Munro's Model 3 Teardown Spells Big Trouble For Tesla

Summary

• Is Model 3 demand flagging? It may be, but I doubt Tesla will divulge the latest reservation number.
• And in a sense, it doesn’t matter. Even if demand still remains strong, the car will be a huge negative for Tesla for two separate reasons.
• First, Tesla will lose money making the Model 3.
• Second, the corners Tesla cut in developing the car will bring great woe.
• Munro & Associates’ teardown analysis of the Model 3 underscores both these points.

There’s a lot of buzz, at least among the bears, about what’s happening with Tesla’s (NASDAQ:TSLA) Model 3 reservation count. Here’s a recent example, outlining what Mark Spiegel hopes we’ll see Tesla disclose when it releases its Q1 financials:

What's the exact current number of net paid Model 3 reservations (and by "current" I mean as of now, not five weeks ago in March), and by "net" I mean net of those that have received OR requested refunds (as once a refund is requested it seems to take at least a month to get it), and by "paid" I mean excluding any reservations allowed to remain after a refund was requested, and (in line with Tesla's self-proclaimed policy) without crediting more than two reservations to any one person or entity?

While I too am curious about the reservation number, I’m not holding my breath, expecting big news. Instead, I anticipate Tesla will continue playing this close to the vest, claiming demand continues to be strong but declining to divulge an actual number.

Why so secretive? Because any significant decline in the Model 3 reservation number would be harmful to the Tesla share price and, indeed, might well undermine the entire Tesla narrative that the mass market Model 3 will catapult the company into sustained profitability. (I discussed this at some length in a podcast with Quoth the Raven, which you can find here.)

However, in a sense, I regard the Model 3 reservation number to be irrelevant. No matter whether the Model 3 reservation number is falling, rising, or staying the same, the Model 3 story is doomed, for two separate reasons, both illuminated by the work performed by Munro & Associates.

What Is Munro & Associates?

Munro & Associates has almost three decades of experience in what it calls “teardown engineering.” By disassembling and analyzing products, the firm helps its clients optimize design, engineering, and manufacturing processes. Those clients include manufacturers in aerospace, defense, automotive, marine, medical, consumer electronics, and other industries.

(Sandy Munro in his discussion with Autoline.tv)

The Munro name is the gold standard in the business, and its website offers a detailed outline of its capabilities.

Munro’s Model 3 Project

The Munro firm bought two Tesla Model 3 cars and methodically took them apart. It sat down to discuss the project with the folks at Autoline.tv. The interview (here), while lengthy, is a must-watch for anyone who is a Tesla investor or who is considering a Model 3 purchase.

A week or so after the Autoline session, the Munro firm hosted auto journalists at its Auburn Hills, Michigan, headquarters, offering additional comments and answering questions.

Two fundamental points emerge from the Munro interviews that fortify two of the key points (6 & 9) in my 23-point Model 3 bear thesis.

1. Tesla Will Lose Money Selling the Model 3

First, and most fundamentally, Tesla cannot make money selling the car. This is hinted at several times during the Autoline interview, including at the segments starting at 19:10 and then again at 54:48.

Munro was more explicit when he hosted the journalists:

There’s nothing here that says "save money," I think $36,000 Model 3s will be rare as hen’s teeth. I don’t see how they could make money at $36,000.

This is sobering news even if Munro is addressing all costs, but it appears to me he's talking about only the cost of goods – his firm’s tally of the cost of sourcing the parts and assembling the car based on its in-depth analysis.

In other words, the $36,000 cost implicit in his statement would appear to be before one considers operating expenses (research and development plus sales, general and administrative).

Last year, Tesla’s operating expenses worked out to more than $37,000 per car delivered. Of course, some part of that is attributable to Tesla’s other business lines. Still, it’s apparent Tesla’s operating expenses exceed $30,000 per car.

The implication of Munro's calculation is that Tesla will lose 100% of its operating costs allocable to the Model 3 (and it already loses much of the operating costs allocable to the Models S and X).

Perhaps, given time and a determination to improve its design, Tesla can achieve savings on cost of goods. Perhaps it can reduce its per-car operating expenses as it ramps up production. And, if those things happen to a large enough extent, then perhaps Tesla can make money on at least a few of its highly-optioned, high-margin, high-cost Model 3s.

