Tesla Energy May Be Dead

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About: Tesla, Inc. (TSLA)
by: John Engle
Summary

CEO Elon Musk has announced that Tesla will cut 9% of staff, but will spare all frontline auto workers as it continues to scale production of the Model 3.

While some cuts to middle management look doable, cuts will have to come from elsewhere; we surmise that a large number of cuts will come from the energy segment.

Tesla’s solar energy generation and storage business has seen diminishing deployment in recent quarters.

With the recent severing of a retail contract with Home Depot, the struggling solar segment may be getting the ax, or at least put on ice as Tesla strives to demonstrate profitability.

Several Wall Street analysts already assign little to no value to Tesla’s energy business; Musk may at last agree with them.

Tesla's (TSLA) financial struggles in recent quarters are well documented, as is the "production hell" bedeviling the efforts to scale production of the Model 3 sedan. With focus almost exclusively on the auto segment, little attention has been paid to Tesla's energy business. In truth, it is quite difficult to give an accurate analysis of that segment in relation to the rest of the business due to the company's accounting methods. Yet it is clear the segment is struggling.

Now, as CEO Elon Musk works to make good on his twin pledges of turning Tesla profitable in Q3 2018 while not raising further capital, the lagging energy business deserves special attention. Certainly, there can be little doubt that the twin announcements that Tesla would be cutting 9% of its workforce and that it was suspending its retail solar partnership with Home Depot (HD) are connected to Musk's pledges. But the implications stretch far beyond cost-cutting to turn Tesla into the black. Tesla may be abandoning much of its energy business in all but name.

In this research note, we discuss the likelihood that Tesla Energy will be facing the brunt of the job cuts, its implications for the segments going forward, and its implications for the company as a whole. We find that while cutting the energy segment makes good business sense, it may undermine aspects of the Tesla - and Musk - narrative that could have significant consequences of their own.

Big Cuts Inbound

Tesla has 46,000 employees, 8,000 of whom have been added since the start of 2018. This rather staggering headcount has led auto experts to conclude that Tesla has a severe overstaffing problem. Thus, shedding 4,100 workers makes considerable sense, especially given Tesla's current cash-strapped position. Elon Musk has indicated that the cuts will be to salaried employees, and not to factory-floor jobs and hourly workers who man the production lines. Indeed, Tesla has recently ballooned its frontline factory headcount in order to achieve Model 3 production. While manning the lines with so many extra bodies may result in a deleterious impact on Tesla's gross margin goals, as we pointed out in a prior research note, it may be necessary to reach the already stretched production timeline.

So where, then, do the cuts happen? Tesla's lack of headcount reporting by segment makes answering that question difficult. However, we can surmise that, if the assembly lines are to be spared, then the cuts will have to be deep elsewhere. The challenge becomes clear when we recognize that the assembly lines accounted for 9,000 workers at the end of 2017, before the recent hiring spree. Since the latest rash of hiring was largely driven by the need to recruit new production workers, it is safe to assume that at a sizeable chunk of the 8,000 employees added since the start of 2018 are protected from the ax. Since there is no better estimate out there, we consider delineating 3,000 of the new employees as assembly line workers to be a fair conservative assumption. That would bring the total assembly line headcount to 12,000.

With 12,000 workers on the assembly line and thus ostensibly protected from the current raft of job cuts, we are left with 32,000 available to be excised. That means 12% of the non-factory floor employees must go. The notion that such a significant portion of the company's headcount consists of "barnacles" that can be scraped off to improve efficiency seems at least somewhat questionable. Tesla may have proliferated middle managers in recent years, but flattening the organizational chart can only get you so far. Clearing out thousands of employees is not a simple feat.

Ripe for the Chopping Block: Tesla Energy

Tesla's energy business has long been a financial lodestone around the company's neck. When it acquired SolarCity in a $2.6 billion all-stock deal in 2016, it also took on the struggling solar energy company's $2.9 billion debt load. While Tesla claimed that absorbing the business run by Musk's cousin was a "no-brainer", it has failed to live up to any of its promise.

Tesla has said that its solar business was cash-flow positive in 2017, but its failure to report its energy revenues in a sensible fashion - or to adequately factor in the significant debt behind it - makes that claim rather suspect. Our suspicion mounts further when we consider Tesla's reported rate of solar energy deployment. A tweet by TeslaCharts highlights the fact that the amount of Tesla solar energy deployed (in megawatts) has been declining precipitously.

If it were not for a few high-profile contracts won from local governments in Australia, the Tesla Energy story would seem almost completely unraveled. Add to that the recent development that Tesla has cut its partnership with Home Depot after just a few months, and we can surmise that the high-cost, low-benefit solar energy segment is struggling badly.

Of course, Tesla has announced that the Home Depot solar energy kiosk workers will largely be able to keep their jobs selling energy products at Tesla stores, we know that is not true through simple arithmetic: Tesla operated kiosks in at 600 Home Depot stores, but only has 300 retail stores of its own worldwide. Even if every single Tesla outlet added a Powerwall sales team, at least half of them would be redundant immediately.

What appears to be happening is a soft withdrawal from the frontline of the energy business. It was clearly never really working, and was likely never to produce the margins Tesla expects from its auto business long-term. Cutting the energy segment - or at least pruning it liberally - may be the lowest-impact method of cutting headcount over the relative near-term.

Implications

Cutting down the energy segment makes financial sense. If Musk is serious about moving the company into the black, Tesla Energy should probably go. Even one of Tesla's long-time boosters, Adam Jonas of Morgan Stanley, has given little credence to the company's energy business. Indeed, his latest valuation breaks down the $291 price target by segment:

  • Core Auto: $196
  • Tesla Mobility: $95
  • Tesla Energy: $0
  • SolarCity: $0

While Jonas was willing to assign $95 to Tesla's as yet non-existent driverless car business, he sees no value at all in the energy segment. That is telling.

Of course, Tesla is not an ordinary business and Musk is not an ordinary CEO. Much of the company's perceived value is built around the narrative that Tesla will lead the way, guided by Musk's unique vision, in all manner of business enterprises. Indeed, much of Tesla's valuation hinges on the idea that it is "more than just a car company". Other Musk ventures, such as SpaceX (SPACE) and the Boring Company, are often lumped in with Tesla as if they were part of some conglomerate of Musk. Of course, that is not the case.

What all this means is that walking away from the energy business, while fiscally prudent, may prove damaging to Musk's visionary image and to the perception of Tesla as a tech company that makes cars. When it is valued simply as a car company, albeit an innovative one, its current share price and valuation look utterly unsustainable.

That puts Tesla and Musk in a bind. It cannot walk away from the energy business entirely. But it can scale it back while continuing to engage in the high-profile public-private partnerships it has been working to build in recent quarters. While hardly revolutionizing the energy sector as once advertised, it could help Tesla save face without having to invest too much in a losing segment.

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.