Tesla Value Analysis (aka, why I'm short)
The day after the now infamous "Funding Secured" tweet, I took a short position in Tesla. I had been planning a short position for some time, though I thought the stock might reach $400, and intended to await that before establishing the position. The fallout I anticipated after the tweet caused me to advance my timeline. It seemed apparent that TSLA may never reach $400. At any rate, my analysis of the financials has led me to conclude that the company will face a cash crisis in the fourth quarter of 2018 and will require additional funding. If the funding takes the form of bonds, the interest rate will be high and the money expensive. If it takes the form of additional equity issues, it will dilute current shares and decrease the price. Additionally, requiring more capital will reflect poorly on CEO Elon Musk and the Board of Directors, and will renew discussions of viability of the company, potentially further reducing the share price.
Here are some numbers (sorry I can't make this larger):
This is a little spreadsheet I created from five years and two quarters of SEC fillings. I've left out interest income and income taxes as they're really irrelevant to my analysis. All of the quarterly numbers are in the thousands; all of the "per delivery" numbers are in Dollars (and cents). To the largest extent, my objective in creating the spreadsheet was to isolate auto sale profits and expenses so I could have a better idea of whether increasing volume would have a chance of decreasing losses. Tesla has the stated objective of becoming "sustainably profitable" in the second half of 2018. Tesla delivered approximately 11,000 more vehicles in 2Q2018 than 1Q2018. In so doing, Tesla lost approximately $40 million more than in the first quarter, or about $3600 per incremental unit delivered. In losing almost $790 million (before other income and taxes) during the quarter, Tesla has a large hole to fill. Here's some perspective. Tesla lost over $19,000 for every vehicle delivered in the quarter. Were Tesla to figure out a way to sell $60,000 Model 3s with no associated cost, they would need to sell over thirteen thousand more to break even. If Tesla is able to sell Model 3s yielding $17k gross profit per vehicle with no additional expense in SG&A, Interest or R&D, Tesla needs to sell over 46,000 additional vehicles to break even, or a little more than double their current volume. Of course, neither scenario is likely, so we must dig deeper into the financials to get a more accurate idea of the task ahead of them.
It's useful here to note that franchise auto dealers (I'm an auto dealer) produce monthly financial statements sent to their manufacturers and finance sources that give much greater detail of income and expenses than what Tesla provides shareholders quarterly. Auto dealers produce statement of income and expense that look like this:
These are just two excerpts from a year-end statement for a Hyundai store that I sold several years ago. They're being used here merely to illustrate that a much greater level of income and expense detail could be released by Tesla in their quarterly filings if they had that desire.
Some Per Delivery Analysis
Back to the spreadsheet, in 2Q2018, Tesla had gross profit of almost $17k per delivery. Unfortunately, they spent over $34k per delivery on R&D, SG&A, Interest and Restructuring & Other. They lost about $19k per unit delivered for the quarter. In the prior quarter, Tesla lost almost $25k per delivery. So, 2Q2018 represented a significant improvement in gross profit generation and expense control on a per unit basis. A quick note on Restructuring & Other expenses: Tesla provided this description of this expense category, "Part of the restructuring cost was related to a reduction in our workforce." The 2Q2018 10-Q remained unavailable as of this writing, so perhaps more explanation will be provided there. However, this explanation felt inadequate for a large expense in a category that was never previously used.
Needing to narrow things down a bit further to the Per Delivery level, I then created this spreadsheet:
In this one, I tried to evaluate Tesla's variable expense in selling a car. As a car dealer, being that I produce a detailed financial statement monthly, I am able to quickly determine what it costs me to sell a car by adding my sales personnel, advertising, interest, and other smaller variable expenses. From this, I'm able to easily determine how many cents in net profit should be derived from producing one extra dollar in gross profit. This analysis ignores fixed expenses (real estate, insurance, etc.), as those expenses are theoretically already being covered. However, Tesla doesn't provide us with much detail. Tesla only reports "Selling, General and Administrative Expenses." In 2Q2018, this figure was $750 million, or about $18,400 per vehicle delivered. In the prior quarter, it was almost $23k per unit delivered. Again, this is a substantial improvement and should not be discounted. Unfortunately, it still results in a net loss per vehicle of about $1500, before considering any other expenses.
