Tesla: Residual Value Guarantees (On Leased Vehicles) Did Not End In July

| About: Tesla Motors (TSLA)

Summary

A recent article is incorrect that the Tesla RVG issue is going away.

The article does not discuss the differences between Resale Value Guarantees for purchases and Residual Value Guarantees for leases.

The article doesn’t mention that GAAP and non-GAAP reporting differences do not affect cash flows.

Introduction

An amusing part of anything to do with Tesla (NASDAQ: TSLA) is the continual back and forth between "Tesla Bulls" and "Tesla Bears" about supposed positives and negatives that will affect both the company and the ongoing price of its stock. In many cases both sides are grasping at straws without complete or accurate knowledge of actual details or reality.

The company itself doesn't help with any of this with its typically dissembling and manipulative approach to communications. Recent examples of the company's sleight of hand communications efforts include describing the owner of a Tesla whose front control arm failed as "living down a long dirt road" (he didn't!), that the "high ride height" of a trailer and a "brightly lit sky" were the reasons that Autopilot didn't see a tractor trailer in the path of a Tesla vehicle (and apparently mistook an object only four feet off the ground as an overhead sign), and Musk's ongoing strange comments that a company which will need $2.8 billion in external financing in 2016 is "cash flow positive."

There also was an article in Clean Technica this week about the differences between Tesla's GAAP and non-GAAP accounting that illustrates there is only minimal understanding of very important and significant details of Tesla's operations and financial reporting.

The article includes some details about how some Tesla accounting entries are being made but the conclusion of the overall article is incorrect as it states that Resale Value Guarantees will no longer affect Tesla's reported results beginning in Q3. The only element that is correct is that Tesla stopped offering the Resale Value Guarantees for new vehicle purchases at the beginning of July. Since the Resale Value Guarantees have a three-year term, the financial reporting effects and any potential contingent liabilities from the guarantees will continue to flow through Tesla financial statements through Q2 2019.

The article also doesn't differentiate or describe that a different program with external leasing partners, which contain provisions that in the leasing business are called Residual Value Guarantees (contingent liabilities potentially payable to external leasing partners) are different from Resale Value Guarantees.

GAAP and non-GAAP differences do not affect cash flow

The article also makes no mention at all that the differences between GAAP and non-GAAP reporting do not affect the cash flow statement. The cash flow statement clearly shows how much cash Tesla is consuming which I project to be $2.8 billion in 2016 and then another $4.5 billion in 2017 and 2018. Tesla's external financing requirements also were thoroughly described in this article which was published on July 8.

For readers less familiar with Tesla's accounting and financial reporting, the company does receive the full purchase price of each vehicle in cash at the time of delivery regardless of whether deliveries are financed by bank lending partners or external leasing partners. As such, Tesla's reported cash flows are completely accurate and NOT understated. Maybe Musk doesn't understand accounting or financial reporting either, however, given his garbled gibberish about GAAP and non-GAAP reporting on conference calls. Musk's comments seem to imply that there is some pot of gold at the end of the rainbow to be collected when GAAP finally allows the full revenues from a financed or leased vehicle to be reported.

The article's breezy tone which asserts that the Resale Value Guarantees which result in differences between GAAP and non-GAAP reporting are the only remaining significant issue for nefarious short sellers also is completely misplaced given that the article does not differentiate or discuss the differences between Resale Value Guarantees which are no longer being offered and Residual Value Guarantees which will continue to be required by Tesla's external leasing partners. Such an assertion also ignores many other Tesla accounting or financial reporting and disclosure issues that have been described by many other articles. There's also no mentioning that TSLA cash flows will still be hugely negative through the end of 2018 with the spending ramp to support the Model 3 introduction also shows that the article has no insight at all about Tesla's overall financial characteristics.

Differences between a "Resale Value Guarantee" and a "Residual Value Guarantee"

The critical fact and topic in this overall issue is that there are significant differences between a "Resale Value Guarantee" to a customer buying a car financed with a bank loan and a "Residual Value Guarantee" to an external leasing partner who buys the vehicle and leases it to a customer.

The Residual Value Guarantees will continue in all of the transactions made with external leasing partners. Since an external leasing partner would probably require even more comfort that the future value of the car will not result in a loss for the leasing partner, the Residual Value Guarantees also probably guaranteed a higher percentage value than did the Resale Value Guarantees. Vehicle deliveries through external leasing partners also are growing at a more rapid rate than through bank lending partners and so the contingent liability Residual Value Guarantees potentially payable to external leasing partners are definitely not going away.

The article's statement that when Q3 2016 is reported that "all of this is behind Tesla" also is completely incorrect given that the Resale Value Guarantees have a three-year term. As such, given that Resale Value Guarantees were still being offered through the end of Q2 2016, the possible contingent liabilities from these guarantees will still flow through Tesla's financial statements until the end of Q2 2019.

The article's claim that the guarantees will no longer affect future financial reporting is only limited to future deliveries on vehicles financed with bank loans. All of the earlier transactions where there was a Resale Value Guarantee previously offered to a customer purchaser of a vehicle prior to the very quiet ending of the program in July (no Tweets or blog posts about ending the program Elon?) are still in place.

The "long tail" of three previous years of Resale Value Guarantees will still flow through the Tesla financial statements through the end of the second quarter in 2019. Any differences between the Resale Value Guarantee amounts and vehicle values less than that amount will have to be paid as settlements to the vehicle owners.

Other costs of vehicle financing programs

The article also does not mention that there are other typical provisions in external financing arrangements between a vendor (Tesla) and a financial institution willing to provide customer financing for a customer purchasing a vendor's product.

All such arrangements usually have commitment fees, standby fees, floorplanning charges, interest rate subsidies, etc., which will add to Tesla's expenses. Depending on the relationship with external lending partners, such additional costs could add up to between one and three percent of each vehicle financed. In absolute dollars the cost of such financing programs may not seem like much given Tesla's overall cash burn but with roughly one-third of deliveries financed through banks, the current costs could be between $50 million and $75 million per year.

Given Tesla's overall accounting, such financing costs, which are actually a cost associated with each sale in my opinion and which should be included in cost of sales (which would then affect reported gross margins), it is anybody's guess where Tesla will put such costs. With the already very high level of SG&A expenses, the financing programs costs will probably be buried in that expense category which will also provide no visibility into the costs to Tesla for ensuring that such financing programs are available for prospective buyers of Tesla vehicles.

Conclusion: No, the "RVG" issue is not going away…

As I've described, the overall RVG issue is not going away. The bank lending partner portion of the RVG (the Resale Value Guarantee) will continue to flow through Tesla financial statements for the next three years. The external leasing partner portion of the RVG (the Residual Value Guarantee) will also probably be a permanent part of the Tesla's financial statements for a long-time given that leasing transactions are the most rapidly growing transaction in delivering Tesla vehicles.

I have my own speculation as to why the Resale Value Guarantee was ended which was that bank lending partners probably starting asking Tesla to fund segregated accounts for some portion of the guarantee amount. The leasing partners are probably already doing that but such details are not disclosed by Tesla.

Any hopes by bulls that differences between Tesla's GAAP and non-GAAP financial reporting will "go away" and stop providing more blueberries for those hungry bears are false hopes. Tesla also does not help itself with any of these issues given all of the things the company does which push the envelope with their financial reporting and other disclosures. All such things also make me very eager to see the combined Solar City and Tesla financial statements which will provide for all sorts of amusing commentary for many years in the future!

Disclosure: I am/we are short TSLA.

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