Some readers have been confused by the suggestion of how Tesla could offer a Reward instead of taking Deposits for the Model Y. Some have suggested that my Reward configuration might be illegal. They are missing the point, so let me clarify here.
This article suggests that Musk sets challenging goals and I explore the possibility that the next goal already being worked on could be to take Tesla to net profits for the entire year 2018. I show optimistic ways Tesla could increase revenue and net profits and that these are insufficient to reach full year net profits. Therefore, to reach the goal, Tesla would need to do something unusual.
I suggest that Tesla could choose to offer some forms of rewards instead of taking deposits. This is how crowd funding start up companies get going. The rewards would partially or fully fund construction of the needed factories in the US and in China.
To realize this Tesla would need to create some form of Reward that people would want. I suggest below the following reward for a $1k purchase price:
- One Bottle of Teslaquila
- One number in a que to purchase a Model Y, and
- One Discount Coupon that if used, will get the bearer $1k off of the purchase price of whatever configuration they purchase.
The person does not have the right to return the coupon to get their money back if they change their mind and decide later to not purchase the car. So, the reward is a sale and is consummated as soon as all 3 of those items are delivered to the customer.
The coupon has zero cash value and imposes zero obligation to refund the cash purchase of the reward package. The coupon has material value since in the future, the holder could sell the coupon to someone else, along with the numbered position in line, to recover the $1k spent.
In fact, scalpers would likely purchase extra tickets hoping to later sell them to people for $2k or more just as has happened with early Model 3 cars that were offered for sale after purchase at a price higher than they had paid. So the coupon and number reservation and bottle of teslaquila do have at least $1k intrinsic value.
Some readers have contended that by offering a coupon for a $1k discount that this sort of offer would be illegal and that may be so. I am not a lawyer nor am I a certified accountant. I have been a CEO and President and have managed companies in the past. If there is anything about my offer that would not work then I would expect Tesla would create a different reward than the one I've put forward.
The point is, by using the reward model instead of the deposit model used for Model 3 car reservations, the sale is complete as soon as all 3 items are delivered. That means in essence, that the sale is complete as soon as the bottle of Teslaquila is delivered since the other two impose zero obligatoin on Tesla.
The coupon, has value. This is because the holder of the coupon could sell it to someone else if they want. Therefore once Tesla delivers the official coupon with the Teslaquila, they have fulfilled the reward obligation and the sale is concluded.
In this way, Tesla could record all of the money that comes in for Model Y becomes income, an asset, rather than as Deposits, a liability plus cash, an asset. In the deposit case the net income is unchanged. In the reward case the money is income and changes the bottom line.
In this way, whatever the reward Tesla might choose, Tesla could conceivably generate a net profit for the entire year 2018. This is something no one is talking about and it is within the grasp of Tesla if they use this methodology.
We will know by the end of November since to generate a net profit for 2018, the complete reward would need to be delivered before the end of the year so that the cash received can be claimed as income in 2018.
If we learn that the Model Y is being revealed with deposits accepted around the end of November, this gambit may be at play. If Tesla holds to the March reveal date, then profits for the entire year 2018 are unlikely.
The stock price would certainly jump upward if Tesla managed to pull off the reward method I describe below.
Summary of this Article
In this article, I discuss that Elon Musk is a people motivator more than an inventor. He sets "impossible" goals and then motivates his team to accomplish them.
The last goal, net profits for Q3 2018, was accomplished more than a month ago now. So, this means that Tesla has already been working on a next impossible goal for more than a month. But what new goal would Elon Musk set to top net GAAP profits of $312M in Q3?
How about net profits for the entire year 2018?
This article discusses how this goal, far from impossible, could be realized. If I'm correct and Tesla pulls a net profit for the entire year out of its Q4 hat, then I think it's safe to assert that the stock price will increase a lot.
This means going into Q4, Tesla is likely a much better bull bet than a bear bet.
