Back in November 2015, I wrote a bearish article on Tesla (NASDAQ:TSLA) mentioning my worries about the burn rate and the aggressive valuation. At the publication date, the stock was trading at around $200. With approximately 131 million shares outstanding, the market capitalization was equal to $26 billion. Following the acquisition of SolarCity, I am more bearish than ever on Tesla.
Before going any further, I want to mention that I am an undergraduate student, not a financial advisor. This is not a recommendation to buy or sell the stock. It is only my own opinion based on my own and independent analysis. I reserve the right to be wrong.
More than a year later, the stock is trading at around $210 carrying a market capitalization of $34 billion based on 161 million shares outstanding. The share price increased by 5% and the market capitalization by 31%, thanks to the secondary offerings needed to finance the aggressive growth plan.
Tesla is relying on its inflated share price to finance its capital expenditures. It is pretty easy to raise $1 billion when the market capitalization is around $30 billion. It is two times more dilutive to raise the same amount with a market capitalization of $15 billion. In other words, any meaningful decline in the share price could threaten the viability and the solvency of the company.
Without its inflated share price, the debt market would be the only solution. The history showed that it is extremely dangerous for a company burning billions every year to issue debt. Matching the fixed payments of interest and principal with the uncertain timing of future cash flow is a dangerous cocktail.
On a market capitalization basis, Tesla is trading at an all-time high due to multiple stock offerings. In my opinion, the stock is vulnerable to a significant re-rating by market participants and shorting the stock at the current level looks like an asymmetric opportunity on the downside. The following graph shows that the shareholders are starting to feel the pain of these multiple offerings.
Investors can argue that an all-time high market capitalization can be justified by the profitability and the free cash flow generated by the firm during the third quarter. Indeed, it was one of the few profitable quarters in the history of the firm.
With record quarterly production and deliveries, Tesla achieved GAAP profitability and generated positive free cash flow in Q3 2016, while remaining on track with Model 3 and Gigafactory development.
However, I am extremely skeptical on the durability of this assumed profitability. With the acquisition of SolarCity, the next quarters are likely to be characterized by negative earnings. Moreover, the street is expecting an increase in capex over the next few quarter as the Model 3 production is ramping up.
During the third quarter, Tesla generated $424 million in operating cash flow versus an investing cash flow of $268 million. Theoretically, Tesla was actually free cash flow positive. However, any company is able to be cash flow positive if it stops paying its bills.
The accounts payable jumped by 44.1% and the accrued liabilities by 24.5%. Over the past six quarters, these accounts on the balance sheet increased slowly in line with the increasing working capital requirement. Tesla unveiled its Q3 results on November 2, 2016, and the vote for the acquisition of SolarCity took place on November 17, 2016. Did Tesla delay the payment to its suppliers to paint a better picture of the company before the vote? I don't know, but I think that the operating cash flow figure does not reflect the current reality.
According to Bloomberg, Elon Musk asked workers to cut costs and step up deliveries to impress investors. Here is an interesting quote from Elon Musk:
We will be in a far better position to convince potential investors to bet on us if the headline is not 'Tesla Loses Money Again,' but rather 'Tesla Defies All Expectations And Achieves Profitability.'
In my opinion, it confirms somewhat my thesis that the big jump in accounts payable and accrued liabilities is not sustainable and is a one-time event. At one time, any supplier must be paid.
In my mind, if we remove the adjustment for the variation of the accounts payable and accrued liabilities from the operating cash flow, it is possible to get a better picture of the ability to generate real and sustainable cash flow.
Without a doubt, the situation is better now than it was in the past few quarters. However, I think it is not accurate to claim that Tesla is now free cash flow positive. If we combine the investing cash flow with the operating cash flow, it is possible to conclude that Tesla will certainly need to issue more share or debt in the near future.
If we add the burn rate of SolarCity, the picture starts to be extremely worrying. Over the past four quarters, SolarCity burned $2.5 billion.
Together, Tesla and SolarCity burned $4.3 billion over the past four quarters. In the future, I think it is reasonable to assume a burn rate of a minimum of $500 million per quarter. Issuing shares is dilutive for shareholders, but it does not increase the risk of default. On the other hand, issuing debt is clearly more dangerous for a company burning a ton of cash. Indeed, it is not possible to go bankrupt if you don't have any debt. Because I am bearish, I would like to see Tesla issuing debt instead of shares. It would add pressure on the financials and worry many market participants.
The debt load is the next chapter of the story. It is clear to everyone that Tesla was more dependent on share offering than debt offering. However, it is the opposite with SolarCity.
I want to mention that these two graphs take only into account the long-term debt figure and excludes any other type of liabilities. Consequently, it is not representative of the total leverage of both firms.
