The Blanche DuBois character in A Street Car Named Desire had a history of erratic behavior and failed relationships. Her deteriorating circumstances throughout the play resulted in an increasingly delusional view of the world around her that resulted in even more dysfunctional behavior. By the end of the play, she is famous for the line "I depend on the kindness of strangers."
Tesla's (NASDAQ: TSLA) huge financing needs also result in being in a similar situation. The company's aggressive growth plans in a very capital-intensive industry along with cumulative operating losses of $2.6 billion have already resulted in the company having raised over $8 billion so far between debt and equity financing. The most recent financing was on May 19 and raised $1.7 billion of additional equity. The timing of that financing is especially interesting given two other Tesla related events on either side of the equity offering.
Fatal Crash 12 days before the recent equity offering
The first is that 12 days before the offering (on May 7) there was a fatal crash of a Model S where the autopilot system failed to see a tractor trailer making a turn in front of the vehicle. As everyone knows, Tesla has also very actively promoted and publicized its autopilot system as being a very innovative competitive advantage for the company. Although the feature is still classified as being in beta testing, Tesla has also already charged 25,000 of its vehicle owners $2,500 (collecting over $60 million in additional revenues) to activate the feature. I would guess that for at least some investors in the recent offering, a factor behind buying more Tesla stock was that the autopilot feature was considered a differentiating competitive advantage for the company.
There were no disclosures in any of the prospectus materials about the fatal crash, however, or the overall failure of the autopilot system in not recognizing another vehicle in its path, or the bizarre subsequent actions of the vehicle (after the entire roof of the car had been sheared off!) in continuing forward for at least another 1,000 feet while it crashed through three fences, ran into a utility pole, and then finally came to a stop after doing a donut! (although maybe that is an unpublicized feature of Ludicrous Mode).
The lack of disclosure (and details!) about the crash in the prospectus materials filed with the SEC is especially curious due to another subsequent disclosure by Tesla on June 30 that:
"Following our standard practice, Tesla informed NHTSA about the incident immediately after it occurred."
Although Tesla did report the crash to one government agency (the NHTSA) "immediately" the company decided that another government agency in charge of regulating full disclosures in securities offerings (the SEC) did not need to know about the fatal failure of a highly publicized Tesla vehicle feature (vehicle owner deaths due to vehicle systems failures are not material according to Musk). There has also already been a lot written about Tesla not disclosing any of this at all until June 30 but that speaks a lot about Tesla's overall manipulative sleight of hand approach in spinning its public relations narrative.
Solar City acquisition announcement one month after the equity offering
The timing of the Solar City acquisition announcement on June 21 only one month after the equity offering also begs a huge number of questions about how long that had been discussed at the board level. Although Elon can be a surprising guy, from my own experience on boards, I can't imagine that Musk, a few weeks after the May equity offering, suddenly said to the other board members:
"Yeah, like hey dudes, I mean like it would be really wow if we now, um, like buy SolarCity (NASDAQ:SCTY)."
And then within only a week or so there is a formal acquisition offer for the company.
I would guess that such discussions had been going on for some time and that a description of such a possibility should have also been included in the prospectus filings for the May offering. Given the well-known relationships between Musk, Tesla, and SolarCity, I also think it was a material omission from the "Risk Factors" section of the 2015 10-K that there could be future business activities between the two companies although I do understand to prevent acquisition speculation that a risk factor could not specifically describe that Tesla might acquire Solar City.
Why Tesla's selective disclosures matter
My comments so far might seem like just a reiteration of already known issues and or just general "Tesla bashing" by another "hater" of its supposedly noble mission but there is a much more significant issue that I am about to describe.
As mentioned at the start, Blanche DuBois reached a state where she needed to depend on the kindness of strangers. Tesla, with its huge future financing needs, will also continually need to depend on the kindness of strangers to support its announced growth plans.
With the company's selective and manipulative communications policies, its own huge operating losses that are projected through 2019 (Musk has mentioned that the company is unlikely to be profitable until 2020), and sudden surprises such as announcing an acquisition offer for an operation that is projected to lose roughly $1 billion a year in both 2016 and 2017, the kindness of strangers may gradually diminish to the point that investors are no longer willing to fund Tesla's operations. After the recent timing of events around the May secondary offering, there may also be a point in the future where major investment banks will be unwilling to underwrite Tesla's equity offerings (six follow-on offerings for a company that stated it would need no further financing in 2012).