Elon Musk is a Genius People Motivator
I first want to dig into who Mr. Musk really is to Tesla.
Most reporters consider the technologies his companies have created and laud Mr. Musk, calling him a genius inventor and citing SpaceX rockets and Tesla electric cars as evidence. My searches at the US Patent Office, however, indicate he is not an inventor and (for the most part) does not work on the technical solutions himself.
Tesla has 249 patents with the latest issued today as I write, October 30, 2018, for a method of curing conductive paste for photovoltaic components. This one is no doubt for the solar tiles.
Of those 249 patents, there are precisely 4 patents where Elon Musk was one of the inventors. This is clear evidence that he does not work on the nitty-gritty details of creating new technologies for Tesla.
So, if Elon Musk isn't an inventor, what is he?
To me, he is the White Rabbit running around and asking for impossible, seemingly nonsensical things. He scurries between his companies motivating other people to do the necessary heavy lifting.
This makes Mr. Musk a genius at motivating people to accomplish what is seemingly impossible. He is the visionary that dreams up impossible things to attempt to accomplish and then molds his employees' focus so that the goals are realized.
In her TED interview on May 14, 2018 (see 6:50 on), Gwynne Shotwell, President of SpaceX, confirmed my take above. She described working with Musk. She said that Elon Musk comes in and rattles the entire team with some new impossible goal. She then calms the engineering team and injects a pause to reflect on how they might reach the absurd goal Musk just suggested.
Eventually, the team buys onto the new goal, and the team begins soaring once they figure out how to do it. Later, when they get a bit comfortable after having solved the last set of goals, Elon Musk scurries in again and throws the next impossible goals onto the table for the engineers to solve.
The team repeats the solving of impossible goals over and over again until finally we have rockets landing back on earth and electric cars beating million-dollar supercars off the drag race line.
I experienced this management style first hand when I was working as a design engineer for a company (later bought by 3M) back in the '80s. During a design meeting with our CEO, John Venaleck of Associated Enterprises, I opened my mouth to explain why the idea he had put forward would not work. He cut me off mid sentence saying:
Ross, I don't care what's wrong about my idea. I'm not the engineer who understands impedance control, you and Chris are. So don't tell me what's wrong with my idea, I don't care. Tell me what we need to do to reach the goal of a multi signal impedance controlled connector to sell to IBM.
With that direction, we had a patentable solution in about 30 minutes. What's important is that John Venaleck's name is not on that patent, yet he is the one that caused it to be created. Same goes I suspect for Elon Musk.
I suspect this is what Musk does with his management teams as this is what Shotwell described. I've never forgotten that lesson and have used the frame of mind we put ourselves into following Venaleck's chiding ever since.
If true then Elon Musk's job is to constantly dream up the next impossible goals to task his teams to accomplish. This is different from inventing, it is visionary target setting. He needs to provide the vision and the direction, but he does not need to actually solve the engineering (or accounting) details.
Now, Tesla just turned in what many thought impossible: a $312M net GAAP profit. But that accomplishment is now a month behind us, and if Musk is the White Rabbit I suggest, the team must already be working toward a completely new and utterly impossible goal. In fact, the team must have been working on the next goal, about which we know nothing, for an entire month already.
Elon Musk should have landed with the next goal on October 1st after Q3 net profit had been accomplished. We are a month behind in trying to figure out what Tesla is doing next.
This begs the question: What "impossible" thing is the next target? What goal would be sufficiently impossible for Elon Musk to have set as a new target?
- I think the answer is to deliver a first net profit year for Tesla, now, in 2018.
To accomplish this would shock even the most fervent of Tesla bulls.
Review of Past Estimates, If Interested
Because reaching net profits for 2018 is so outrageous and will certainly garner me a couple hundred chidings from bears, I felt it was a good idea to list some of my past predictions for your review.
Skip this review and go to the next section if you are not interested.
I wrote two articles (Oct. and Nov. last year) where I projected Tesla would hit $500 and later $1,000 per share as the Model 3 sales ramped up.
