Tesla Will Face A Cash Crunch Without A Capital Raise In The Next 90 Days
- Tesla's about face on Model 3 will have severe consequences.
- Tesla is facing a cash and credit crunch within the next 90 days.
- We expect a capital raise to be difficult and expect the stock to plummet.
Tesla's (NASDAQ:TSLA) Q3 conference call was surreal and one for the ages. There is so much ground to cover that it is tough to summarize the meeting in a single article. Instead of covering all that is wrong with Tesla, we will focus on a single item – Tesla’s need for cash.
Tesla’s narrative is that it does not need further cash to ramp Model 3. The company, in its Q3 release says:
“Between cash on hand, future cash flows and available lines of credit, we believe that we are well capitalized to accommodate the revised ramp of Model 3 production to 5,000 per week.”
While the management denied the need to raise cash soon, the company has been perennially wrong in forecasting its cash needs. We believe, as we demonstrate below, the reality couldn’t be further from the truth.
Let us start with a review of the business with the P&L (image below).
There are several key items to note in this context:
- The ongoing deterioration of gross margins is alarming. Tesla is now claiming 18% gross margins as opposed to a corporate goal of 30%-plus gross margins.
- However, even the 18% gross margin number is not credible. The reality is that, by offering high and unsustainable resale value guarantees, the company is claiming high gross margins. But such tactics go only so far. The company has to give back these gross margins when the older cars come back to Tesla for resale. Tesla includes these costs in the service business. Note that the losses in service business have increased greatly over time. In Q3, the service business gross margin was negative 20%. Adjusting for the service business, Tesla gross margin dips below 15%.
- We have repeatedly pointed to the heavy discounting that Tesla uses to move to the right on the demand curve and the impact of that shift is evident. Note that in spite of a 18% jump in units from about 22K in Q2 to 26K in Q3, revenues have hardly budged. In other words, the company needed to collapse the ASPs by nearly 18% to maintain the growth narrative.
- While some of the ASP decline was due to change in mix toward the lower end 75 kWh mode, discounting during the quarter to drive sales has truly been spectacular.
- The company claims the discounting was a “one-time” thing in Q3 but, ironically, later in the call, discussed how the gross margins are going to be lower in Q4. Looks like Tesla’s one-time discounting, which started in Q3 of 2016, will repeat for at least one more quarter.
Looking further down the P&L, (see image above), we can see that the company’s SG&A spiked further, although there has been no change in revenues. We wonder if this is due to incentives (note Section 5.0.2 of this SEC filing for an example) and other costs necessary to drive Q3 sales – costs that probably should have been in the CoGs line.
Whatever the reason, the end result is that Tesla recorded a loss of nearly $620M (compared to our estimate of $600M), or a staggering -22% net margin.
Wall Street analysts who follow management guidance like sheep should pay attention this net profit number. Gross profits can be obfuscated but it will all show up on the bottom line.
The Balance Sheet
Now, let us continue to the balance sheet (image below).
There are several key things that are readily apparent:
- Tesla raised $1.8B in August in the form of unsecured debt. In spite of that, the cash balance at the end of Q3 remained about the same as Q2 levels. At the outset, it would appear that the $1.8B disappeared.
- But it gets worse. While the company has successfully maintained the level of cash at Q2 level, it came at the expense of dramatic deterioration of working capital and debt levels. Account payables, accrued liabilities, resale value guarantees jumped significantly from Q2 levels.
- Total liabilities increased by a staggering $2.47B in a single quarter from $19.46B in Q2 to $21.93B in Q3.
- Current assets of $7.07B and current liabilities of $6.47B means that working capital is just about $0.6B.
Near-Term Cash Needs
While the balance sheet is precarious, the near-term cash needs of Tesla are scarier.
Let us consider the different ways the company will burn the cash:
- The company is forecasting 15% gross margins for Q4 on relatively flat unit sales. In other words, the operational cash flow situation will be getting worse. As a first order approximation, let us say the company needs at least $500M for current operations.
- Because of the Model 3 delay, we estimate that the company is piling up inventory at a rate of $30M per week. For Q4, given the company did not begin throttling the inventory build until late, this amount could be at least $650M.
- The company intends to spend a billion dollars in capex in Q4.
- Interest payments of approximately $100M.
- Unknown amount of cash to honor Q4 resale value guarantees.
Just these items will need over $2.2B in cash by the end of Q4. What this means is that the working capital, which was at $0.6B at the end of Q3, will go to negative $1.6B.
Sources of Cash
The company has been resourceful in the past in raising debt and stretching out the payables but we believe that is now largely played out. The company can get further cash from asset-backed loans, or ABLs, but that is unlikely to be more than $500M.
