Starting From the Top: Model S/Model X
Since inception, Tesla's (NASDAQ:TSLA) business model has been selling high-end EVs, the Tesla Model X and the Tesla Model S. Let's just look at deliveries. In Q2'2018, Tesla delivered 10,930 Model S cars, vs. 12,000 Model S cars sold in Q2'2017, down 9% Y/Y. The Model X sold 11,370 units in the quarter, compared to 10K in the year ago period, up 14% Y/Y. Seeing this data brings me to the conclusion that the Y/Y drop in units sold with the Model S isn't driven by production capacity at the Fremont Factory, rather the cannibalization of the Model S by the Model 3, driving demand away from the Model S to the Model 3. An interesting note I would like to point out is that with similar companies like Mercedes-Benz and BMW, when lower end vehicles are rolled out, the high-end vehicles overall demand drops off, as the luxury brand image is hurt by low-end products.
(source: Wikipedia)
So if the Model 3 doesn't pan out, and demand doesn't persist, it isn't like Tesla can fall back on the Model S to generate revenue growth based on the delivery totals. If the problem with unit sales were increased intensity around Model 3 production, eating into S/X production, wouldn't it make sense if Model X sales declined? The bread-and-butter of Tesla's business is high-end EVs, and now the Model 3 is cannibalizing the total unit sales of the Model S. Even worse though, Tesla now has competition. The problem, Tesla doesn't have anything in the way of a moat to protect Tesla from competitors. Such "moats" used to include the Supercharger network and the vertically-integrated sales model that Tesla uses to sell their EVs. Now however, the Supercharger network has been opened up to other EVs. Competitors don't even need to create their own infrastructure, as Tesla is providing it for them. And while Tesla can charge other EVs not made by Tesla on a pay-per-use basis, the Supercharger should no longer be considered an adequate moat for Tesla. In terms of the vertically integrated sales model, what prevents Porsche, Mercedes Benz, or GM from developing their own stores to sell EVs in? All in all, competition will not hit Tesla in 2018, but more like 2019-2020, with the only meaningful competition coming from the Jaguar iPace in 2H2018. But competition indeed is a long-term headwind. Here are some of the cars that will be competing with the Model S:
- Jaguar XJ Revamp (coming in 2019)
(source: Autocar)
- Porsche Mission E (coming in 2019)
(source: Porsche)
- Volkswagen ID Vizzion (coming in 2022)
(source: TheVerge)
- BMW i4 EV (coming in 2020)
(source: Motor1)
- Aston Martin Lagonda (coming in 2021)
(source: Motoring Research)
As you can see, Tesla is up to its neck in competition, with high-end car companies creating good-looking and high-performance cars that will sell thousands of cars per year. These are companies that have decades of experience in manufacturing cars. So as long as there's demand for their cars, you can count on these companies to produce at the levels of consumer demand. Tesla's differentiating factor was the fact that it made EVs look nice, but now that these other companies have created their own good-looking EVs, Tesla doesn't have much of a differentiating factor other than a great brand image. But even then, all these other automakers have great brand images that have been established for decades.
For the Model X, current sales trends are extremely strong, but the future shows even more competition than the Model S has. Again, Tesla is a victim of its own success. By creating hit vehicles selling thousands of units per quarter, they started to eat into ICE sales, which did not go unnoticed by the large automakers. Here are some SUVs that are set to compete with the Model X:
- Jaguar iPace (coming in 2H2018)
(source: Jaguar)
- Audi e-tron Quattro SUV (coming in 2H2018)
(source: Audi)
- Mercedes Benz EQC (coming in 2020)
(source: Mercedes-Benz)
- Porsche Mission E Cross Turismo
(source: Porsche)
And except for the Porsche, none of these are even crossovers. These companies will have electric crossovers in production before the Model Y release in March 2019. All in all, the competitive picture for Tesla in both high-end SUVs and sedans is not looking pretty. So while one may argue that the market is large enough for many different automakers, it is the ones with the most capital and manufacturing resources that will survive in the EV revolution.
Despite all that, while we have seen certain SUVs and sedans that charge quicker than the Teslas, we are yet to see any EVs come out in the short term that rival Tesla in range. Currently, the Model S has a range of 335 miles of range on a 100 kWh battery pack compared to just about 300 miles for the Porsche Taycan (Mission E sedan). As such, the underlying range on the cars could deliver a competitive advantage to Tesla, but a small one. The other advantage that Tesla may or may not have over the competition is Tesla's ability to execute over-the-air software updates that change battery configuration and the underlying Autopilot system software. Again, I don't know for a fact if any of the automakers have this, but if they don't, then Tesla could have a bit of a moat their.