Soon thereafter, we learned that in spite of attempting to get the production lines running, the initial machinery designs did not work and needed to be completely redesigned and then built. This fix would take 6 to 9 months, Elon Musk told us.
So, my first estimates at Seeking Alpha were very wrong. I re-calibrated my expectations going forward.
On January 8th, I projected that the Model 3 would pass the Chevy Bolt as #1 selling EV in the US that month. It did.
On May 19th, I projected a "Tsunami of sales and profits in Q3". Enough said, right?
On July 16th, I wrote "Tesla Q3: $6B Sales, Top 20 U.S. Car, And Path To Shanghai with $12B to Pay For Factories". This article estimated Q3 sales at $6B, they turned out to be $6.82B. The $12B I wrote about then appears again in this article in the form of Teslaquila, below.
On Sept. 20, I wrote "Tesla Model 3 Revenue Is #1 For U.S. Passenger Cars In August". To my knowledge, I was the first to report that the Model 3 had become the #1 selling car in the US in August in terms of revenue.
(Source: Authors article linked above)
Tesla recently used a similar graph in their Q3 shareholder letter showing that Model 3 had become the #1 selling car in the US for the entire Q3.
(Source: Tesla Shareholder Update Letter)
Then, on October 16th, a week before this past week's earnings call I wrote "Tesla Sales Soaring, Competition Failing". In that article, I reported the following estimates:
|My Estimate||Actual Tesla Performance||Error|
|Q3 Revenue||$6.78B||$6.82||+ $40M|
|Q3 Net Profit||$300M||$312M||- $12M|
Those estimates were perhaps lucky guesses, but I was amazed at how close they were.
Now, in this article, I will show how Tesla may turn in a profitable year 2018.
I am not aware of anyone that claims Tesla might turn a profit for the entire year 2018. While most news outlets are focused on Elon Musk's antics, Tesla is quietly killing legacy auto companies with performance.
Reporters are focused on the next crazy thing and missing the fact that the entire auto industry is swiftly being disrupted by Tesla. Reporters are missing that legacy auto companies are right now headed the path of Kodak and within 5 years will be in ashes. Reporters are missing all of this because they are mesmerized by the antics of Elon Musk and failing to study what the changes Tesla is introducing are causing to happen to the auto industry.
Is Mr. Musk crazy like a fox running around in a Mad Hatter Halloween costume like Johnny Depp as Captain William Sparrow, stealing the fastest ship of the British fleet? I think he is. And like Captain Sparrow, he has things thought out far in advance with everyone else reacting after the fact.
How Could Tesla Show a Profit for the Year, 2018?
There are two paths Tesla could follow to generate a profitable year.
The first path is to increase sales, improve margin, and cut spending. This is the traditional recipe that every company follows to generate profits. Analysts are focused 100% on these metrics.
Last quarter, using the above methods, Tesla improved its books by around $1B. That created a $312M net GAAP profit. To reach profitability, Tesla needs to generate another $800M in net profits over the Q3 results. The net profit Tesla needs in Q4 is a bit over $1.1B.
Reaching profitability for the entire year 2018 in this way is possible but would be extremely difficult and, in my opinion, unlikely.
The second path to generate a net profit is to do something crazy. This seems likely to be at least part of the solution as "crazy" is right up Elon Musk's alley. Elon Musk tweeted, on October 12th, what may be a clue as to his next radical action:
Teslaquila coming soon ...
Elon Musk also suggested that a Model Y reveal event might take place in March. However, Elon Musk also just announced that he had approved the final designs for the Model Y to go to production.
(Source: Electrek here)
Why would Elon Musk wait 5 months to host the Model Y reveal party if he can do it sooner?
Reasonably, Tesla could just offer deposits as they did with the Model 3 and bring in 500k to 2M reservations, or, $500 million to $2 billion in deposits. Doing this would completely eliminate any concern over the $900M debt coming due next March. Knowing this the fact that Elon Musk and Tesla claim they do not need to raise capital makes more sense.
