Tesla In The Rearview Mirror

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About: Tesla, Inc. (TSLA)
by: Rogier van Vlissingen
Summary

Tesla is the spawn of the political wish to ostensibly do something about climate change.

With the mounting list of broken promises, executive departures and lawsuits against the company, the expected financial disappointment for Q2 will merely be the confirmation of the obvious.

Clarity, transparency and accountability for sustainability have always been far too hard to find, and this enabled unclear objectives.

Politicians were only too eager to run up the taxpayer credit card and were the midwives.

The consumer use case and the regulatory use case for the BEV strategy are both dead.

As a disclaimer, I want to state clearly that I'm as green as the next person, i.e. not very, but I'm trying, very very trying. However, because of my business involvement in the energy retrofit field, I'm constantly bewildered by today's corporate culture of "commitment to sustainability," combined with a seemingly complete ignorance of corporate finance, and project finance in particular.

With Tesla (TSLA), we seem to have arrived at a magical inflection point, where the company has made a lot of noise about "record deliveries," which at 95,200 surprised most active watchers and made some question if these are really all end-user sales. But the real spoiler is the overwhelming evidence that both multiple announced price reductions and some "unofficial" discounting are going to produce substandard returns for the quarter, even if the number of sales is real. Combined with the halving of the tax incentive in the US per July 1, the general expectation is that the company has moved future sales forward on a massive scale. Not only would they have less income in Q2 from moving more metal, but they dug themselves a hole to the point that Q3 promises lower prices and lower volumes. Investors and traders are on the lookout for the financials, to see what actual results the company is going to post and expecting a let down. However, the real story of Q219 may well be that the mythical business assumptions on which Tesla is based is coming undone in a major way. We explore.

The Myth Unraveling

From the earliest days, when Elon Musk was actively promoting Tesla, he was very vocal about the idea that hydrogen was baloney and hybrids were a silly mistake. The major contrarian analysis from environmental circles was that the lifecycle entropy/pollution from a BEV was more or less the same or greater than from an ICE car, albeit pollution was moved from the city to the country, from the tailpipe to the smokestack, and the mining of raw materials and recycling at the end of life of the car. Musk acted as the prophet who rationalized BEV as the only way forward, pooh-pooing the alternatives, while most notably Toyota (NYSE:TM) de-facto committed themselves to a hybrid path, holding out hydrogen as a likely ultimate future.

Recently, some refreshing general criticism of the whole climate change argument has arrived to begin with some common sense about the climate debate, courtesy of psychology professor Jordan Peterson, in which he notes that the issue fosters more disagreement than agreement. In short, it's perfect territory for unquantifiable aspirations and more disagreement. Frankly, if we all just learned some finance and economics and a smattering of civil and electrical engineering, more would get done by practicing proper capital allocation than attending the next conference on sustainability. Technology has advanced far enough that energy retrofitting is frequently a superb intra-marginal investment with high alpha and low beta. Compared to that, the dubious economics of the ICE>BEV transition appear debatable and not worth the fuss.

Teslahas become the poster child for environmentalism gone wrong. It will become more evident in due course, since the financials of the company are rapidly deteriorating, quality problems are mounting, and the environmental analysis is progressively invalidating the business premise. Musk just captured the spirit of the times, and at least for a while did well enough with it, at least personally and with his family (remember SolarCity?). What's not clear to me if he himself believes any of what he's saying or if he's a mere opportunist. Certainly de facto, he was a brilliant opportunist, but presently the story is unraveling fast.

Tesla's 2Q19 will prove devastating enough to know that the world has passed them by and time is running out amidst more competition, but also a decline in car sales overall. In this article I hope to lay a contemporaneous foundation for the post mortem.

Exploding the Environmental Myth of BEVs

The above-cited piece from Jordan Petersen is extremely relevant, a climate of that much disagreement is an ideal setup for hard-to-quantify objectives. It pays to realize that Musk just played the role of messiah in a play that derived its meaning from the desperate need of politicians to give the appearance of doing something about climate change. If 80% of success is showing up, Musk appeared right on cue. And he's the evident master of filling in the perceived need - and we may indeed wonder if he himself believes any of it, for he is certainly not living it with his GS650, his mansions and other paraphernalia.

