Monday, June 10, 2019

Update on Tesla

In the past, we had asked, "Why Doesn't Tesla Raise Capital?" There were such obvious signs of undercapitalization (see: layoffs, severely stretched payables to suppliers, closing stores), and the company was so richly valued compared to any competitors, yet they did not borrow money or sell equity.

Some people thought that Tesla and Musk were being prevented by regulators from raising capital. Others thought that Musk was careful raising equity because the overvaluation of the equity (which he needs to maintain) is caused by limiting the float and keeping the stock in the hands of diehard believers in him and his mission - and he was out of believers whom he could trust to not sell the shares.

Ultimately, at the beginning of May he at least settled the question of whether he is "allowed" to access the capital markets and raised $847.6 million from selling stock and $1.84 billion from selling convertible debt. (Maybe someday we will learn why he did not sell equity at far higher prices in 2017 and 2018.)

When the capital raise was announced, the most pessimistic Tesla bears were shocked and despondent. They even thought the SEC might block the deal at the 11th hour. Yet what ended up happening was that the deal closed but then stock began a precipitous decline.

The most bearish Tesla bears had been looking at the stressed balance sheet and concluding that bankruptcy was imminent - which it would have been if it was truly prevented from raising capital. Meanwhile, the bulls thought that bankruptcy was off the table because of the multi-billion dollar market capitalization. They thought that while Musk is "eccentric," the idea that the government would be intervening secretly to protect investors from him was a wild conspiracy theory. Both sides were focused on the bankruptcy argument; bears advancing it to the incredulity of bulls.

Maybe what both sides missed was that the stock was priced for growth and absolute perfection, but in 2019 the growth was reversing into volume and margin contraction, the management and business model are far from perfect, and if the valuation were simply to adjust to that of other automakers then there was (and still is) a very long way for the share price to fall. See the chart below of automakers' enterprise value to sales ratios versus their operating margins:

Tesla is in a league of its own - in a bad way. The other automakers are profitable right now, with an average operating margin of five percent. Recessions are tough in the auto business so you had better be making money when things are good. The other automakers have enterprise values (their market capitalizations plus debt minus cash) that are fractions (an average of 20%) of their annual sales revenues. Meanwhile, Tesla in the top left corner trades at an order of magnitude higher EV/sales multiple despite chronic unprofitability.

At the beginning of 2019, something happened to Tesla that a lot of analysts could not ignore: sales collapsed.

This chart (by @TeslaCharts) shows just the Model 3, but the other two models (S & X) are similarly troubled. (The Europeans in particular seem to be finished with those models.) And these volume declines are despite significant price cuts. Tesla was already unprofitable, and in a business with operating leverage like an automaker, price cuts will amplify the losses.

Without growing sales at constant profit margins (i.e. no price cuts), there is no path to profitability for Tesla, and that in turn implies insolvency. There has been a big change in tone the last few months as sell side analysts and journalists want to get in front of this story. Morgan Stanley's research analyst Adam Jonas was shockingly bearish on a call with investors on May 22nd:

  • And today Tesla is not really seen as a growth story by at least the feedback we were getting which was quite one sided. But we'll get the feedback in a minute. It's seen more as a distressed credit story and a restructuring story. So from a growth story to a distress credit and restructuring story. At the heart of this though is demand. What's changed? What's changed is demand. Right? And then from demand I could go on and say it's a cost problem but - or a debt problem which it also is - but it started with demand. That's the first domino and I won't get into too much details as there is so much public published around him. Most of our clients have vastly superior ways to look at demand than we do on a daily or weekly basis. But demand basically fell one third sequentially from 4Q to 1Q 19.
  • The gross debt as a percentage of market cap and even net debt as a percentage of market cap is really at all time highs right now on our numbers at least since at least since the it's been a public company. Gross debt - I'm giving you round numbers - is roughly 50% of revenues. When I say revenues I mean the 2019 revenue forecasts that are 350,000 unit number. 50% of revenues is debt, that compares to about 10% of revenues gross debt at Ford and GM and for Volkswagen and BMW it's somewhere between gross debt is about 2 to 5%. I mention that because on our $10 bear case you know the EV to sales is almost double Volkswagen. And again I know it's heresy to suggest that you can compare the valuation of Tesla with a genuinely class leading tech and brand positioning to Volkswagen, but you know if a company is not growing you invite yourself to those comparisons. Even at a zero dollar equity value the enterprise value to sales ratio of Tesla would be 50% or so higher than VW. It would be in the range of a BMW EV to sales at zero dollars. So the exercise of moving to 10 bucks was not so much saying "hey it's a it's a black zero or the so much a commentary on insolvency, but just to put in perspective the composition of enterprise value and how large debt is as a proportion of that enterprise value at those levels.
It appears as though insiders at Tesla have seen this coming for a long time. We have previously noted the executive departures, like David Morton, who joined as a new Chief Accounting Officer on August 6th, 2018 only to quit a month later. He had worked at his previous employer Seagate Technologies for 23 years.

The insiders who are still, for whatever reason, stuck at Tesla dump their stock instead. Jeffrey Straubel was part of the founding team and is the Chief Technical Officer of Tesla. On May 28th, he exercised his stock options to buy 15,000 shares at $31.49 and sold the stock in the high $180s to low $190s. These options were not due to expire until February 2022, so the early exercise threw away a lot of time value.

Tesla is facing serious competition for the first time, and seems to be crumbling in the face of it. If you want a luxury EV, there are the Jaguar I-PACE, the Audi e-tron, and soon the Porsche Taycan. If you actually care about the environment, there are the Chevrolet Volt and Nissan LEAF. And if you are actually frugal, there is the Toyota hybrid lineup (including the Prius) and any number of highly fuel efficient diesels.

P.S. Does anyone remember actors and actresses showing up at the 2003 Academy Awards in the Prius?


Anonymous said...

good stuff...

Joe Walker said...

You left out VW, they will clean Tesla's clock in China.

eahilf said...

Stopped following TSLA some time ago -- a real market and corporate freak show -- Musk seems more like a carnival barker than a business executive -- last I checked approx 1/3 of the float is short -- was not familiar w/ @TeslaCharts -- thanks.

"The mission of @TeslaCharts is to unabashedly serve the confirmation bias of #Tesla bears. We flow with the content curation current, providing exactly what bears most want to see. Especially helpful on days the stock goes up on bad news. Enjoy accordingly.."

That's funny.