Tesla Energy is a Non-Starter
In FY2017, Tesla did about $1.12 billion in revenue coming directly from their Energy business. And while I will not focus on the Energy business much, as it generates minimal revenue and won't be a large part of Tesla's future revenue, it's still a part of Tesla's business. It was only 10% of Tesla's overall revenue last year, and will most likely be an even smaller part of Tesla's revenue this year, as Tesla ramps sales of the Model 3. And while revenues did increase ~1,000% from 2016 to 2017 from Tesla Energy, to assume that these growth rates will continue is ludicrous. Tesla Energy has a few different segments. It has solar installation, Powerpack for commercial energy services, and Powerball for residential energy services. Here is the problem, the gross margins on the Energy business are minuscule when they are not negative. According to the annual shareholder letter after the Q4 report, Tesla's Q4 Energy gross margin was 5.5%. However, Tesla expects this gross margin level to grow significantly. So let's be optimistic and assume that Tesla delivers a 25% gross margin on $1.57 billion in sales (+40% Y/Y revenue growth). That is only about $392 million in annual gross profit, which won't make much of a difference either way for Tesla in the short term. Another thing I like to point out is that Tesla's Energy revenue could be volatile, based on Tesla's ability to win contracts with governments to supply certain areas with energy. While Tesla may win a big contract one year, the lack of another contract the next year creates volatility around the revenue. So while Tesla Energy may be a high growth segment of Tesla's business, it isn't going to move the needle on the company's profitability and is negligible in the short term.
Model 3: Recurring Revenue Doesn't Exist
Tesla longs/bulls like to tout the fact that Tesla has 420,000 total reservations sitting in their backlog, representing about $23.1 billion in potential sales assuming a $55K ASP. While Tesla's backlog is massive, Tesla hasn't shown the ability to generate new reservations at a high enough clip to sustain brief glimpses of profitability. Keep in mind, Tesla also had 450K reservations as of their Q1 report, meaning they have lost 30K reservations since then. I wouldn't be surprised if Tesla continues to lose reservations as they press the patience of their reservation holders. Such reasons for a reservation cancellation may include the following:
- General phase-out of the $7,500 federal EV tax credit
- Inability to produce the $35,000 base Model 3 that about half of the reservation holders are waiting for.
- Volatile production creates inaccuracy in delivery timelines, annoying customers.
- Reports about quality issues with not only the Model 3, but the factory conditions in which the Model 3 is produced.
(source: TheDrive)
With regard to the $7,500 tax credit phase-out, the basics of the situation is that after Tesla produces their 200,000th EV, consumers purchasing a new EV will have their tax write-off of $7,500 halved to just $3,750, before being halved again to $1,875, and then finally reaching $0. Assuming you wanted to buy a Tesla, but you didn't want to spend six figures on a Model S/X you could theoretically buy the $35K Model 3, and then get $7,500 back for purchasing the car, leaving your net price at $27,500, a steal. Just to gauge how many people want the Model 3, a YouTuber named Ben Sullins created a great cookie that tracked how many people looked to configure different Model 3 variants on his site. 49% were for the base Model 3, 45% were for the long-range battery Model 3, and 6% were for the performance version. If you extrapolate this against Tesla's total reservation count, it means Tesla has ~206K reservations for the base model, ~189K for the LR battery model, and ~25K for the performance version of the Model 3. If Tesla continues to push out production of the $35K version, they could be jeopardizing 206K of their orders. Now obviously I'm not saying that Tesla will lose all 206K of their base reservations, but if Tesla doesn't start production soon, many more reservation holders will cancel their orders. Here are two graphics from Second Measure describing the Model 3 cancellation rate:
(source: SecondMeasure)
(source: SecondMeasure)
As the second graphic shows, we hit an inflection point around January, when new deposits were matching refunds 1:1. Then however, refunds started growing at an enormous rate, eventually exceeding flat new deposits. This is a serious risk. While I will talk about Tesla's ability to grow past their initial backlog later, the current negative state of their backlog should concern investors. The customer pool is getting smaller, not larger, as Tesla struggles. In terms of catalysts for a further increase in the refund rate, one should understand that of the 5,000 Model 3s that were created by Tesla in the last week of Q2, 4,300 of them required rework, significantly below industry standards. So while Tesla hastens production, it's coming at the expense of quality. That could damage brand image and consumer confidence even further, with refunds swelling. Tesla currently has 420K reservations which is down by 30K from the previously reported 450K level. Things are deteriorating at Tesla and will most likely continue to deteriorate as quantity is valued over quality. I would not be surprised to see <400K reservations by year-end.