More specifically relevant to Tesla are the excellent articles here on Seeking Alpha, from John Peterson, including his most recent one Long-Range EVs are the antithesis of efficiency and sustainability. If John Peterson can be suspected of being an old grouch who is probably long oil, Green Car Reports came to the rescue on July 2 with an article titled Analysis finds hybrids make better use of scarce batteries than pure EVs. That puts the idea in the environmental mainstream. The focus of the analysis has shifted now from the all-inclusive life cycle cost of the car, which may still be relevant also, to the big picture of how do we get the most bang for the buck in terms of reducing emissions, and it seems pretty convincing that the total effect is that the displacement of emissions by the hybrid strategy is very favorable indeed, for a hybrid car will do a lot of local driving on electric energy with decent performance, but still have a range that's higher than most regular ICE cars. Many hybrids post spectacular numbers for range, with admirable torque. In short, the policy argument for BEV has gone up in smoke. The environmentally-sound path forward is hybrids now, FCEV later.

What a rational analysis of this type reveals is that in a hybrid you can have spectacular range, and quite peppy performance in the 0-60, if not the rubber burning performance of BEVs. However, if you have to visit a supercharger just once, the incremental time compared to buying gas will make up for the seconds saved, by doing 0-60 in 5 seconds versus 7 or 8, even if we assume that you can do that with regularity. It was a sexy idea to sell high torque with green credentials, but in real life the advantage may be elusive.

Meanwhile, on a more general level it's evident that some more critical thinking is in order. Germany is having second thoughts about the real economics of its "Energiewende," which has nearly doubled the cost of electricity in the last 15 years. The issues of climate change and sustainability have definitely achieved cult status, as brilliantly analyzed in this blog post by Alexander Marchand, where he lays it out fine how the climate change issue has become a cult, and woe be to anyone who dares question it. There's an orthodoxy that's based on dogma and entirely beyond challenge. Alex's comments are evidently applicable to investments, with Tesla is a prime example. For politicians, it proves irresistible to embrace a cause that's so fuzzy, they escape accountability, although New York's Gov. Cuomo will likely have to have an Easter egg hunt for the elusive Buffalo Billion, once the Riverbend project comes to a predictable ignominious end without recourse to a bankrupt Tesla, or even Panasonic.

Professionally, I constantly get to deal with the endless and mostly pointless conversations about sustainability, and usually my attitude is that if we talked finance, economics and engineering, we'd be accomplishing a hell of a lot more sustainability than with the public charade of sustainability agendas, which mostly are the material for feel, good events for employees and shareholders, as well as to beef up public perception, but are often lacking in rigorous management and financial accountability. Energy retrofitting is often so wildly profitable and a high alpha, low beta investment, that it should feature prominently on the agenda, but too often it's relegated to O&M management in companies and does not get its place in the sun at capital allocation time. The result is more talk than action.

The upshot is that there's no rational discussion to be had about climate change, but more rational assessments are circulating, such as this piece from the Manhattan Institute on Inconvenient Energy Realities. In terms of my own involvement, my focus is entirely on the intersection of finance, economics and engineering, and my vision is that renewable energy retrofits in many cases are superior investments, as is often the case with quality intra-marginal investments. What I mean to say is that from a standpoint of capital allocations energy retrofitting should probably be a corporate priority for the next 20 to 40 years. More would get done with proper financial analysis than with more talk about the environment or "green" agendas.

How bad is it right now?

Too many words are being spilled, and Musk has a good way of diverting the attention to everything that does not matter, but here are some observable facts:

On Twitter @orthereaboot reports that Tesla has fallen from the 8th percentile of financial risk to the 3rd in reporting from D&B, paying within terms only 46% of the time.

Harder to quantify is the fact that warranty reserves seem to be going down, but warranty claims and various lawsuits seem to go up. And Tesla dockets on Plainsite are showing robust growth and very few of them are small claims matters.