SG&A Will Continue to Increase
Some have argued that SG&A will not continue to increase, as Tesla has already paid for sales facilities, etc. This is partially true, but mostly false. Selling more cars requires more personnel to sell and delivery and maintain the cars; thus, though Tesla may not add many more facilities, they will continue to add personnel. From 1Q2018 to 2Q2018, Tesla delivered about 11k more vehicles. During that period, SG&A increased about $65 million, or almost $6k per additional vehicle. Fortunately, this is far below the average of $18400 per vehicle. At this rate, after SG&A Expense is applied, Tesla keeps about $11k of gross profit generated from incremental sales volume. Unfortunately, R&D, Interest and Restructuring Expenses were over $16k per unit for 2Q2018. Thus, we have to analyze the incremental direction of these as well.
Restructuring can arguably be ignored. Tesla has only used this category once and may not need to use it again. R&D and Interest Expenses added to about $13,500 per unit delivered in 2Q2018. This was a substantial decrease from over $17k per unit delivered in 1Q2018. R&D Expense only increased $20 million from the first quarter, or about $1800 per incremental unit. Interest increased $14 million during the period, or about $1300 per incremental unit. Arguably, neither increases on a per unit basis and Tesla could make a decision to allow increases in neither, perhaps even a decrease in either. Decreasing interest would require paying some debts; decreasing R&D may be more realistic, depending on new product plans. Tesla provided guidance of $170 million in interest expense in the third quarter, just $7 million more than the second quarter. Additionally, Tesla received about $5 million per quarter in interest income. I have not included this on my spreadsheet as it has fluctuated very little. My objective has been to isolate variable income and expenses. The total per unit incremental increase in R&D and Interest for 2Q2018 was about $3100 per unit additional unit delivered. Looking forward, I believe $1500 is a very conservative estimate for the additional increase we may see. Granted, this is less than half the 2Q2018 increase and is a total guess; however, these expenses are not closely tied to actual sale volume and the company does have some control over these budgets. Additionally, I want to produce a number of required sales units to break even, and I want this number to be reasonably conservative.
Using $1500 per incremental unit in increased R&D and Interest Expenses, and ignoring Restructuring Expenses, incremental sales should produce roughly $9500 toward bottom line profits. 2Q2018 loss before Other Income was roughly $790 million. Thus, according to this analysis, Tesla would need to sell an additional 83,000 vehicles in the third quarter to break even. This would roughly triple the 2Q2018 delivery volume. Producing and delivering 125,000 vehicles per quarter requires Tesla to build approximately 10,000 vehicles per week, exactly the number Tesla has cited several times as an objective. The fourth paragraph of the 2Q2018 Shareholder letter states this in the first sentence. It's worth noting, however, that the first paragraph in the letter cites 7,000 weekly production will enable sustainable profitability. I have to disagree with that statement.
Bizarre UBS Report
As reported by the Wall Street Journal on August 16th, UBS performed an analysis of Model 3 profitability and determined that Tesla is generating an "operating profit" of over $3200 per vehicle. The article goes on to suggest, "That would help explain why Mr. Musk is forecasting a profit in the third quarter." I don't completely follow this line of reasoning. If UBS determined that Tesla profits $3200 per Model 3, and we expect all incremental sales to be Model 3s for the foreseeable future, then Tesla needs to sell an additional 246,000 Model 3s in the third quarter to break even. This is 19,000 per week, in addition to the current volume of perhaps 5,000. For the article to make sense, WSJ is suggesting that Tesla expects to qunituple sales immediately; thus, Mr. Musk has predicted a profit. Tesla has predicted no such volume increase and there's no conceivable argument for the possibility of this occurring. The article goes on to suggest that profitability may be possible. I asked the author, Tim Higgins, some of these questions on Twitter, but haven't received as response.
Some Final Words
Tesla ended 2Q2018 with about $2.2 billion in cash, having burnt about $1.7 billion in the first half of 2018. Tesla estimates that they'll burn a little less than $2.5 billion for all of 2018, or about $800 million in the second half of 2018. However, they also estimate that they'll become cashflow positive in the second half of 2018. These statements appear inconsistent, unless Tesla expects to reach positive cash at the very end of the second half. At any rate, burning another $800 million leaves less than $1.5 billion in operating capital. For a company their size, this would almost certainly result in the need to raise capital, unless of course they are truly cash flow positive. Assuming this won't happen, let's try to estimate the timing of hitting the $1.5 billion mark. Having burnt $740 million in the second quarter, Tesla could hit $1.5 billion as soon as the end of the third quarter. However, assuming some real progress in production rate, as appears to be happening, I estimate the third quarter cash burn is closer to $500 million. This assumes Tesla will build and deliver about 20,000 more vehicles in the third quarter versus the second quarter. That's a fifty percent increase, so it's very aggressive. An additional 20,000 units delivered provides about $200 million to the bottom line, reducing cash burn to perhaps $500 to $550 million. This leaves about $1.7 billion in cash. Continuing at about that rate, Tesla will fall below $1.5 billion sometime around mid to late November, perhaps early December if they can slow it further. These are all estimates from the sky, but it's hard for me to comprehend increasing deliveries more than fifty percent one quarter to the next. I could, of course, be wrong. So, you should take all of this with a grain of salt.