The company may be able to sell or borrow based on SolarCity assets and that could potentially raise another $500M.
Beyond the above two sources, the company could raise some money by selling inventory. However, much of the inventory is likely already tied to an ABL and incremental cash flow from inventory sales is likely to be small.
The bottom line is that the sources of cash, excluding capital infusion, will fall far short of cash needs.
But It Gets Worse
As bad as the above scenario appears, we believe things could be much worse for Tesla.
Contrary to management narrative, the demand situation for Model S and Model X does not appear to be promising. Inside EV’s October sales report indicates that Model S and Model X numbers are running at a level well below normal. Given this data, we are skeptical that Tesla can make Q4 delivery guidance. If Tesla were to miss guidance, the cash situation for Tesla will be worse. Furthermore, it does not help that Model S and Model X demand is migrating toward the 75 kWh model and reducing the ASPs and margins for the company.
Credit Rating Revisions Imminent
A very large threat ahead for Tesla is a near certain downgrade of credit ratings.
In August, when Tesla did the last debt raise, credit rating agencies gave Tesla a very generous credit rating of B2.
While we believe the credit analysts credit ratings were farcical, it was par for the course that the analysts went with Tesla management guidance in estimating cash needs. The lack of diligence was deplorable but understandable.
To quote Moody’s at that time:
“The B2 CFR reflects Moody's expectation that the launch, production ramp up, and market acceptance of the Model 3 will be successful enough to achieve approximately 300,000 unit sales during 2018 (a full-year sales rate averaging about 5,500 per week) with a gross margin approximating 25%. This level of sales and profitability would enable Tesla to strengthen its performance from sizable losses to an operating position that supports the B2 CFR.”
We suspect that Moody’s analysts have now woken up to the reality of Tesla’s claims and will revise these numbers down drastically in light of the new guidance in the conference call.
As such we expect Moody’s to reduce Model 3 shipment estimates by nearly half given the 5k per week ramp is not expected to start until the end of Q1 and given there is no guidance on if and when 10k per week ramp will occur. We also would expect Moody's to dramatically adjust down the gross margins to account for the ramp and to be far more skeptical of the management’s terminal 25% gross margin claims for Model 3. Which analyst in their right mind believes Tesla can deliver 25% gross margins for Model 3 when they are already under 20% for the high-end Model S and Model X?
With the revised numbers, realizing the dire cash flow consequences, we expect Moody’s and other rating agencies to downgrade Tesla’s credit ratings. Typically, credit ratings move down by only a notch or two with company execution problems. However, in Tesla’s case, the deterioration is severe and we can easily see Moody’s downgrading the current B2 credit rating to a Caa2 (see ratings chart below). Even credit ratings equivalent of Caa1 can be a major problem for Tesla.
The credit downgrades are likely to have far reaching consequences on Tesla’s credit dealings including the ones with suppliers.
Very soon, Tesla is going to find that many suppliers have withdrawn credit or have dramatically increased the cost of credit. If the vendors require letters of credit or require COD, Tesla’s cash situation can become a dire one in short order. We expect the credit situation of Tesla to become miserable in short order.
With nearly $4B in accounts payables and accrued liabilities, what we have here is a ticking time bomb.
Tesla Needs To Raise Cash Immediately To Escape The Credit Crunch
Just about the only way Tesla can stall the credit crunch is by raising capital.
But an equity raise is likely to be challenging as Tesla will likely face serious questions about its narrative. As such, we are highly skeptical of Tesla getting to a 5K per week ramp by the end of Q1 2018. Given Elon Musk’s track record of missing even “high confidence” near-term targets, we expect the capital markets to be skeptical.
With the delay in Model 3 ramp, the chances are increasing the $7,500 federal credit would we on the verge of expiring and very few Model 3 cars may be able to avail the credit. Not having the credit is likely to seriously set back Model 3 shipments as many customers are likely to be priced out of the market.
Tesla’s execution on the Autopilot also has seen some major setbacks. It is becoming increasingly clear that Tesla will be unable to deliver on the coast-to-coast autonomous demo before the end of the year.
After saying there should be “zero doubt about reaching 10,000 unit run rate by the end of 2018,” Elon Musk has completely backed away from the target during the conference call. This will not sit well with investors who have been pricing in that growth. For those investors chasing growth, it should be clear that Tesla now is being forced to choose between growth and survival.
We believe Tesla is on a precipice of a cash/credit crunch and needs to raise capital immediately to avoid a liquidity crisis. But, a capital raise with the current Model 3 story could be difficult and put severe downward pressure on the stock.
We see the stock collapsing from the current levels.
Our View: Sell short.
This article was written by
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