Projected Future Financing Needs
Some may also remember previous statements I've made in either comments on other articles or more recently through some of my own articles that I've published as a Contributor that I believe the company will need another $6 billion of external financing in 2017 and 2018 (including increased funding from its leasing partners) to support its stated growth plans.
Since the Master of the Universe, Mr. Musk, hasn't tweeted any statements about such future financing needs (he suffers from delusions that Tesla is cash flow positive), my own statements probably might have seemed like just another "Tesla bashing" exercise to spread dreaded FUD from a luddite who doesn't understand the world-changing innovations of the company.
What I do understand after a 20-year professional career managing small-cap growth stock portfolios where part of my research and analysis was to create full financial models (with linked balance sheets, income statements, and cash flow statements) for over 3,000 companies analyzed during that period, is that innovations take a lot of money to develop and commercialize and so that is why I am now about to publish my current Tesla financial model.
From my perspective, successful investing requires having no biases at all (something that Tesla bulls should also think about) but to rely on as many data points and consider as many other people's opinions as possible and then make a decision based on such inputs. As such, the financial model that you are about to see is not intended to present a "negative" view on Tesla but is actually just for my own understanding of the financial dynamics of the company.
I believe the model even presents a pretty positive view of future vehicle deliveries (my unit delivery assumptions are listed after the overall model) and possibly even of future gross margins. But, even with such positive assumptions, the financial reality of Tesla is that my model tells me that it will still need at least $5 billion of direct additional financing between now and the end of 2019 and an additional $8 billion of funding support from its financial partners who offer bank financing and leases for Tesla vehicles.
If financial markets are okay and the Tesla stock price stays levitated at current levels and Musk doesn't torch the currently low interest rates available to Tesla by going through with the Solar City acquisition (some of the Solar City bonds are now priced at 20 percent yields), then maybe Tesla can directly raise another $5 billion over the next three years. That is still a very large amount of money and so that is a very significant risk factor for Tesla's stock - whose currently high price is needed to facilitate its future financing needs.
An even more underappreciated risk is whether the much larger amount ($8 billion) of indirect external financing will be available depending on changing views of Tesla's creditworthiness as guarantor of the RVGs imbedded into their indirect financing agreements but which are not publicly disclosed in Tesla's SEC filings.
With all that being said, here are my balance sheet, income statement, and cash flow statement projections though 2020:
Projected Capital Spending needs
What will be most controversial and a topic for discussion are my Capital Spending assumptions, which are $2.5 billion in both 2017 and 2018. An initial reaction may be "how can that be as 2016 Capital Spending plans have already increased from $1.5 billion to $2.2 billion to support the Model 3 introduction."
My opinion is that most of the increase in 2016 is actually to make sure the current Tesla operations are properly configured (given the debacle of the initial Model X launch) for both current Model S and Model X production and to reconfigure the plant so that equipment for a Model 3 line can be installed. That opinion was supported by the Q2 deliveries announcement, which confirmed that current vehicle production operations are still producing erratic and inconsistent results.
In any case, given that the Model 3 design and engineering is not even complete, there is not yet a lot of capital equipment that will be needed in its production that can yet even be ordered. Given typical capital equipment ordering and installation lead times of four to six months, once equipment can be ordered for the Model 3 when its design is complete, almost all Model 3 related capital spending would start being recognized in 2017 and would not be part of the 2016 Capital Spending total.
The $5 billion of additional capital spending that I'm projecting for 2017 and 2018 may also seem like a very large number for a company run by a supposedly brilliant engineer who can land rockets on barges and who has now had the insight that the company is only using two to three percent of its plant when measured volumetrically (it took eight years after becoming CEO for that insight to be announced). From a quantitative perspective, however, I use asset turnover ratios to support my projected capital spending assumptions but there is also a very straightforward intuitive way to look at my assumptions.