But there is a better path than deposits. Deposits are what other car companies do.
Tesla and the Boring Company have sold or proposed to sell little kids cars, hats, surfboards, Not Flame Throwers, Bricks, and of course, Teslaquila. Are these really just to bring in a few dollars?
I doubt it. I think these have been tests to determine what a good crowdfunding reward would be, with Teslaquila the clear winner.
Tesla is certainly working on the first path, and I will show how Tesla may increase its net profit to as much as $650 to $947 million during Q4 without any antics.
But to create its first fully profitable year, Tesla will need around $1.1B. That's where Teslaquila may come in. First, let's explore how much Tesla might generate in net profit from sweat equity.
Let's SWAG a First Estimate for Q4 Net Profit
Engineers estimate outcomes by comparing projections to known and similar things. This is known as a Scientific Wild A - Guess, or SWAG for those that don't know. If it's just a guess without some reasonable foundation, then it's a WAG. Engineers trust SWAGs more than WAGs.
To begin, we know that Tesla just turned in a $312M profit for Q3. So, we only need to figure out how Q4 will differ from Q3.
We also heard Elon Musk comment in the shareholders earnings call that he expected that even in Q1 2019, where $900M will come due, that Tesla would still be cash flow positive and profitable in spite of paying off that debt in cash. Paying the debt doesn't alter profits, but it does alter free cash flow.
This means Elon Musk expects Q1 2019 free cash flow to be around $1B so that Tesla can repay $900M in cash and still be cash flow positive.
Paying the debt, of course, is easy given the company is now profitable and has more than $3B cash equivalents on hand. Why CNBC's Gasparino is writing that Tesla needs to raise cash to repay that debt is strange. Tesla could repay it today if it wanted to and going forward with profits coming in, the cash position would be replenished. Anyway, it seems reasonable that Tesla expects its net profit to grow to more than $1B by Q1 2019.
Using a simple averaging of Q3 2018 net profit and Q1 2019 projected net profit, ($1B + $312M)/2 = $656M, we could guess that Musk is targeting a Q4 2018 net profit around $650M based on this trivial assessment.
This would be nice growth, but would not be enough for Tesla to be profitable for the year 2018.
Could Tesla do better?
Q4 Net Profit Estimate #2:
Since Model 3 cars began shipping, Tesla has been building more cars than it has shipped. This fact has been overlooked by most, and bears that have noticed it ascribe it to Tesla building junk for the junkyard. At any rate, it has been stated that as much as 80% of the cars rolling off the production line, especially toward the end of Q2, were in need of some rework.
Whether shorts claimed the cars sighted in parking lots were due to a lack of demand as claimed by Electrek here, or they were scrap doesn't matter. They exist. To throw away a car that is close to good enough to sell is of course silly. You take the car, do whatever minor fix is needed, and then sell it.
Personally, I think the reports that Tesla had about 80% of its production in need of minor re-work is the reality. That's why Tesla has created a large presence in Lathrop, CA.
(Source: Electrek here)
Most car companies have to rework perhaps 20% of their cars coming off the production line. At the end of Q2, Tesla, with its new production line and logistics team, needed to perhaps rework 80% of the cars coming off the production line.
This meant the cars needed to be stored until the rework could be performed. Cars were clearly rolling off the line faster than they knew how to rework them as is evidenced in the above image.
In the table below, you can see the "dN" or change in number of vehicles in inventory. That number, dN, is simply Production minus Deliveries so that for Q3 2017 you see that 260 - 220 = +40 cars added to inventory of Model 3 cars. The total that month was of course 40 cars. In the final column, I use an ASP of $55,000 per car, though this number changed from start to today. So, this is just a rough estimate for the value of the inventory.
|Production #M3||Deliveries #M3||Inventory dN||Net #M3||~$55k Value|
One thing to notice is that in Q3 2018, for the first time, Tesla managed to rework more cars than it built in need of rework. In other words, sales exceeded production for the first time.