The Model 3 hangover

The hangover from the quality problems will be ferocious. Someone close to me just went shopping for a new car, and was strongly pressured by one of their kids to go with Tesla, while he drives a brand new Toyota Tundra, and not a Tesla, because he "needs a truck." When confronted with all the reports and the fact he has not yet cashed in his deposit, nor asked for a refund, he will argue that "at least he made money on Tesla." We'll see about that when the stock finally really crashes and he loses his deposit for good. Like some other people, it seems as if Musk could shoot someone on Fifth Avenue... for he does the equivalent thereof every day with his lifestyle, yet people continue to treat him like an environmental prophet.

For now, the type of illogic cited here is what sustains the buying public for Tesla, as well as retail investors, as the Robin Hood site attests. A mixture of green intent, and magical profit expectations (stock going to $4K per ArkInvest) are what has fueled the cult. There will be lots of tears as all this evaporates, the money along with the green pretenses. What really blew the lid off recently was the comments by BMW, that there's essentially no European demand for BEV, but there is for hybrids. HEV and PHEV are going to be the way to go, according to BMW, and that means automakers like Toyota and BMW may come out ahead. Combine that with the fact that the Chinese government is rolling back BEV stimulus and shifting $17 billion in incentives to FCEV. BEV demand may be strong in the short run, and that picture is likely to change as a hydrogen infrastructure arises. There already are taxi services running on hydrogen, and in long haul trucking it seems clear that the hydrogen fuel cell weighs less than the batteries you would need for long distances. In short, the consumer use case for BEV is dead (see this British YouTube video about the best hybrids for 2019), plus, as both California and China are driving the ICE>BEV transition with incentives, and China already has given up, the future is getting decidedly murky.

From a pure investment standpoint what will matter is if we learned anything or not. I'm betting we won't. People are awful resistant to learning from anyone else's experience. Tesla will be a virtual postscript to Mackay's Extraordinary Delusions And The Madness Of Crowds and it should be studied in conjunction with Robert Burton's The Anatomy of Melancholy, with the cover text of my edition saying: "His conclusion, that the world is mad, seems as pertinent today as it was when the book first appeared."

Tesla's 1H19

The first half of 2019 is when Tesla will demonstrate how to make less money with more sales, and the growth story is undeniably over. The quality of analysis that's taking place on Tesla is breathtaking. The TSLAQ community on Twitter is extraordinary, and there are tons of good articles here on Seeking Alpha and even in the mainstream press. Lora Kolodny on Business Insider, and Charlie Grant at the Journal are some of the people who have seen through it since quite some time and methodically have exposed the pretense for what it is. If you're still in doubt, you can follow the dockets on Plainsite or occasionally check the broken promises on Elon Musk Today, or the Tesla Deaths spreadsheet, not to mention the ever growing list of executive departures. The most interesting departure of late may well be Peter Hochholdinger moving to Lucid Motors, where he may get a chance to do it right.

The effective obsolescence of the business assumptions behind Tesla is a fascinating corollary to the deteriorating financials.

The Altar of the Sustainability Cult

As Jordan Peterson helpfully points out in this video, the language of Greek myth is so very helpful, because discussing the major psychological drivers of our lives as "gods" who we serve and pray to is very helpful indeed. The whole discussion about the transition from ICE (Internal Combustion Engine) vehicles to BEV (Battery Electric Vehicles) is a case in point. The more you study it, the more ambivalent you get, for different environmental analyses conclude that the lifecycle cost of BEV may be worse than ICE, while some others lean the other way. In my business, I realize that only one thing matters and that's proper financial decision making, but in the consumer market, mythology is all powerful. Recently, former Energy Secretary Steven Chu spoke out about the best-kept public secret that meat and agriculture are worse for the climate than all of power generation and transportation. This issue already was starting to be discussed in the late seventies, so it has taken almost 50 years before it's gaining some notoriety. Having it come from Chu surely lends credibility. In round numbers, producing the same amount of protein from beef vs. from plants makes an order of magnitude (tenfold!) difference in the dimensions of land, water and GHG emissions. Not to mention Americans over consume protein by a factor of 2-3 anyway. So a lot can be done here that has more impact than changing from an ICE to a BEV vehicle, and in the long run, hydrogen vehicles may provide a powerful alternative, since they are easier to refuel.