At the end of the first quarter of 2016, overall Property, Plant, and Equipment was $4.3 billion on the balance sheet and that supported the current production capacity of 100,000 vehicles a year. Part of that is for the Gigafactory, which is not yet supporting current vehicle production and so I'll subtract $500 million as an assumed cumulative investment so far in the Gigafactory. That then leaves a figure of $3.8 billion supporting the current auto production operations. But, as our dear friend Elon blessed us with additional field guidance in a tweet about "having to rethink those production plans," the company now intends to have production capacity of 500,000 vehicles a year by the end of 2018.
I'll also adjust the $3.8 billion number by quite a lot by assuming that $1.5 billion of that could be considered capital to support the general operation of the company and which can be levered without additional investment to support expanding operations. That then leaves a figure of $2.3 billion supporting current vehicle production capacity of 100,000 vehicles a year.
Based on those metrics, expanding production to 500,000 vehicles a year could require additional capital spending of close to $9 billion - not my current assumption of $5 billion in 2017 and 2018. The interpolated $2.3 billion number is also in line with the asset turnover ratios of much larger and long-established auto manufacturers including Ford (NYSE:F), GM (NYSE:GM), Toyota (NYSE:TM), Nissan (OTCPK:NSANY), Volkswagen (OTCPK:VLKAY), and BMW (BAMXY) which are below (links are to source financial statements):
For clarification, I'm using a ratio of sales to gross fixed assets as the original value of fixed assets invested, which are still in place until either fully depreciated or written off, as a more representative figure for assessing the productivity of assets in place. Tesla's future capital needs may actually be somewhat under estimated using such ratios as Tesla's current capital investments are in today's dollars where capital bases in place at the auto manufacturers probably cost less than current prices for the same equipment.
I'm also assuming a bit of a capital efficiency "discount" in the ratio for Tesla relative to the much larger major auto manufacturers as those companies operations are long established, stable, and a lot more efficient. Some might note the apparently much more efficient capital ratios of both Ford and GM relative to the rest of the companies listed and to my ratio assumptions for Tesla. GM's ratio is skewed by having written off a large portion of the their assets during their bankruptcy and Ford also did the same while it worked its way through the financial crisis but a lot of the assets written off by both companies are still probably in place and being used.
An additional clarification and assumption is that given Tesla's aggressive growth plans and the recent debacle of the prematurely introduced Model X, I'm also assuming that Tesla will need additional capital investments in place at the end of each year to support the following year's revenue growth plans. Once sales growth is more stable, the ratios calculated from such an assumption will essentially be the same as a ratio of average fixed assets in place during the year as asset growth will be lower at that point.
You can see the asset turnover ratios that I use to support my Tesla capital spending assumptions as they are in the ratio section below my financial model. That ratio was 1.9 for Tesla in 2015 but that was also a year where Tesla probably didn't invest enough in capital equipment given the botched launch of the Model X. With the already announced capital spending plan for 2016 of $2.2 billion, my model projects that ratio to be 1.4 in 2016 and so that shows how the ratio can decrease to show lower capital efficiency given Tesla's aggressive growth plans.
With projecting $5 billion of additional capital spending in 2017 and 2018, my model projects the revenues to fixed assets ratio to show positive operating leverage by increasing to 1.6 in 2018. That is actually somewhat counterintuitive as the projected capital spending will also mainly be to support a new vehicle, which will generate less than 50 percent of the revenue per vehicle than the two vehicles that are currently being produced. Another probably underappreciated additional source of capital spending will be to significantly expand Tesla's Service Centers locations and capacity to support a mass-market oriented vehicle that is planned to increase total vehicles sold by a factor of at least three-times cumulative sales by when the Model 3 is introduced.
There is also a very significant item that is included in my overall capital spending projections of $2.5 billion per year in 2017 and 2018 that is in addition to my assumptions for capital spending for the Fremont plant of $1.8 billion for each of those years. My assumptions include $700 million a year in 2017 and 2018 for additional investment in the Gigafactory.