(Source: YouTube here)
Notice, in the center of the building, there is one bay door rolled up with a black Tesla Model 3 driving into the building. The video title claims the drone video proves Tesla is storing cars inside the building. However, reviewing many other similar videos shows cars coming to this lot from another location in Lathrop, and also, cars from this lot being loaded onto car haulers and heading south on I-5 just adjacent to the building. South of Lathrop is Los Angeles.
In other words, I suspect this is where Tesla Logistics has set up shop to fix minor problems with the Model 3s coming off the production line and then ship them on their way to the showrooms for delivery to customers.
(Source: YouTube video troopr1023 here)
FYI, the above image comes from the linked video and the author says it is an 870,000 square foot future Tesla Distribution Center.
Recall that the so called tent, aka sprung structure for production line #4 in Fremont is 137,250 square feet. This facility is large enough to be the future Model Y production factory.
More on this when details come available. Let's get back on point.
I estimate that Tesla will sell 8,750 cars more than it builds in Q4 by reducing its inventory of cars.
The revenue boost should be about 8,750 cars * $57,000 ~ $499M. Part of that is already on the balance sheet as inventory. If the claimed parts cost is $27k, then there is $30k * 8750 cars = $262M that could show up as extra profit in Q4 due to sales of re worked inventory cars. This is primarily labor paid out in previous quarters to build these cars. So, previous quarter losses will turn into Q4 net profits.
Therefore, compared to Q3 numbers:
- Inventory car sales may boost Q4 revenue by $500M, and,
- Inventory car sales may boost Q4 net revenue by $262M.
Q4 Increased Production of Model 3
In Q3, Tesla built 53,239 Model 3 cars or about 4,259 cars per week on average. The margin on those cars was 20%.
In Q4, I expect Tesla will build 5,500 cars per week on average.
Because Q3 showed that cars delivered exceeded cars built, I expect that in Q4 Tesla will succeed at delivering all of the cars it can build. It has created adequate rework facilities to handle the workload coming from the production line plus a little more.
This means Q4 Revenue from Model 3 production should be around:
$57,000 * 5,500 * 12.5 weeks = $3.92B. If I assume a margin of 25% for Q4, up from the 20% margin in Q3, then the margin from the cars built should be around $3.92B * 25% = $980M.
Repeating this for Q3 so we can find the change, Q3 numbers were:
$57,0000 * 4,259 * 12.5 = $3.03B, revenue for Model 3. Using the 20% margin reported this means about $607M margin.
Q4 net margin should increase compared to Q3 net margin by:
- $980M - $607M = $373M
Potential Growth in Net Margin in Q4 due to Model 3
Tesla could of course also cut spending further, but I'll assume it spends the same amount as in Q3 for simplicity. I'll also assume the Energy net margin is the same as it was in Q3.
This means the potential Q4 net margin would be the sum of increases from the different parts of the operations detailed above added to the Q3 net margin of $310M.
Total Potential Q4 Net Margin = $310M + $262M + $373M = $947M.
This is my first estimate for net profit in Q4 2018. This is up from $312M in Q3, and it would be an awesome outcome.
But it is not enough to transform 2018 into a profitable year.
Enter the White Rabbit
This is where Elon Musk steps in and says, "I want Tesla to turn in net profits for 2018. Find a way to do that."
It turns out there is a way to do it.
When the Model 3 was announced Tesla brought in over a short period of time, around 450,000 reservations. At $1,000 each, that totaled about $450M. The problem is that deposits show up as both cash in the bank and also, a liability called appropriately, "Customer Deposits".
For the Q3 report, customer deposits totaled $906M. In other words, people are not cancelling their orders as some bears claim.
As far as accounting for "net income" is concerned, +cash -deposits = $0. Tesla could raise a billion dollars in deposits, and it doesn't help net earnings one penny.