On October 9, Elon Musk published a tweet mentioning that it will not be necessary to issue debt or share during the fourth quarter.
However, Tesla increased its borrowing capacity under two credit agreements by about $500 million in December. Considering my bearish thesis, I am pleased to see Tesla taking more and more debt. An increasing debt load is an important part of the puzzle. I am also concerned about the forecasting ability of Elon Musk. Two months after saying that no debt or equity offering will be needed in Q4, Tesla increased its borrowing capacity by $500 million. I agree, it is not a debt offering. However, it is playing on words at this point.
The following quote from Elon Musk in February 2012 is also interesting:
Tesla does not need to ever raise another funding round.
Ironically, Musk raised around $6 billion in five different offerings after February 2012. It is also worth mentioning that many people in executive positions left the company over the past year.
So, we have an all-time high valuation based on the market capitalization, we have an entity burning more cash than ever with the acquisition of SolarCity and we have an increasing debt load.
It is also important to mention the increasing competition in the electric car industry. Elon Musk himself is well-aware of this.
[...] but given the success of Model S and Model X, the overwhelming interest in Model 3, and the fact that other car companies are finally starting electric vehicle programs of their own, no one should doubt that anymore.
Many well-established car manufacturers are investing massively in this industry which means pressure on price and ultimately lower profit margin.
The mean reversion attribute of profit margin in any competitive industry is a variable to take into account in my opinion. Many competitors are largely profitable and well-capitalized versus Tesla. In other words, they are not relying on share or debt issuance to finance their research and development program.
Elon Musk himself is not able to forecast one quarter ahead the number of deliveries, so I doubt that anybody on this planet is able to forecast the number of sales in 2020 or 2025. However, the ability of the research firm Cairn ERA is certainly better than mine.
According to the research firm Cairn ERA, Tesla is expected to sell around 55,000 Model Ss and around 200,000 Model 3s in 2020. I did not find any forecast for the Model X, but let's assume that it is the same number than the Model S. I think that my hypothesis is overly optimistic considering the probable cannibalization between these two vehicles.
Tesla delivered 24,500 vehicles in the third quarter and Cairn ERA is expecting 310,000 vehicles sold in 2020 considering my presumption of 55,000 Model Xs. Did I talk about the huge cash infusion needed for working capital purpose?
For now, let's assume that Tesla will achieve without any problem this production level which I doubt strongly.
The net profit margin of well-established car manufacturers is equal to around 5% on average. This number is based on the results of Toyota (NYSE:TM), General Motors (NYSE:GM), Ford (NYSE:F) and Fiat Chrysler (NYSE:FCAU).
Again, let's be overly optimistic and assume that the net profit margin of Tesla will be equal to 10% in 2020 which I doubt strongly.
Tesla is not profitable and the average selling price is currently around $135,000. Let's assume that the profit margin will be equal to 10% when the majority of the sales will come from cars with a selling price of $35,000. Losing money by selling $135,000 cars and trying to make it up on volume by selling $35,000 cars. Here is the strategy.
With total revenue of $21.85 billion and a net profit margin of 10%, it is possible to assume a net income of $2.18 billion and a P/E multiple of 15.85 which is well-above the comparables.
There are two important assumptions behind this simple calculation. The first one is that Tesla will be able to produce enough vehicles. The second one is that Tesla will be more profitable than well-established car manufacturers. The second hypothesis is extremely unlikely in my mind. With 400,000 units sold, the net income would be around $2.89 billion with a P/E multiple of 12x. With 600,000 units sold, the P/E multiple is in line with peers at 9.66x.
The only aspect that might be constraining for the short sellers is the already high short interest. It might be hard and costly to borrow shares. The other solution is to buy puts which is much more risky in my mind.
In conclusion, Tesla has horrible financial results and huge losses in times when the firm faces no direct competition. Is it logical to assume above normal profitability in times of massive competition? It does not make sense in my mind. My thesis is that the all-time high valuation is not justified considering the higher than ever burn rate, the rapidly increasing debt load and the fierce competition arriving on the market. I understand that Tesla is like a religion or a cult and Elon Musk is literally a guru for many shareholders. I just want to mention that it is nothing personal. I just do not believe in the story. Many opinions are needed to create a market and I respect both side.
The question is what will be the next thing Elon will unveil to distract people from the cash flow figure?
Tesla will be out of business before producing anything near its target of 1 million cars in 2020. My price target on Tesla is $0. If we forecast an increasing debt load, the stock is probably worth even less than $0. In other words, the debt will be worth more than the equity in my opinion.
The good old days of Tesla back in December 2011. Another promise, another deception.
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