Additional Gigafactory investments would lower the asset turnover ratios given the greater degree of vertical integration. Without the portion of capital spending assumed for the Gigafactory, the projected capital spending for Fremont and all other operations (sales and services centers, supercharger expansions, etc.) is $1.8 billion in 2017 and 2018 that I've already mentioned above. Those figures would also result in asset turnover ratios that are closer to the asset turnover ratio for BMW in the table and so I feel very comfortable that such assumptions are reasonable. I also believe that my projections could be on the low side as the assumptions in my current model may be underestimating the investment needed in both sales and service centers and for further supercharger network expansions.
Other than my capital spending assumptions, I don't think there are many other items that could be considered controversial in my financial model. Gross Margins are anybody's guess at this point with how much they change on a quarterly basis but I also don't think it is reasonable to assume that they will increase when the Model 3 is introduced as its unit revenues will only be around 40 percent of the current average unit revenues.
My model's projected increases in R & D and S,G & A expenses may appear very large in absolute dollars but the model does actually assume continually increasing positive operating leverage from those two categories. My projections for 2020 have them being less than 27 percent of revenues as compared with them being 40 percent of revenues in 2015 and projecting them to be 43 percent of revenues in 2016 (although they were 48 percent of revenues in Q1 2016). Other assumptions in the model, particularly for balance sheet items such as working capital and the company's leased vehicle portfolio, are effectively driven by overall sales increases and so I'm not making any judgmental assumptions about how such things affect the projected cash flows.
The projected revenue growth is based on my unit delivery assumptions, which are as follows:
The difference between the projected revenues in my unit delivery spreadsheet and the overall model's projected revenues is that my model uses GAAP numbers. All cash flow adjustments between GAAP and non-GAAP numbers are accurately included in the cash flow section of my model, however, including assumptions for stock-based compensation.
Based on the projections in my model, Tesla will need $5 billion in direct external financing between now and the end of 2019 and an additional $8 billion in indirect external support from vehicle financing and leasing partners. That is why I strongly object to any comments from the company that they will soon be cash flow positive. You may also note that my model does not show that the company "goes broke" by running out of cash to support its operations as I have each year ending with $1 billion in cash.
The critical issue if my model is reasonably accurate, is what are the risks that such capital will be available and at what cost. Tesla's debt interest rates could spike to junk levels of eight to ten percent if the SolarCity acquisition is approved and such negative assumptions are not currently in my model. My model also doesn't include any assumption that future equity offerings will occur as I have no way of predicting future stock prices at points when it would be prudent to raise additional equity instead of funding the $5 billion I describe with almost all debt (the line item in my model for "Capital Stock Issued" is all from stock options being exercised).
If there is any speculation that I am writing this to support my short position (which I am required to disclose by Seeking Alpha), there is actually a much more significant reason for me personally as to why I believe that investors need to be more aware of Tesla's financial dynamics instead of just blindly buying into the mission of Tesla to revolutionize vehicle transportation.
The significant reason for me is that I have interacted with thousands of company CEOs during my 20-year professional investment career, listened to probably over 5,000 earnings conference calls, seen the communications programs of at least 3,000 public companies, and I have never seen anything like what I believe is the manipulative sleight of hand and spin control that is behind everything the company both does and communicates. Effectively, what we are seeing with Tesla is a high level game of Three-card Monte where the shill is spreading all the hype and manipulative selective disclosures, the dealer is collecting all the money, and all the players may end up losing all their money.
As a growth-oriented investor, I actually started looking at Tesla as a potential long. When my original financial model indicated that the company was going to burn huge amounts of cash for at least four years, I then started to look at other factors that could still persuade me to feel positively about the company's potential.
Instead, I heard a lot of rambling mumblings on conference calls that evaded most questions, saw a lot of manipulative "announcements" from either Musk or the company (most of which are never fulfilled anyway!), and saw silly stuff on the order page where projected gas savings are deducted to show a "Cost After Projected Savings" number as the most prominent number on the page instead of the actual purchase price. Reading through the financial statements and notes in Tesla's 10-K also raised a significant number of concerns about the overall financial reporting and the amount of detail given in the notes.
From all these factors, I had far too many concerns to ever consider the stock as a long but also felt that there really wasn't a lot of awareness about the company's actual financial dynamics. As such, that is primary reason for including my current financial model in this article.
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.