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Full Elon Musk Email Confirms He Doesn't Know The Difference Between Income And Cash Flow

|Includes: TSLA, Tesla, Inc. (TSLA)

Bloomberg has now posted the full Elon Musk email / memo, excerpts of which had been leaked a few days ago. Sometimes a very short text can reveal a lot.

Let's cut to the chase. Elon Musk claims:

The third quarter will be our last chance to show investors that Tesla can be at least slightly positive cash flow and profitable before the Model 3 reaches full production. Once we get to Q4, Model 3 capital expenditures force us into a negative position until Model 3 reaches full production.

...

Right now, we are tracking to be a few percentage points negative on cash flow and GAAP profitability, but this is a small number, so I'm confident that we can rally hard and push the results into positive territory. It would be awesome to throw a pie in the face of all the naysayers on Wall Street who keep insisting that Tesla will always be a money-loser!

This is nonsense: the amount Tesla invests in capital expenditures has almost nothing to do with its chances of reaching profitability this quarter, or the next, or the one after the next.

This is really basic: capital expenditures are not expensed as incurred. If you spend $15 million towards a truck fleet this quarter, this amount of money will not show up as a cost in your profit&loss account - yet. Rather, the cost will be recognized over the useful life of the trucks. If it's 15 years, then that's $1 million a year or $250,000 per quarter. In accounting jargon these costs are amortized or depreciated; one can also say that cost recognition is deferred or delayed.

With a sprawling facility like the Gigafactory, rather than a single 'finish date' and depreciation time, there are many, for the Gigafactory is made up of many sections (some of which are already up and running) and devices. Still, the money that will be invested this quarter by definition cannot have an impact this quarter, only in future ones when the asset will depreciate.

Okay, okay - the asset won't be finished precisely the last day of the quarter, so in reality a small amount of depreciation will take place in the very quarter you're spending the money; that's why I said 'almost nothing' before. But the impact in any single quarter is very small, even if the full 90 days go by.

For example, imagine Tesla actually invests the $1.74 billion it's supposed to invest in the year's second half. Let's assume that sum is split 50/50 between 16Q3 and 16Q4. What would happen?

It all depends on the assets' depreciation time, but a good rule of thumb is that carmakers spend 1/10 of their property, plant and equipment per year just to keep up with depreciation; in other words depreciation is about 10% per year, or a depreciation time of 10 years. Per year, that's a depreciation cost of $87 million; per quarter it's $22 million.

So if Tesla spent that much the result would be a loss of $22 million in the last quarter of this year, and $44 million in the first quarter of 2017. The company is supposedly aiming to sell 30,000 cars in the last quarter, for revenues of about $3 billion, so the impact should be less than 1% in operating margin. In short, the idea that capex will keep Tesla from profitability is wrong.

This is assuming the entirety of the money spent results in capital expenditures projects being completed; in reality part of the money will go into projects that remain unfinished by the end of these quarters, and thus will not start to be depreciated (and won't be recognized as a cost by Tesla) until a later quarter.

Once you're sloppy, twice you're...

One could claim this was just a momentary confusion on Musk's side. But exactly the same mistake appeared in the last earnings call (page 12):

Elon Musk:Well, if you exclude Model 3 CapEx ramp, then - well in fact, really for Q3 and for Q4, Tesla would be profitable excluding the Model 3 CapEx ramp.

And again, in page 14:

Jason Wheeler: Yeah, sure. On the profitability question, just reiterate what Elon said earlier. If we can execute on our production and our delivery goals in the second half of the year, we got a great chance to be non-GAAP profitable. So...
Elon Musk: Yeah, excluding Model 3 CapEx.

Also notice that while Elon Musk's email doesn't directly say capex will hit GAAP profitability, he appears to treat the former as equivalent to 'cash flow', saying both are 'a few percentage points negative'. There is no question this 'cash flow' is the contraption the company calls 'core operational cash flow', which has nothing to do with capital expenditures. This time the 'nothing' is literal: by definition, the difference between operational and free cash flow is that the latter subtracts capex, while the former doesn't.

How good is Musk with numbers, anyway?

You be the judge.

  1. The original Hyperloop proposal which he had been hyping for a year was a joke. Among other things he overestimated train energy consumption five-fold.
  2. Tesla claimed the solar panels (still not) mounted on Superchargers would provide more electricity than cars consumed. This is just absurd - the specific numbers will depend on station, but there is no question cars will consume several times more than the panels can generate.
  3. Elon Musk claimed switching from gasoline to electric cars would actually save electricity because of reductions in refinery activity. In reality, these reductions can only offset about 1% of the increase in electricity consumption coming from electric cars*
  4. He also claimed solar panels could generate more electricity than nuclear on a same-area basis. This is off by a factor of about 200.

With such a track record no wonder he usually avoids hard figures and goes for vague, off-the-hook vocabulary.

*Yeah, link in Spanish; I couldn't be bothered to re-write it in English. If you want a summary I can provide one in the comments.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.