Tesla (NASDAQ:TSLA) q4 2016 earnings call was the one for the ages. In this article we highlight a few salient notes from the call and share our view of the reality behind the commentary.
The Great CFO Mystery:
The call started with CEO Elon Musk announcing that CFO Jason Wheeler has chosen to leave the Company to pursue public policy after about 15 months on the job and Tesla's Ex-CFO Deepak Ahuja will be back at the helm. When asked to comment on the event Wheeler said:
"It's been a great ride and I'm really going to miss working with all the wonderful people at Tesla. This is an A team and when I walked in the door, I was very passionate about the mission of the company. And today, I'm even more passionate than I was on the day I walked in. And I think it's also important to say, that I'm looking to scratch an itch that I've had for many, many years now. I'm going to go do something in the public sector, but I wouldn't have felt comfortable about leaving if we didn't have a really good plug-and-play solution in place for the company. And I think with Deepak's history here, on the verge of bankruptcy and everything that he's gone through, he's well positioned to -"
It was very strange that Wheeler thought appropriate to mention "bankruptcy" in introducing the new/old CFO. As a sign of alertness, Musk cut Wheeler mid-sentence to say "A long time ago.".
In a subsequent 8-k filing, the Company communicated that Jason Wheeler gave the notice on 21st, i.e. a day before the earnings call. It is quite strange that the new/old CFO was on board within a day.
As far as alacrity in getting Deepak Ahuja on board goes, we suspect that Tesla needed someone intimately familiar with Tesla financials to be able to rapidly conduct a capital raise. With the Company burning through precious cash at, a new CFO who takes time to understand Tesla's business was likely not an option.
Tesla made it clear that it needs a capital raise to de-risk the company. The Company outlined many cash preservation techniques the it has undertaken to reduce the cash burn. In spite of that, capex is a reality of auto manufacturing business. More specifically, Wheeler indicated that Tesla needs to spend 2 to 2.5 billion of Capex between now and Model 3 ramp and the cash position is cutting a bit too close.
We seriously doubt that Tesla can raise much capital in the form of debt as it appears to have used up much of the debt capacity under ABLs and given that most auto manufacturing assets too unwieldy to be lienable. That makes it likely that Tesla is likely to resort mainly to equity or convertible debt. A delay in capital raise can materially impact the Company's Model 3 plans.
The key concern in this context is if there is anything precluding Tesla from being able to do an equity raise.
Insurance: Another Sinkhole?
A fascinating revelation in the call was that Tesla has a vision to offer, and is already offering in Asia, bundled maintenance and insurance services tailored for Tesla products through third party partners. Apparently, a majority of Tesla's Asian sales go with bundled insurance. Given Tesla's history of weak cost controls and accounting, which we have also seen at SolarCity, we suspect that this venture, while cash additive in the short term, will end up being a disaster and a cash sinkhole for Tesla.
AP2 Parity With AP1 By Next Month
Mr. Musk revealed for the first time that Tesla planned to do a dual Mobileye/Tesla Vision program together for AP 2.0. However, Mobileye pulled the plug and Tesla had to go on its own. As such we were skeptical of this effort when it was first unveiled.
Due to AP 2.0 teething problems, Tesla was unable to recognize revenues for AP 2.0 in the December quarter. Musk cited that as the reason for the AP 2.0 delays and said that AP2 will reach parity with AP1 by next month. Based on this premise, Tesla expects to realize these revenues for both Q4 2016 and Q1 2017 AP revenues in the current quarter.
However, customer feedback to date indicates that the technology is currently highly immature and not road worthy. Even the most recent release from earlier this week has been attracting critical comments from Tesla customers. Barring marked improvement before the end of the quarter, revenue recognition for this feature would be highly questionable.
What is worse, Tesla may start seeing its sales taking a hit as this type of news increasingly reaches more widely read media outlets.
Model 3 Cost Reductions
When it came to Model 3, Mr. Musk mentioned that he expects the car to have horrendous gross margins at the beginning of the ramp but reach gross margin level comparable to Model S and X by the time Model 3 ramps to 5000 units per week.
To buttress the argument, Mr. Musk cited that Model 3 has several cost reductions. For example, the Model 3 only has one screen, whereas the Model S and Model X have two screens, and two separate computers powering each screen. The Model 3 has 1.5 kilometers of wiring. The Model S has three kilometers of wiring. Model 3 does not have bells and whistles such as self-presenting door handles, or falcon-wing doors.