However, for the sake of argument let's say that Tesla's backlog flattens out at around 420K. For DCF, which is the way that I would value Tesla, I go out five fiscal years, to FY2022. Assuming an optimistic sales rate of 7K/week, it would take about five quarters for Tesla to completely fill their backlog. And let's also make an optimistic assumption, assuming Tesla adds 5K new reservations every week for those sixty weeks. This means that after Tesla works through its backlog of 420K reservations, another 300K will have stockpiled. I'll go into more depth when I show my model, but if you assume 300K annual Model 3 sales from here on out, which is an extremely optimistic assumption, then breaking even, much less generating FCF, is going to be a real challenge. 300K * $55K = annual Model 3 revenue of $16.5 billion. At a 30% gross margin, annual gross income is $4.95 billion. On OpEx of $5 billion annually, you near breakeven territory. We push into positive net income when you include gross income from Tesla Energy, Model S/X, and Other Revenue. However, the net income is so minuscule that the CapEx required to generate it leaves Tesla burning hundreds of millions to billions of dollars annually. So even being an optimist leads to severe cash burn. I'll delve into this exact subject later in the writing, but for now I want to talk about production capacity.
Production
Tesla's production process has been labeled by CEO Elon Musk as "production hell," and to be honest, it still seems like Tesla is in production hell. Only this time, the trouble isn't getting thousands of cars off the assembly line every week. The trouble is getting quality cars off the assembly line. Tesla's first pass yield, the percentage of total cars that come off the assembly line not needing rework was 14% for the week ending Q2. This was the same Q2 where Tesla attempted to hit its 5K/week target using a makeshift tent and offer free Red Bull to employees to keep them alert and awake. It was gruesome, and while Tesla did hit 5K/week, not only was it a burst rate, it also was at low quality. According to Ron Harbour, efficient auto manufacturers have first pass yields of 65%-80%. Tesla had only 14%. Also, these cars took about 37 minutes per car to rework. Tesla's ability to produce quality cars has been hindered by management's ambition to meet their production targets.
An interesting, and somewhat two-sided fact I also noticed, was that Elon Musk says that by 2020 he is targeting production of 1 million cars. This isn't cumulative, this is 1 million cars in 2020. Currently, the Tesla Fremont Factory can ramp up to 500K/year, about half of Elon's 2020 target. So how does he get to this 2020 production target? China. During the 2018 shareholders meeting it was announced that Tesla would be building its own factory in China producing both batteries and EVs. This factory is estimated to produce 500K+ cars annually at max capacity. Theoretically, if Tesla ramped to max capacity on both factories they could achieve this goal. However, Tesla has acknowledged it will take a couple of years to permit and build the factory (not to mention billions of dollars) which would push actual production out until at least 2022. So, how does Elon get the 1 million car target? I don't know.
Current Financials
It's no secret that Tesla's current financials are not very great, with total liabilities of $22.64 billion and quarterly cash burn of $807 million as of the Q2 report. The financials will continue to erode until the company can make the jump into sustainable cash generation and profitability. Currently, the company has working capital of -$2.44 billion, vs. working capital of -$190 million in the year-ago period and -$2.27 billion in the quarter prior. This is created by a combination of massive cash burn and increases in Tesla's overall debt level. So then how is it that Tesla has been able to survive for so long? Tesla has had a consistent ability to tap Wall Street for capital whenever they needed it. While this business model has worked since Tesla's IPO, it's inherently unsustainable in the long term, as capital markets are not open forever. Tesla's business model is based exclusively around its ability to call upon bulls to fund them in times of need. Such times include when Tesla raised capital to fund Model X production and the creation of the Gigafactory. The real question Tesla investors need to be asking themselves is if Tesla can achieve long-term cash flow positivity. If they can't, then how will Tesla survive a financial crisis? Even if Tesla can deliver decent net income, they are projecting $2.5 billion CapEx for this fiscal year.
(source: Tesla Q2 Earnings Slides)
As such it will be difficult to build a DCF model that doesn't assume cash burn.