But there's a limited demand for small sedans costing $50,000 and up. We are seeing this already as Tesla quickly burns through its reservations. While some of the reservation holders no doubt are holding out for the all-wheel drive version, an even larger cohort is awaiting the promised $36,000 version.

And those hoping for a $36,000 Model 3 will be disappointed. Tesla simply cannot afford to sell this car at that price. It may offer a few hundred for sale, just to say it kept its promise.

But it won’t offer more than that. It will, instead, try to change the topic and focus buyers and investors on the next great thing, the Model Y.

2. Tesla’s Shortcuts Will Be Costly

The second reason the Model 3 is doomed, independent of cost, is that it is, mechanically speaking, a terrible car.

That’s not to say some aspects of the Model 3 are not terrific. To the contrary, as Munro states emphatically, there are many wonderful things about the Model 3:

• It looks great.
• It has superb electronics.
• The design and assembly of its battery are outstanding – markedly better than anything Munro has seen in any other EV.
• It has an excellent suspension, which gives it outstanding handling capabilities.

However, the care and ingenuity lavished on these features are absent from other aspects of the product design and production engineering.

In the Autoline interview, Craig Cole of Autoguide.com notes the high praise Munro earlier had for the fit and finish of BMW’s i3, and asks how the Model 3 compares:

Cole: Mechanically, the i3 was the best. Where does the Model 3 fall on that scale? Way at the bottom? Is it somewhere in the middle? Can you share that?

Munro: Now, I’m pretty sure that there’s going to be Tesla fans here, so I really don’t know if I want to say the truth, so I will give you a nice lie…

Cole: Measured answer…

Munro: …Yes. It’s, it’s, it’s in the lower half. I think that in essence what they did is they ignored, you know, a hundred years, two hundred years of experience. There were coach builders before there were car builders.

And in the old days, we had some whiz kids who said, "Oh, quality, doesn’t mean a thing." And then the Japanese came in and basically kicked our butts.

We learned a lot. That’s why everybody uses the AIAG [Automotive Industry Action Group] the PPAP (Production Part Approval Process) and the APQP (Advanced Product Quality Planning) and all this other stuff. These processes – everybody uses them. And the reason for that is you can’t get a good quality build if you don’t do it that way.

If people want to not use them, you can, but at end of the day, you’re going to wind up with a lousy car.

Munro compared the Model 3 build quality to a KIA from the 90s.

In view of the Model 3’s highly advanced electronics and battery, and its excellent suspension, Munro sees the car as a terrible missed opportunity for Tesla:

Dr. Jekyll and Mr. Hyde. That’s where they are. And that’s the good thing for the auto industry. Because, hey, you know what, even if it just would have been a normal car from the mechanical side – like I say, the dinosaur technologies, the old stuff that everybody knew, if it would have come out like that, even decent, with all the other stuff, they’d have mopped the floor with everybody.

But they didn’t, unfortunately. And that’s where they are right now, so they’re spending money like crazy and they can’t get cars out the door and they’re pissing off their customer base.

Ignore the education, training, and experience of Sandy Munro and his talented team at your peril.

What Does this Mean to the Share Price?

Do I continue to believe the fundamentals will eventually weigh down the share price? Yes, I do.

Do I continue to be uncertain about when that will happen? Yes, I do.

Tesla's strategy for the next several quarters will be to keep hope alive:

• It will continue to hype each improvement in its Model 3 production rate, as if that is some great achievement.
• It will create a huge media event around a Model Y reveal.
• It will load all possible expenses into Q2, and pack as much revenue as possible into Q3 (including, of course, the sale of hoarded ZEV credits and transferable tax credits), all in hopes of generating a one-time non-GAAP Q3 profit.
• It will raise capital on the back of that engineered quarter.
• And it will hope its investors continue to be fooled by these maneuvers.

But no matter how Tesla moves the numbers around, its trajectory for 2018 remains: a GAAP loss of approximately $2.8 billion (and I anticipate CoverDrive will have an update soon on this estimate).

And the prospects for 2019? An even greater GAAP loss than 2018.

But, as I say, the stories never end. That's why I favor long-dated puts. Time is the only reliable solvent of folly.

Analyst’s 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.

I am short TSLA via long-dated options.