ:TSLA) acolytes are fertile in theories on why TSLA can rightfully trade at the current $35.7B fully-diluted market capitalization and not be overvalued, as well as to explain away the risk of a bankruptcy.

For instance, to explain away the need for profits, it's usually put forward that TSLA still hasn't got the scale. The theory here is that other low-volume auto makers were and would also be unprofitable at TSLA's scale. Thus, the explanation for profits is "just wait a few years". Or, as one commenter in a recent Montana Skeptic article put it, just wait until 2025.

As for the bankruptcy risk, another commenter on the same article said, the worst case is Tesla being bought out.

This article seeks to show why both of these bullish theories, as with many others, are simply bunk.

On Scale And Profits

Just today, Anton Wahlman showed how TSLA compares to Jaguar in terms of size and growth. He did this in his article titled "Tesla, Jaguar And Math: You Will Be Surprised". The conclusion is that both companies are pretty comparable - with Jaguar actually being larger.

Jaguar Land Rover

Now, Jaguar itself is just a part of the Jaguar Land Rover group. And this group is just part of Tata Motors Limited (NYSE:TTM). Tata Motors, however, does publish detailed information on the Jaguar Land Rover group. This information can help us ascertain as to whether this group's size has been a roadblock to its IFRS profitability (IFRS standards are akin to GAAP but used in different geographies, namely Europe).

What's the answer? It hasn't. We can see that as far back as FY2012 (ending in March 2012), the Jaguar Land Rover group was profitable both on an EBITDA and before/after tax basis:

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Source: JLR Presentation

Of course, Jaguar Land Rover is quite a bit larger than TSLA, at 509.3k vehicles sold during FY2016. But then again, this profitable reality already existed during FY2012, at 314.4k vehicles. And indeed, this remained true even during FY2011 at 241k vehicles. And mind you, these aren't non-GAAP numbers excluding stock-based compensation - which lately has been running at 4.9% of TSLA's GAAP revenues.

Basically, Jaguar Land Rover was profitable even at a level of sales similar to the level expected by TSLA for 2017.

Moreover, Jaguar Land Rover wasn't just profitable but it was free cash flow positive in spite of significant investments:

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Source: JLR Presentation

TSLA can't make either statement. What we see here, is that scale is not an impediment to profitability in the automotive business, not even in the presence of significant growth.

Indeed, while TSLA might seem to be growing much faster (and still is, in percentage terms), it should be noted that TSLA added ~60k unit sales from 2013 to 2016 (3 years). Jaguar Land Rover added "just" 48.7k … per year, on average, during the last 4 years (so 194.9k in total). Will TSLA achieve the same? Certainly not by 2017 (in spite of what Elon Musk might say regarding selling 100k Model 3 during 2017 -- something which is a near certainty won't happen).

Ferrari

If Jaguar Land Rover isn't enough, we could also bring the example of Ferrari (NYSE:RACE). Ferrari at $3.3 billion in sales is smaller than the current TSLA size. Ferrari shipped just 7.7k units during FY2015, versus the 80k+ expected from TSLA during 2016.

Is Ferrari lacking scale, then? Not really. Ferrari reported both positive EBITDA (26% margin) and net profits (10% margin) with no "excluding share compensation" excuses.

In short, the "lack of scale" excuse for TSLA's lack of profits is just that, an excuse. Quite to the contrary, with TSLA presently being a leader in a market with no competition (long range EVs), if anything TSLA should be more profitable today than in the future. The competition which is set to arrive, mind you, will include Jaguar Land Rover (and everybody else, I'll add).

On An Acquisition Saving Tesla

While the original idea was that an acquisition would be the worst possible scenario in terms of Tesla customers getting service, it should be added that such an acquisition is also often seen as a factor limiting downside risk for shareholders.

This is put forward due to Google's rumored approach back in early 2013, as TSLA was standing on the verge of bankruptcy, as well as Apple's (NASDAQ:AAPL) rumored - and near certain - coming involvement with EVs.

Here, I'd like to add two thoughts:

  • First, it's different acquiring a company in trouble before it has amassed significant liabilities, from doing it after it has those (like TSLA today).
  • Second, back in 2013 TSLA had no prospect of direct EV competition. That's not true today, as it's widely known that a significant number of EV competitors are about to hit the market. Thus, the EV "premium"/uniqueness which an acquisition proposal would be buying back in 2013 will soon be lost forever during 2016, 2017.

Then, as a comparison, we could again go back to the Jaguar Land Rover group. Back in mid-2008, Tata acquired Jaguar Land Rover from Ford (NYSE:F). At the time, Jaguar Land Rover was actually EBIT profitable and significantly larger than TSLA is today (300k units, vs 80k for present-day TSLA 2016 estimate). Jaguar had seen plunging sales for years, but Land Rover was growing. Yet, what was the price for this? $2.3 billion, and the company came with no debt plus Ford had to make a $400 million contribution to JLR's pension fund, showing how despised liabilities are, no matter what their nature.

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Source: JLR acquisition presentation

The short story here is, if you think TSLA shareholders can be rescued by an acquisition in the event that its financial troubles are ongoing, think again. Given the debt TSLA already carries, it would be very unlikely for equity to hold much value. Even customers could potentially lose some of their TSLA lifetime promises, in the event of such an acquisition.

Conclusion

There are two conclusions to be drawn from this article:

  • What TSLA lacks is not scale. What TSLA lacks is intrinsic profitability for the scale it already has.
  • An acquisition wouldn't save TSLA shareholders. It might also not save some of its consumers, as the acquirer could use a prepacked bankruptcy prior to acquisition to get out of onerous customer rights like free supercharger access "for life".

Again, while TSLA's equity raise increased its runway, TSLA remains very risky for as long as it continues to burn significant cash. Were the equity markets to close to TSLA's ongoing cash needs, TSLA would be in a world of hurt in little more than one year and a half (if it sticks to its 2016 capex plan).

Disclosure: I am/we are short 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.