Autonomous Driving
On the Q2 earnings call, Tesla spent a lot of the call talking about a new AI chip that would perform 10X faster than the Nvidia offering that Tesla had utilized before. While this may sound lucrative and make investors bullish, Tesla is the same company that said they would sell hundreds of thousands of more vehicles than they actually sold in 2017. They also said that their next generation Tesla Roadster will do 0-60 in 1.9 seconds and a 620-mile range, something that experts say is impossible with current battery technology.
While autonomous driving is a lucrative industry, who is to say that Tesla will be the leader? As such, I believe that anything Tesla says should be taken with a grain of salt. If Tesla is the leader however, then why is it that Jim Keller, former AMD and Apple (AAPL) chip architect, left Tesla recently to be hired on at Intel? If Tesla really did produce an in-house chip that was 10X faster than the Nvidia's offering wouldn't it have taken multiple quarters for Tesla to produce this chip? Why would Keller leave Tesla for Intel if this chip was truly going to move the needle for Tesla's autonomous driving program? It just doesn't make any sense.
I have one optimistic and one pessimistic viewpoint with regard to Tesla's autonomous driving business.
The optimistic belief is that Tesla has racked literally billions of miles using the Autopilot program, meaning it has the most experience and the best autonomous driving system on Earth. This may be true, as Autopilot has actually been deployed on the road, whereas systems like Google's (GOOG) (GOOGL) Waymo are not road bound yet, and are still testing in different cities across the country. Autonomous driving is a form of machine learning, where the total miles that the system racks up allows the overall system to grow and strengthen. So for every mile the system operates, it gets smarter. Theoretically, on-road deployment strengthens the program, and Tesla is the leader. But this also brings me to a point about Tesla's ability to execute on promises. Back in early June, Tesla's CEO Elon Musk said that Version 9 of Autopilot would include many new interesting features that would bolster the convenience and performance of Autopilot. Most notably, he said that a fully autonomous feature would appear. He said that this feature would arrive in August. Now, it's being pushed out to September. So, when is Tesla going to pump out fully autonomous software? Will it?
The pessimistic side of me is saying that despite Tesla's experience on the road, other competition from Waymo, GM (GM), and many other companies have surpassed them. Waymo logged 2.7 billion simulated miles in 2017, as well as 8 million real world miles overall. They also are logging 25,000 miles of autonomous driving every day.
(source: Waymo)
Basically, Waymo is getting better and better in autonomous driving by the mile, just like Tesla. But unlike Tesla, Waymo and basically every other manufacturer software/auto OEM are using LiDAR, whereas Tesla is designing their own system based on completely different standards. In terms of what stage Tesla is in, they are being crushed by the competition. Stage 5 autonomy represents fully functioning autonomy. Companies like Waymo and GM are already at Stage 4, nearing fully autonomous driving. Uber (UBER) is in Stage 3. Tesla on the other hand is only on Stage 2. Even Apple is beating them. And while right now, no other car may have cool features like Smart Summon or Autosteer+, in terms of fully autonomous driving, Tesla is lagging the competition dramatically. Keep in mind, Waymo's goal never was and never has been to deliver a partially autonomous driving system. They are yet to deploy an autonomous driving system not because they can't, but because they don't want to. They are going to deploy a fully autonomous system, not a partially autonomous system that continues to get developed with new versions. So in autonomous driving, I find it difficult to be optimistic on Tesla's standing.
Well, What About China?
China is one of Tesla's largest markets alongside the US and Norway, and recently, bulls have talked about how expansion into China will help fuel further growth. You see, because Tesla produces all of its vehicles at one factory in Fremont California, they face import tariffs when they send these cars to China. So when the volatility around China began (trade war talks) costs began to rise against Tesla as the tariffs grew. Eventually, Tesla actually hiked prices on mainly the Model X to meet the cost of the tariffs. However, there's a way to work around these tariffs. Instead of producing the vehicles in the United States, Tesla will build these cars in China, directly at the source, allowing them to bypass import tariffs. So, Tesla announced plans to build a factory in Shanghai.
