I published an article yesterday about the increasing trends in Tesla (NASDAQ: TSLA) RVG percentages, but there were comments that suggested that I didn't understand either the accounting for the Deferred Revenue and RVG accounts or how the two accounts would behave over time in relation to each other. While I am open-minded and always open to learning new things, I'm also usually very thorough in how I analyze company financial statements (as I've analyzed thousands of companies over a 20-year professional investment management career), and also already had some other supporting analytical spreadsheets that confirmed my assumptions, but which were too large to include in the original article.
I've now reformatted the main spreadsheet testing my hypothesis to fit in the width of an SA web page so you can see more detail behind my assumptions. The spreadsheet analyzes how the Deferred Revenue and RVG accounts will behave in relationship to each other over a 20-quarter period. The reason that the initial spreadsheet shown in yesterday's article only showed six quarters is that it is very notable that Tesla, which is supposedly only using RVG percentages of 50 percent, could go from an RVG percentage of total Deferred Revenue and RVG balances of 50 percent six quarters ago to 64 percent by the end of Q1.
Since Tesla does not give any detailed information about its bank financing and leasing activities for new vehicles, including quarterly originations data for both categories, which would be very helpful, I had to assume hypothetical numbers in the spreadsheet to test how the relationship between the Deferred Revenue and RVG balances would behave over time in relation to each other. The hypothetical numbers assume a beginning quarterly "originations" number of 10,000 and then increase by 1,000 each quarter throughout the 20-quarter modeling period.
The originations number and assumed RVG percentages each quarter then results in a quarterly Deferred Revenue "amortization" amount for each subsequent quarter (that amount is also recognized as revenue during each period over the 12-quarter amortization period), which is then subtracted from the previous quarter's Deferred Revenue balance. As such, the ongoing Deferred Revenue balances are a net number, which is the sum of the previous quarter's balance plus the current quarter's Deferred Revenues portion of the originations minus the current quarter's Deferred Revenue amortization.
Since the stated RVG period is 36 months (12 quarters), the RVG balances are an accumulating gross number until, in quarter 13, the ongoing balances then begin to subtract the RVG allocation from 12 quarters earlier, as that is now the end of the RVG period for originations made in quarter 1. At that point, any differences between the static RVG balance that has been on the balance for 12 quarters and the actual value of a vehicle at the end of the RVG period would be reconciled as a gain or loss on the income statement.
Hopefully, all of this will be clear in the following spreadsheet:
As you will see in the spreadsheet, the RVG percentage does continually increase over a 12-quarter period by one percent each quarter, and reaches 62 percent of the total balance of Deferred Revenues and RVG by the end of that period. At that point, however, if the RVG percentage for each subsequent quarter's originations stays the same, then there will be no further increases in the RVG percentages.
As such, a general comment made about the original article that the Deferred Revenue balances, which amortize over time, would decrease in size relative the RVG balances which stay fixed over a 36-month RVG period is theoretically correct. That sort of math someone can easily do in their head, but what they can't do in their head is to thoroughly understand the dynamics of how small changes in the numbers can have significant effects on the overall percentages.
Before I even analyzed the numbers, I could also do in my head that a 50 percent RVG percentage with a three-year guarantee period would ultimately reach 62 percent after 12 quarters and then stay at that level. As I showed in my first spreadsheet in yesterday's article, however, the RVG percentage changed from 50 percent to 64 percent in just six quarters - which is a lot different than changing only one percent a quarter over 12 quarters - and that is what attracted my attention that RVG percentages must be increasing.
The next spreadsheet shows how much the RVG percentages have to be increasing on a quarterly basis to go from 50 percent to 64 percent in six quarters:
As you can see, to reach the actual end of Q1 RVG percentages relative to total Deferred Revenue and RVG balances, RVG percentages for each quarter's originations would have increased by between two and four percent each quarter to reach the 65 percent figure you see in the "RVG %" column in quarter six (almost 70 percent, using Muskian precision!).
I hope the additional detail will enable greater understanding about how the percentages are actually working in the relationship between ongoing Deferred Revenue and RVG balances as an indicator of the direction and magnitude of underlying RVG percentages in Tesla bank loan and leasing contracts. As with everything about the company's reported financial statements and notes, this is yet another area of mystery, where current disclosures are completely inadequate and mask the underlying reality that potentially high RVG percentages are being used in loan and leasing contracts.
Since everyone has an opinion about things, I'll let others decide if they are comfortable with assuming that a three-year old Tesla will be worth 65 percent of its original value. If not, there will be a lot of cash payments in the future to reimburse banks and owners if vehicles have a lower value than the RVG percentages in each contract.
For example, for a vehicle with a price of $100,000, but where there is a 65 percent RVG agreement, the initial accounting will allocate $35,000 to deferred revenues (to be recognized over three years) and $65,000 to the RVG account. If the vehicle is only worth $50,000 after three years, there will then be a $15,000 payment due to the holder of the RVG agreement and a $15,000 loss to be booked to the income statement.
Net of the $15,000 payment, Tesla actually only received $85,000 for that vehicle. That will also have the result of having artificially increased the reported gross margin over that three-year period for the original delivery of the vehicle, since the original sale would have been booked with an assumed price of $100,000 relative to the vehicle's original cost of $75,000 (an assumption using current gross margins). The lower revenues and margin for the vehicle will ultimately be recognized on the gross margin line on a delayed basis in periodic income statements when the adjustments are made, as the value adjustments are actually booked to Cost of Automotive Revenues when RVG adjustments are booked.
Another side of all of this may be seen in Tesla's very volatile income statement, where expense percentages can have significant changes from quarter to quarter (and not just from all those GAAP requirements, apparently!). Although the adjustments described above are booked in Cost of Automotive Revenues, they are definitely not matched to the original revenue event which began three years earlier.
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.