Adam Jonas of Morgan Stanley (NYSE:MS) published another Tesla (NASDAQ:TSLA) note last Friday, claiming to see a “potential major FCF (free cash flow) inflection.” Although the “inflection” would be temporary, it might be enough to “drive a very sharp upward move in the equity price.”
Anton Wahlman has detailed how, without calling attention to it, Jonas has lowered his forecast for 2018 deliveries to about 223,000 units (Models S, X, and 3 combined). That is not only lower than Morgan Stanley’s forecast from August, but also much lower than Tesla’s latest 2018 guidance of at least 300,000 units.
The Jonas note is remarkable for several other reasons.
To begin with, Jonas offers a quarter-by-quarter forecast for Model 3 deliveries in 2018. In Part I, CoverDrive details how Jonas’ delivery numbers translate to a 2018 GAAP loss of $2.6 billion.
Then, in trying to put a smiley face on Tesla’s production problems, Jonas employs the same misleading distortions in his free cash flow calculation that Tesla used in its most recent quarterly update. We’ll take a look at a few of Jonas’ benders in Part II.
Finally, despite all its happy talk, the Jonas note has some ominous warnings that Tesla investors would do well to consider. We’ll review those warnings in Part III.
I. With Jonas’ Numbers, Tesla Is More Deeply Insolvent than CoverDrive First Calculated.
A few weeks back, CoverDrive used a simple financial model to demonstrate why Tesla will be structurally bankrupt even after Model 3 production fully ramps up. CoverDrive assumed production of 20,000 Model 3 units in Q1, growing to 65,000 units in Q4.
Based on those numbers, CoverDrive forecast Tesla will lose about $2 billion in 2018.
CoverDrive was not without his critics. Several of them challenged his Model 3 production estimates as unrealistic, urging Tesla will ramp up far faster than he assumed and therefore lose much less money than he forecast.
After he saw the Adam Jonas note, CoverDrive wrote me a short memo. He acknowledged he has no special insight into what goes on behind the curtains at Tesla. “However,” he wrote:
Some people do. And one such person is Adam Jonas from Morgan Stanley. Here are his recent projections for Model 3 sales in 2018.
OK, then. Let’s run these presumably more informed and realistic numbers through the spreadsheet and see what we should expect for automotive revenues and income in the upcoming year.
I will make a modest adjustment in operating expenses based on sales volume. For every 100% increase in sales volume, I will assume operating expenses increase by 12.5%.
Here are the results with the Jonas delivery numbers, quarter by quarter:
No Matter Whose Delivery Numbers Are Closer, the 2018 GAAP Loss Will Be $2B or Greater.
So, whose Model 3 production numbers are likely to be closer, CoverDrive’s from his original estimate, or Adam Jonas from his recent note?
Your guess is as good as mine. There are just too many variables and uncertainties, including the problems and delays that may arise from Tesla’s decision to shorten or skip altogether the production parts approval process, the production line validation, and rigorous beta testing.
Sure, Jonas is more plugged in to the goings-on at Tesla, and most assuredly has more contact with Tesla management than does CoverDrive. Still, it’s possible Jonas is deliberately setting the bar low so that he can later claim a production “beat” by his precious Tesla.
What are Tesla’s 2018 losses likely to be? CoverDrive’s production numbers led him to a $2 billion GAAP loss forecast. Using the Jonas production numbers, CoverDrive pencils out $2.6 billion in losses. Jonas’ spreadsheet, by contrast, calls for only $1 billion in GAAP losses.
While I’m uncertain whether CoverDrive’s delivery assumptions will prove more accurate than those of Jonas, I’m completely confident the losses will be closer to the $2 billion to $2.5 billion range seen by CoverDrive than they are to the $1 billion seen by Jonas.
Expect More EPS Forecast Slashing Ahead.
And I promise you this: As they have repeatedly done in the past, Jonas and the other Tesla analysts will continue to slash their EPS forecasts as 2018 progresses, and will eventually catch up to CoverDrive.
As an example, Jonas, who not long ago was seeing Tesla as profitable in this quarter, now projects $583 million in GAAP losses for Q4. (CoverDrive’s tentative forecast is for a GAAP loss of $638 million.)
(This is an actual instagram account. Just another reminder about why Tesla remains a dangerous short.)
II. Jonas’ Misleading Free Cash Flow Analysis
Just as CoverDrive is a far more reliable forecaster of Tesla’s losses than Adam Jonas, so too is Bill Cunningham superior to Jonas when it comes to understanding Tesla’s cash flow.
Bill’s three most recent articles are here, here and here. If you’re not following Bill Cunningham, then you’re simply in the dark about a vast amount of important Tesla financial detail that is reported nowhere else.
Bill advises he is working on an article about Jonas’ free cash flow calculations, so I will keep my remarks brief and urge you to read Bill’s article.
Here are a few key points, though.
First, “free cash flow,” defined as operating cash flow minus capital expenditures, is not an especially useful metric as it does not deduct principal repayments on debt. Keep in mind that Tesla has $100 million due to the Musk clan in February of 2018.
Second, Tesla distorts the FCF metric even further. When Tesla reported its FCF in its Q3 quarterly update, it artificially inflated the number by failing to deduct distributions to “Variable Interest Entity” partners or principal payments on capital leases. That made for a $100 million swing.