(source: Zeebiz)
The thing is, it will take Tesla at least three years to fully build the factory if the goal is to build it to the scale of 500K/year. And after that it will take an additional 2-3 years to ramp production to maximum capacity. Not to mention these things take money. Tesla will need to raise capital from investors in order to get this factory built. In February 2014 Tesla sold about $2 billion of bonds to help finance the building of the Gigafactory in Reno, Nevada. Now, I'm not saying that the Chinese factory will cost $2 billion, but assuming it is going to ramp to the production capacity of the Fremont Factory, and the fact that things generally cost less in China, it would make sense if the factory cost $900mln-$1bln. Would Tesla get the funding? Assuming there's still a loyal fanbase for Elon on Wall Street, I assume he would still get the funding. It doesn't seem like the bullish crowd is dying away, with ARK reiterating a long-term target of $4K. And while some analysts have downgraded Tesla, and there are more bears than bulls, there are still eight buy ratings on the stock, with the highest target being $530. So I doubt Tesla will have trouble getting funding from the equity markets. However, Tesla's bonds haven't been trading very well lately, so I doubt bondholders will go along with Tesla in terms of a capital raise.
(source: Business Insider)
The yield is now at 7.72%, vs. the 5.3% coupon at issue. Skepticism on the side of the bond market will make it difficult for Tesla to raise capital via debt, with equity being much more lucrative.
Then there's the competition in China. If you thought that the competition Tesla has in the United States is intense, it pales in comparison to China. Whether it be small startups backed by companies like Tencent (OTCPK:TCEHY) and Alibaba (BABA) such as Xpeng or Nio, or larger firms like Great Wall Motors.
That is just to name a few of the startups. There are literally dozens of startups devoted to EVs and autonomous driving exclusively in China. And while the Chinese government's stance on foreign companies infiltrating China has lightened, there's no doubt that the government is very nationalist, preferring that Chinese companies do better in China than foreign competing firms.
(source: Teslarati)
So, even if Tesla does get a factory in Shanghai fully operational, will there be any demand for the Teslas there if Chinese competitors are able to create competing EVs that the government would prefer over Tesla? In China, the government likes Chinese companies selling to Chinese consumers. They aren't as keen on foreign infiltration of their market.
Interesting Accounting
Short sellers like Jim Chanos have repeatedly mentioned Tesla's interesting accounting predicament. They mention that Tesla may be inflating gross margins by leaving out basic gross costs for the operating cost line. So when Tesla delivers gross margins of 25%, it's more like 15% if you compare it on an apples-to-apples basis against companies like GM or Ford (F). And while bulls point out that costs like dealership costs don't apply to Tesla, as Tesla's sales model is vertically integrated, Tesla also has costs like servicing and warranty that other auto OEMs have as well, but Tesla logs under OpEx. Additionally, Tesla has other costs that GM and Ford don't, mainly their Supercharger network. Then there's Tesla's version of free cash flow, which is operating cash flow less capital expenditures, the capital that Tesla gets from Wall Street. Basically, Tesla records free cash flow as regular free cash flow plus the money Tesla gets from Wall Street investments.
The Catalysts That Would Bankrupt Tesla
Let me be frank for a second. Tesla is extremely capital intensive, relying on Wall Street to grow their business. Tesla performed its IPO in 2010, after the Great Recession. Tesla has never encountered a market crash/recession where investors no longer invest in speculative assets like Tesla, rather flea to safety in government bonds or gold. Tesla is a speculative and volatile stock. If a recession comes and investment banks flea into safe-haven investments, risky assets like Tesla not only will be on investment banks sell list, when Tesla comes calling for capital nobody will listen, as there is no capital to go around. And while timing the market is an extremely risky strategy, when the market inevitably collapses, Tesla will fold. That's why Tesla's business model of taking in capital from outside investors to fund the day-to-day operations and the long-term business plan will not work indefinitely. So if Tesla doesn't clean up their balance sheet and start generating cash before the next recession comes, Tesla will fold.
Assuming that a recession doesn't suffocate Tesla's ability to generate capital, then how else would Tesla go bankrupt? In my opinion, Tesla and Elon Musk are synonymous with each other. The only real reason that anybody buys Tesla stock is based off of the hype that Elon Musk is "an innovative genius" who is transforming and revolutionizing the transportation system. OK. What if you leave Elon Musk out of the equation? Tesla is nothing without the hype that surrounds Elon Musk. And while I doubt that Elon Musk will voluntarily leave Tesla, what if he was forced out?