Here are some numbers (sorry I can't make this larger):
This is a little spreadsheet I created from five years and two quarters of SEC fillings. I've left out interest income and income taxes as they're really irrelevant to my analysis. All of the quarterly numbers are in the thousands; all of the "per delivery" numbers are in Dollars (and cents). To the largest extent, my objective in creating the spreadsheet was to isolate auto sale profits and expenses so I could have a better idea of whether increasing volume would have a chance of decreasing losses. Tesla has the stated objective of becoming "sustainably profitable" in the second half of 2018. Tesla delivered approximately 11,000 more vehicles in 2Q2018 than 1Q2018. In so doing, Tesla lost approximately $40 million more than in the first quarter, or about $3600 per incremental unit delivered. In losing almost $790 million (before other income and taxes) during the quarter, Tesla has a large hole to fill. Here's some perspective. Tesla lost over $19,000 for every vehicle delivered in the quarter. Were Tesla to figure out a way to sell $60,000 Model 3s with no associated cost, they would need to sell over thirteen thousand more to break even. If Tesla is able to sell Model 3s yielding $17k gross profit per vehicle with no additional expense in SG&A, Interest or R&D, Tesla needs to sell over 46,000 additional vehicles to break even, or a little more than double their current volume. Of course, neither scenario is likely, so we must dig deeper into the financials to get a more accurate idea of the task ahead of them.
It's useful here to note that franchise auto dealers (I'm an auto dealer) produce monthly financial statements sent to their manufacturers and finance sources that give much greater detail of income and expenses than what Tesla provides shareholders quarterly. Auto dealers produce statement of income and expense that look like this:
Some Per Delivery Analysis
Back to the spreadsheet, in 2Q2018, Tesla had gross profit of almost $17k per delivery. Unfortunately, they spent over $34k per delivery on R&D, SG&A, Interest and Restructuring & Other. They lost about $19k per unit delivered for the quarter. In the prior quarter, Tesla lost almost $25k per delivery. So, 2Q2018 represented a significant improvement in gross profit generation and expense control on a per unit basis. A quick note on Restructuring & Other expenses: Tesla provided this description of this expense category, "Part of the restructuring cost was related to a reduction in our workforce." The 2Q2018 10-Q remained unavailable as of this writing, so perhaps more explanation will be provided there. However, this explanation felt inadequate for a large expense in a category that was never previously used.
Needing to narrow things down a bit further to the Per Delivery level, I then created this spreadsheet:
In this one, I tried to evaluate Tesla's variable expense in selling a car. As a car dealer, being that I produce a detailed financial statement monthly, I am able to quickly determine what it costs me to sell a car by adding my sales personnel, advertising, interest, and other smaller variable expenses. From this, I'm able to easily determine how many cents in net profit should be derived from producing one extra dollar in gross profit. This analysis ignores fixed expenses (real estate, insurance, etc.), as those expenses are theoretically already being covered. However, Tesla doesn't provide us with much detail. Tesla only reports "Selling, General and Administrative Expenses." In 2Q2018, this figure was $750 million, or about $18,400 per vehicle delivered. In the prior quarter, it was almost $23k per unit delivered. Again, this is a substantial improvement and should not be discounted. Unfortunately, it still results in a net loss per vehicle of about $1500, before considering any other expenses.
SG&A Will Continue to Increase
Some have argued that SG&A will not continue to increase, as Tesla has already paid for sales facilities, etc. This is partially true, but mostly false. Selling more cars requires more personnel to sell and delivery and maintain the cars; thus, though Tesla may not add many more facilities, they will continue to add personnel. From 1Q2018 to 2Q2018, Tesla delivered about 11k more vehicles. During that period, SG&A increased about $65 million, or almost $6k per additional vehicle. Fortunately, this is far below the average of $18400 per vehicle. At this rate, after SG&A Expense is applied, Tesla keeps about $11k of gross profit generated from incremental sales volume. Unfortunately, R&D, Interest and Restructuring Expenses were over $16k per unit for 2Q2018. Thus, we have to analyze the incremental direction of these as well.