If there were a way to convert the liability into income, then, the deposits could have been income. Normally, for a car company, that means delivering the car. But doing that will take a few years. Enter "Teslaquila" and crowdfunding.
Elon Musk recently tweeted that Teslaquila would be available soon.
The way crowd funding works is that the startup company offers a reward to patrons for a price. Different rewards are offered for different prices. Once the reward is fulfilled, the payment becomes income.
Tesla could, for example, offer for $1,000:
- One bottle of Teslaquila
- A Model Y reservation number, and
- A coupon good for $1,000 off the purchase price of a Model Y car.
- When vehicle configuration is requested an additional $2,000 will be required.
Tesla could alternately offer for $2,000:
- One case of Teslaquila
- A Model Y reservation number, and,
- A coupon good for $2,000 off the purchase price of a Model Y car.
- When vehicle configuration is requested, an additional $1,000 will be required.
In both cases, the customer will have fronted exactly $3,000 prior to receipt of their Model Y car. But in one case they will also receive for free, a bottle of Teslaquila, and in the other case, they will receive a full case of 9 bottles of Teslaquila.
Teslaquila, therefore, becomes the free bonus for enabling Tesla to record the cash as income instead of as a liability. While this may seem like a bad deal to most, what one needs to understand is that Tesla purchasers by and large desire for Tesla to succeed. To them, this path wins them some free Teslaquila, and the case is the far more attractive option.
The tequila industry manufactures about 3 million cases of super premium tequila per year. So, if Tesla were to receive 2 million orders of the case reward, they would be one of the largest tequila purveyors in the world.
But what's more important is that if they received 2 million orders at $2,000 each, they would have received $4 billion in net income for a tiny cost to fulfill the tequila reward.
How Many Orders Might Tesla Receive for Model Y?
To answer this question, we first need to understand there are between 25 and 50 million people in the US that are waiting for the right EV based on the AAA survey. There are likely around 3 to 6 million US customers ready to purchase an EV today if the right EV existed. For many, the Model Y will be the right EV.
But orders will come from the US and China and Europe. The total could be very large, and I expect orders of around 6 million Model Y cars will be placed if Teslaquila is offered as a reward.
If 6 million people place an order for a Model Y, then Tesla could generate income of $6B to $12B. If Tesla repeats the deposit method, then the money would be cash and also a liability in the same amount as I wrote in my article July 16th.
What's really interesting about this is that $12B would be more than is required to build a couple new production lines. So, the new production lines could be entirely crowdfunded and Tesla will never again need to raise money from banks.
In chemistry or physics, this is a positive feedback loop. It is where the income generated exceeds the cost of building the next production lines.
No other company of this scale has ever managed to develop a product that people wanted so much that they would partially pay for it in advance to help the company build the production lines.
This is normal for crowd funding of new products. But it new for a car company. Tesla could pull this off because it has succeeded at building the Model 3 production lines so that the company has gained credibility with customers. Tesla has the best EVs and the best charging infrastructure, bar none.
Will Tesla use Teslaquila to generate income with which to generate a net profit in 2018? Will Tesla use Teslaquila or other rewards to fund the construction of new vehicle production lines? We will know very soon.
Based on possible company improvements, Tesla may manage a net profit for Q4 between $650M and $947M. Either of these would be a fantastic improvement. Neither of these would be sufficient for Tesla to claim a net profit for the entire year 2018.
I expect Tesla will use Teslaquila as a crowd-sourced funding reward with which to earn several billion dollars in income. If so, Tesla will be profitable in Q4 no matter what the other financial metrics turn out to be.
If we learn of a Model Y reveal event in late November or the first week of December, then Tesla may be attempting to convert 2018 into its first profitable year via Teslaquila being offered as a reward in place of deposits.
If Tesla does this, I would expect the share price to jump by more than $100 and also that Tesla will generate income from rewards that will total between $6B and $12B when the rewards are all delivered.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.