In my view, Tesla's board of directors is in complete support of whatever Elon Musk decides to do with the company. They won't force him out. And the retail shareholders are too blindly in love with Tesla to think about pushing out Musk. Even institutional shareholders haven't wanted to force out Musk, with the largest one (the only material one) being BlackRock. So that leaves me to the only other scenario in which Elon Musk leaves the company. A regulatory body forces him out. Ever since the "$420 funding secured tweet" was published dozens of lawsuits have been thrown at both Tesla and Mr. Musk. And while some have brushed off the lawsuits and said that Tesla will only pay a small civil fine, others, like former SEC chair Harvey Pitt, have a less optimistic view. He called the tweet misleading, and said that it could constitute securities fraud if he intended to manipulate the share price of the stock. And while I won't delve into the situation with Tesla's $920 million in convertible debt expiring in March, the stock would need to be at or above ~$360 in order for Tesla to ignore the debt, and convert it into stock. This $360 price is a key price, and if Elon Musk was attempting to use this tweet to bring shares above the $360 level, then the SEC lawsuit could have some legs. Let me reiterate however, I have no proof WHATSOEVER that Tesla or Mr. Musk are acting fraudulently. But if the SEC investigation leads to something, then one potential ramification is Musk losing the CEO title and/or being forced off the board.
My Targets/Building Fair Value
The first way of valuing Tesla's stock that I will use is DCF. For the DCF model, I'm using a WACC of 12%. I get to this discount rate using a CAPM with TSLA's beta of 0.78, a 15% return from the S&P 500 benchmark, and a 10-year treasury as the risk free rate, at 2.939%. I'll provide my individual targets on Tesla's business going out to the year FY2022. This model is highly optimistic, and is only in use to show investors that despite optimistic FCF estimates, TSLA's stock is extremely overpriced. Later on I'll give you my FCF target for the next two years when I talk about the next capital raise. Here we go:
Tesla Revenue Estimate:
(source: my estimates)
Tesla EPS Estimate:
(source: my estimates)
Tesla FCF Estimate:
(source: my estimates)
So as you can see, we do get FCF+ results in 2019 and beyond. These estimates do however include phenomenal revenue growth and gross margins in the energy business and in other with an autonomous driving SaaS platform in 2021-2022. The 2019 FCF estimate also doesn't include the $920 million that comes due in 1H2019. But let's discount this optimistic FCF back to present value anyways. This gets me to a terminal value of $22,545.55 million. This brings me to a $15,881.95 million enterprise. If you subtract net debt of $12.53 billion, you get a market cap of just $3,351.95 million. On 170 million shares, the stock trades at just $19.71, ~$20. And this is at massive free cash flow levels. However, I don't see Tesla ever being cash generative. If Tesla is never cash generative and soon the stock is not going to be worth anything.
The next valuation tool I'll use is P/B (price/book value) at a premium relative to the median of GM, Ford, and Fiat Chrysler (FCAU). The median P/B of these three major automakers is 1.04X (Ford's). While I do recognize that these companies are older and some of them have credit risk, I have decided to make TSLA's book value 6 times the size of the median, meaning the P/B is 6.24. TSLA has equity on the balance sheet of $3.91 billion. At 6.24X, the market cap is $24.398 billion. On 170 million shares, the stock is at $143. And that's at 6X all the other automakers valuations.
However, many recognize Tesla as a technology company. OK, at 6.6X my 2018 revenue targets, TSLA stock trades much higher than where they currently trade at. However, the average net margin is 14.59%, whereas Tesla's is currently negative. And when Tesla's net margin turns positive, the margin will be in the low single digits (1%-5%). As such, when a recession inevitably hits and the capital market locks, Tesla's cash burn will take over, potentially bankrupting the company.
When Will Tesla Next Need to Raise Capital?
As you can see with my free cash flow chart, I don't expect Tesla to ever generate cash, at least not on a GAAP basis. I've already talked about Tesla's funky FCF accounting. For FY2018, I'm forecasting about $2.06 million in cash burn, compared to the starting total of cash of just $3.52 billion at the beginning of the year, bringing the cash pile to $1.46 billion at the end of FY2018. And while I only expect $888 million in cash burn in 2019, there's a massive wild card with Tesla's cash burn that could dramatically increase cash burn. It pertains to Tesla March 1 2019 convertible debt. Basically, if Tesla shares do not trade at roughly $360 or above, Tesla will owe $920 million on March 1 to the bondholders. This changes things quite a bit, as theoretically, Tesla's cash burn would increase by $920 million for the FY, bringing cash to a negative number. And while I do put by best effort into these estimates, Tesla's ever-changing business and capital could leave these estimates useless, as Tesla's cash burn could be better or worse. While my estimates that I just provided aren't displayed on the chart, that is because I'm optimistic on these charted estimates.