Restructuring can arguably be ignored. Tesla has only used this category once and may not need to use it again. R&D and Interest Expenses added to about $13,500 per unit delivered in 2Q2018. This was a substantial decrease from over $17k per unit delivered in 1Q2018. R&D Expense only increased $20 million from the first quarter, or about $1800 per incremental unit. Interest increased $14 million during the period, or about $1300 per incremental unit. Arguably, neither increases on a per unit basis and Tesla could make a decision to allow increases in neither, perhaps even a decrease in either. Decreasing interest would require paying some debts; decreasing R&D may be more realistic, depending on new product plans. Tesla provided guidance of $170 million in interest expense in the third quarter, just $7 million more than the second quarter. Additionally, Tesla received about $5 million per quarter in interest income. I have not included this on my spreadsheet as it has fluctuated very little. My objective has been to isolate variable income and expenses. The total per unit incremental increase in R&D and Interest for 2Q2018 was about $3100 per unit additional unit delivered. Looking forward, I believe $1500 is a very conservative estimate for the additional increase we may see. Granted, this is less than half the 2Q2018 increase and is a total guess; however, these expenses are not closely tied to actual sale volume and the company does have some control over these budgets. Additionally, I want to produce a number of required sales units to break even, and I want this number to be reasonably conservative.
Using $1500 per incremental unit in increased R&D and Interest Expenses, and ignoring Restructuring Expenses, incremental sales should produce roughly $9500 toward bottom line profits. 2Q2018 loss before Other Income was roughly $790 million. Thus, according to this analysis, Tesla would need to sell an additional 83,000 vehicles in the third quarter to break even. This would roughly triple the 2Q2018 delivery volume. Producing and delivering 125,000 vehicles per quarter requires Tesla to build approximately 10,000 vehicles per week, exactly the number Tesla has cited several times as an objective. The fourth paragraph of the 2Q2018 Shareholder letter states this in the first sentence. It's worth noting, however, that the first paragraph in the letter cites 7,000 weekly production will enable sustainable profitability. I have to disagree with that statement.
Bizarre UBS Report
As reported by the Wall Street Journal on August 16th, UBS performed an analysis of Model 3 profitability and determined that Tesla is generating an "operating profit" of over $3200 per vehicle. The article goes on to suggest, "That would help explain why Mr. Musk is forecasting a profit in the third quarter." I don't completely follow this line of reasoning. If UBS determined that Tesla profits $3200 per Model 3, and we expect all incremental sales to be Model 3s for the foreseeable future, then Tesla needs to sell an additional 246,000 Model 3s in the third quarter to break even. This is 19,000 per week, in addition to the current volume of perhaps 5,000. For the article to make sense, WSJ is suggesting that Tesla expects to qunituple sales immediately; thus, Mr. Musk has predicted a profit. Tesla has predicted no such volume increase and there's no conceivable argument for the possibility of this occurring. The article goes on to suggest that profitability may be possible. I asked the author, Tim Higgins, some of these questions on Twitter, but haven't received as response.
Some Final Words
Tesla ended 2Q2018 with about $2.2 billion in cash, having burnt about $1.7 billion in the first half of 2018. Tesla estimates that they'll burn a little less than $2.5 billion for all of 2018, or about $800 million in the second half of 2018. However, they also estimate that they'll become cashflow positive in the second half of 2018. These statements appear inconsistent, unless Tesla expects to reach positive cash at the very end of the second half. At any rate, burning another $800 million leaves less than $1.5 billion in operating capital. For a company their size, this would almost certainly result in the need to raise capital, unless of course they are truly cash flow positive. Assuming this won't happen, let's try to estimate the timing of hitting the $1.5 billion mark. Having burnt $740 million in the second quarter, Tesla could hit $1.5 billion as soon as the end of the third quarter. However, assuming some real progress in production rate, as appears to be happening, I estimate the third quarter cash burn is closer to $500 million. This assumes Tesla will build and deliver about 20,000 more vehicles in the third quarter versus the second quarter. That's a fifty percent increase, so it's very aggressive. An additional 20,000 units delivered provides about $200 million to the bottom line, reducing cash burn to perhaps $500 to $550 million. This leaves about $1.7 billion in cash. Continuing at about that rate, Tesla will fall below $1.5 billion sometime around mid to late November, perhaps early December if they can slow it further. These are all estimates from the sky, but it's hard for me to comprehend increasing deliveries more than fifty percent one quarter to the next. I could, of course, be wrong. So, you should take all of this with a grain of salt.
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