We can also expect Tesla to get better pricing for Model 3 than Model S or X due to expectations of much higher volumes. However, despite these differences, it is difficult to see dramatic cost reductions to support an ASP compression of over 50% (about $90k+ ASP for S/X compared to the touted $35K entry level Model 3 or even a more goosed up $45K Model 3). Except at much higher ASP than $45K ASP, it is difficult to see Model 3 having positive gross margins, let alone gross margins comparable to Model S and Model X.
Whack-a-mole Model 3 Ramp
Tesla indicates that it produced first initial prototypes of Model 3 this month. For Tesla to be even attempting to get to production within this year is a very high risk gambit on the management part. There is no successful precedent for selling volume modern cars within months of the product reaching prototype stage.
In describing Model 3 ramp challenges, Mr. Musk noted that new issues pop up every week on Model 3 and Tesla tries to anticipate the challenges but at times problems pop up somewhere else - like a whack-a-mole. Mr. Musk used this reason along with a rapid manufacturing ramp as reasons why 2017 Model 3 production is difficult to forecast but why forecasting will be easier in 2018.
In spite of this whack-a-mole, Mr. Musk indicated that Tesla has informed its suppliers that it needs them to supply 1,000 kits a week in July, 2,000 kits a week in August, and 4,000 kits a week in September. In spite of the lag from parts procurement to vehicle build completion, Mr. Musk said he was confident that Tesla would reach a production rate of 5,000 units per week by the end of 2017. Assuming a one month lag between parts supply and production, this would imply a revised best case guidance of about 50K units.
One of the intriguing discussions about Model 3 constraints was the discussion about lack of parking for employees. As Elon's thought process goes, to not increase the head count and to keep the Capex lean, Tesla needs to increase the speed of the production lines. While sounding attractive in theory, we suspect this is fraught with risk is more likely to backfire than not. Quality problems, safety issues, and equipment failures being the key concerns.
With $2B to $2.5B of Capex still to be spent PRIOR to Model 3 production, it is highly dubious that the Company is forecasting production in the August/September time frame (assuming a one to two month offset from parts order)
It is interesting to note that Tesla has delayed the production Model 3 unveiling to July/August time frame from the earlier expectation of March unveiling. While a case can be made that the unveiling is being delayed so as Model 3 features will not stunt Model S growth, we find such an argument questionable. By delaying the unveiling to Q3, we believe, Tesla is essentially saying the car is not even ready to be shown outside of the Company prior to the new July date. This is likely indicative of the product not completely "pencils down" and the product is still likely in need of some final refinements. If true, even a H1 2018 product ramp starts becoming questionable.
Considering all the data points above, any cars that Tesla produces in 2017 are almost certain to be beta cars. Could Tesla sell these prototype cars to its investors and employees and claim production? While we can never put such a thing past Tesla as evidenced by Model X introduction and AP 2.0 release, making its own employees paying guinea pigs likely indicates a stoop to a new lower level and sets a terrible precedent.
What does this mean?
It means that there will certainly be no volume shipments of any kind of Model 3 in 2017 except to beta testing employees and investors.
It should be noted that no competent analyst believed Musk when he guided 100k-200K Model 3 units for 2017. Nevertheless, the incredulity of such a claim would not stop Musk from making such a claim. Mr. Musk, instead of coming up clean this time, has chosen to resort to the similar hyperbole yet again. Why does Mr. Musk want to keep this charade going? Why would Tesla management not acknowledge the vehicle is not production ready?
We suspect there are several reasons including:
- Because communicating the likely Model 3 production ramp story would kill the Tesla growth story for 2017 immediately.
- Keeping the story alive helps the capital raise
- Keeping Model 3 production a quarter or two away will also help reduce the reservation defections as competitive models come to market.
- The hopium of Model 3 also means Mr. Musk can talk about production S curves and not have to provide specific guidance for the year.
All things considered, we expect:
- The capital raise could have been delayed a bit due to the new CFO.
- We do not expect Tesla to have a production worthy Model 3 in 2017.
- Any Tesla Model 3s sold this year are likely to create innumerable problems and create unprecedented service center delays as early owners help with the relatively high volume beta testing process.
- Tesla employees are likely to become a rare breed of paying beta testing employees but even here the shipments for the year are likely to be far less than the planned 50K unit best case numbers.
Our View: Sell Short
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.