So, if Tesla shares don't trade at or above $360, then Tesla will owe $920 million upfront, meaning Tesla will need to raise capital in 1H2019.
A Bullish Perspective On Tesla
Here are the key things that I'm worried about with the Tesla bear thesis:
- Massive consumer attention and love for the Tesla product lineup.
- Tesla has produced EVs for years now, whereas competitors have only started on the EV production process.
- If Tesla is able to pull away as the leader in autonomous driving a SaaS business model could emerge with autonomous ride sharing, sending shares much higher.
- Tesla has historically been able to pull a rabbit out of their hats in terms of raising capital. And while I believe it will be getting increasingly difficult to raise capital over the next many years, Musk could pull a rabbit out of the hat again.
Tesla has become massive attention and love from people all over the world. Their Model S, Model X, and Model 3 have captivated millions, with it comparable to the hype surrounding the iPhone. The key to Apple's underlying success was their ability to captivate the imagination of consumers around the world, and create an everlasting golden brand. They are then able to leverage this brand to charge high prices at extremely high gross margins. While the iPhone cost little for Apple to produce, they were able to charge high prices. While Tesla might not be able to generate the gross margins of Apple, having an extremely strong brand can create pricing leverage. However, Tesla's "golden brand" is rusting a bit with Elon Musk's erratic Twitter behavior and vicious attacks on the media and short sellers. If he continues, a key pillar of the bull thesis will crumble.
The next bullish point is the very real fact that Tesla is ahead of the competition on EV production. While the competition has the resources to adapt EV production at a faster rate than Tesla, and eventually catch up and pass Tesla, that's still years away. You can invest as much as you want, but the raw experience Tesla has building cars is unmatched by the competition. This is the reason for the push out of production in the Porsche Mission E and even near-term competitor Jaguar i-Pace. It will be a hard and grueling process for these legacy auto OEMs to master EV production, by which time it's reasonable to believe that Tesla could be way ahead of the competition. So a lack of competition for the next many years and the evolution of the auto industry from ICE to EV could allow Tesla to hold a monopoly for the next few years until competition hits scale. But it could be an Apple-esque moment where Tesla is far ahead of the competition and creating a booming market before the competition tries to get back at Tesla. There's no doubt in my mind that Tesla will face long-term competition, my question is the scale and viability of that competition
One of the risks I pointed out with TSLA's stock is the elevated multiple the company has relative to other automakers like GM and Ford. While TSLA's multiple is much higher than the auto competition, if the market reevaluates Tesla as a SaaS company instead of an automaker, the multiple shouldn't be at the levels of an automaker, but those of a tech stock. Here's what I mean:
Many believe that the autonomous driving race is five main players:
- Tesla
- Waymo
- GM
- Uber
- Apple
And the rest are the runner-ups. But there are those who say because of the billions of miles Tesla has racked up, it's the leader in autonomous driving. Morgan Stanley believes that Tesla's currently non-existent autonomous driving ride-share services are worth ~$95/share. That's significant, and while Tesla doesn't have such service up and running right now, if Tesla can eventually utilize these billions of miles to create one of the best autonomous driving platforms in the world, then Tesla will no longer be valued like an automaker, but like a software company. The valuation will no longer be 2-3X revenue, but 6-7X revenue. This isn't as much a revenue/profit opportunity as much as it is a definition of the business Tesla operates in.
Finally, betting against Elon Musk and Tesla has been a terrible long-term strategy since 2010, with the stock up almost 1,500% since the IPO.
Who knows, maybe Elon Musk and Tesla will be able to pull a rabbit out of their hat, and continue to execute on cash burn and negative working capital. To this date, betting against Tesla and Elon Musk has not worked.
Conclusion
Tesla's current share price is dictated by hype that may or may not materialize. And while shorting is not for the faint at heart, Tesla's broken financials and inherently cash burn based business model may eventually destroy the company. When a financial meltdown inevitably hits the global economy, Tesla could be swept away. And even if Tesla does survive, the current valuation is extreme relative to other automakers, with the stock getting cut in half at six times the median P/B. All in all, Tesla remains one of my top picks on the short side. And while I'm currently not short the stock, I will most likely initiate a small short position via puts once the stock rallies again and build it up over time.
(source: TechCrunch)