To my knowledge, Bill Cunningham is the only business writer to have written about this hugely misleading distortion.
Third, although Jonas sees a $1.5 billion improvement in free cash flow during the first half of 2018, that's an improvement from a deeply negative number. Any such improvement, even by Jonas' misleading reckoning, would still translate to $700 million or so of negative FCF in H1.
Fourth, any “improvement” in FCF does not translate to an improvement in earnings. Rather, the improvement Jonas sees arises from his belief that Tesla can defer paying its suppliers for two to three months after delivery of parts, while transforming those parts into cars and collecting from its customers before the bills come due.
Even assuming Tesla can avoid paying the bills until after the cars are sold (and the current production problems cast doubt on that proposition), stretching out suppliers is a short-sighted solution to a cash flow problem. If anything, Tesla’s relations with its suppliers are becoming more problematic, as evidenced by Q3’s sharp increase in outstanding letters of credit.
III. Gigafactory, Mobility, Nirvana
Jonas’ note includes several features which ought to give any investor pause.
Gigafactory Problems. Jonas professes to have no knowledge “on a week to week basis” about the Gigafactory bottleneck problems, but assumes they will be alleviated by early 2018. However, he warns he is unable to determine when those problems will be resolved, “if they ever are at all.”
Did you catch that? The suggestion that the battery module production problems may be intractable?
Jonas was certainly prudent to include this “CYA.” Some Gigafactory employees like to pass their free time in the Reno casinos, and the dealers there hear things. Word has it that Tesla has flown in a large number of Grohmann employees from Germany to attempt to get the battery module automation equipment up and running. Musk himself is said to have spent the better part of the Thanksgiving weekend at the Gigafactory.
This was always a disaster waiting to happen. At a time when most automakers are opting for prismatic cells, Tesla is employing a new type of cylindrical cell, with a new module and battery pack design, requiring tens of thousands of circuitry connections per unit. And all without any time set aside for testing and validation.
Even assuming the Gigafactory problems eventually are ironed out, a good chunk of the supposed Gigafactory cost savings will have been eroded by the extra expense and delay.
Tesla Mobility Fantasy. While Jonas’ financial model assigns zero value to either Tesla Energy or SolarCity, it includes a $106 per share value for “Tesla Mobility”.
Paulo Santos has definitively demonstrated (most recently, here) that far from being a leader in the autonomous driving sweepstakes, Tesla is decidedly a laggard. The idea that “Tesla Mobility” is worth $19 billion (which is what Jonas’ $106 per share translates to) is laughable.
If anything, as Santos has detailed, Tesla faces material liability for its misleading “full self-driving” promises. And, indeed, a class action suit on this issue is pending. The latest docket entries indicate both parties have agreed to a mediation, which suggests to me that Tesla appreciates the lawsuit has merit, or is eager to avoid extensive discovery about what it knew when, or both.
Nirvana Is 12 Years Away. Jonas states Tesla cannot be valued on “near term metrics or multiples.” Consequently, his discounted cash flow model achieves his $379 target price only by extending the analysis to 2030.
Jonas pretends to see 12 years down the road? Let's take a look at how he has done seeing just one or two years down the road.
Jonas’ EPS forecasts for Tesla have been abysmally wrong for the past five years, forecasting imminent profits that never materialized. In 2014, he was forecasting a 2015 EPS of $2.45, a 2016 EPS of $3.65, a 2017 EPS of $4.12, and a 2018 of $6.99.
Actual results: 2015 was ($6.93), 2016 was ($4.68), and 2017 is shaping up to be about ($11.00). While 2018 is TBD, it will be at least as bad, if not worse, than 2017.
Folks, none of Jonas’ forecasts for Tesla EPS three years out, two years out, or even one year out, was even close. He was off by between $1 billion and $3 billion in each of those years.
Jonas can’t even see what’s just one year ahead. There’s no reason to believe he has the first clue about how things will work out in 12 years.
Jonas’ most recent note is of a piece with his endless Tesla cheerleading. I thought this comment to Anton Wahlman’s piece hit the nail on the head:
This continues Morgan Stanley's pattern of cutting numbers, letting out negative information that he got from its discussions with Tesla, while throwing non-substantive happy talk in the headline of its report.
This has happened four times in the last year. Morgan Stanley gets insights from Tesla that cause Morgan Stanley to conclude Tesla has to cut its numbers. Sales will be lower, losses will be bigger, units will miss...
But then Jonas picks some single happy sounding theme, and writes some inane headline that is palatable to Morgan's client, to cloak the estimate cut in sugar.
As a firm, Morgan Stanley puts out all kinds of great research. And it distributes its buy recommendations on big stocks in comprehensive pieces that summarize many recommendations on different stocks and sectors. What's notable is that these broad pieces NEVER include recommendations on Tesla. The research wing of the institution hides from its own Tesla coverage.
In sum, Adam Jonas’ Tesla “research” is completely detached from Tesla’s fundamentals. It is all about pumping Tesla’s share price. Morgan Stanley’s compliance department may choose to overlook this pattern of behavior, but Tesla shareholders should take care to heavily discount both Jonas’ analysis and his conclusions.
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.
Additional disclosure: I am short TSLA via long-dated options