How to look at a business plan

Tesla’s mission is to accelerate the world’s transition to sustainable energy.

That, to me, sounds like a mission statement for a non profit, not a business. The results confirm that impression. Throughout the communications from Tesla there's this appeal to "green," but nowhere is there an actual analysis of the claims and a very defensive attitude about possible alternative solutions. The whole ESG market segment is full of these types of woolly claims, and it should be the first sign of trouble. If solving climate change were that easy, we would be doing it already.

I used to follow SolarCity when it was its own business, and did a fair amount of research on it, so needless to say I saw it as pretty ridiculous when Tesla bought out SolarCity and acquired another boat anchor. Everything since then has only confirmed that impression and they have done nothing but paring back the remnants of SolarCity in a vain attempt to stanch the hemorraging, held back mostly, or so it would seem, by their obligations to NY State over the Gigafactory #2 at Riverbend in Buffalo, which accounts for three quarters of the now infamous Buffalo Billion.

After looking at SolarCity for a while, I never bothered to look into Tesla very deeply, particularly since there already was an army of highly competent analysts who were more than on top of the situation. Since that time it has evolved into an incredible online analytical and research operation, affectionately known as $TSLAQ. That Tesla has been able to go on as long as it has, demonstrates only the power of myth. Musk is quite capable of guilt shaming people into buying a Tesla, while commuting around the world by jet himself.

Regulation, Subsidies and Other Nonsense

A brilliant opinion piece in the WSJ says Get Ready for a Pileup, Tesla, documenting exactly how all the legacy automakers are subsidizing their EV portfolios from ICE car revenues, while Tesla is having to make money from BEV only. Next, we are greeted by new attempts to propose more federal subsidies for electric cars. Put side by side, you get the picture of why investing in Tesla is more like gambling than investing, or perhaps people are simply paying their dues to a cult. We've seen in other jurisdictions how Tesla's sales collapsed with changes in the subsidy regimes (Hong Kong, Netherlands) and the US can now be added to the list since Tesla's tax credit was cut in half at the end of last year, with results that indicate just how powerful these incentives are. The next halving was July 1. Will Tesla have to lower prices again?

Meanwhile, there's a growing sentiment that in the long run hydrogen vehicles will exist in parallel to BEVs and hybrids. Toyota (and others) appear to do well enough with hybrids, and producing cars with long, all-season range, like up 400-600 miles, which undermines the use case for all electric cars. The plans of Nikola also make it clear that they see BEV as a short range solution and hydrogen as better for the long range, since the lesser weight compared to large batteries directly translates into more cargo hauling. Japan Inc. is committed to the hydrogen future, and people love their Mirais. In short Tesla chose a niche that's hard to defend.

On the positive side, we should note that Sandy Munro is now quite laudatory about Tesla's technology, in spite of his initial withering criticism of the Model 3, including mention of the possibility of Tesla eliminating almost all of the wiring with a hyperlocal wireless communication system for the cars. It remains to be seen how far that will get.

Conclusion

Regardless of how the market deals with the inevitable revenue disappointment of Q2 financials, the wolf is at the door for Tesla with an incredibly tough Q3 ahead, amidst avalanches of new competition from established automakers. Meanwhile Tesla's business assumptions are being ripped to shreds and the use case of BEV in general is becoming more dubious. The bigger question will be how foolish were the big automakers by jumping head over heels into the BEV game, however much it is understandable for those who were fleeing the aftermath of dieselgate, and like Volkswagen (OTCPK:VLKAF) were almost forced into picking this option. But the consumer use case for BEV is up for question, certainly in Europe as BMW points out. Even California might eventually figure out the dubious environmental benefits.

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.