Tag Archives: Tesla
A large number of parts intended for the Tesla Model 3, along with parts for the Model S and Model X, have been spotted outside a machine shop in San Jose. Such third parties are sometimes used to fix flawed parts after manufacturing, and previous reports suggest Tesla has struggled with an unusually high rate of flaws in parts coming from suppliers and its own production line.
The parts were spotted by CNBC outside a shop called JL Precision, not far from Tesla’s Fremont factory. They included door frames and a variety of other components shipped from suppliers in China and Ohio. Tesla told CNBC they use JL Precision to add a coating to some parts, but sources within the company said the same shop was used to rework designs or correct flaws in components.
Outsourcing the fixing of flawed parts is common practice in the auto industry, according to a former GM plant manager who spoke to CNBC. But Tesla appears to be dealing with a higher than average ratio of problems, with one engineer there estimating that as many as 40 percent of parts manufactured by Tesla or its suppliers required fixes.
Multiple current and former Tesla employees told CNBC that Tesla spent less time vetting suppliers than is standard in the auto industry, and that some of those responsible for the screening were not experienced with ISO standards and other quality assurance methods normally used in that process.
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A Tesla spokesperson said that parts fixes aren’t adding to delays in Model 3 production, but the reports add to an evolving picture of Tesla’s manufacturing issues. The company has continued to fall far short of production targets, particularly for the new Model 3 sedan. When Model 3 production officially began in July of 2017, Tesla predicted it would be producing 20,000 vehicles per month by December of that year.
But that target has been revised downard repeatedly, and in the entire first quarter of 2018, Tesla produced only about 10,000 Model 3s.
Tesla CEO Elon Musk recently admitted that part of the problem was his over-commitment to automating the production process. But the reports of supplier issues, along with reports last year of battery pack production shortfalls, suggest an interconnected array of challenges facing the carmaker.
Tesla stock had declined in recent weeks on production worries, but rallied Friday after Musk claimed the company would be profitable by the second half of 2018.
The top three updates are on Model 3 production, Tesla’s cash flow, and Model 3 quality.
Model 3 production is at a burst rate of 2,000/week
After six months of delays, Model 3 production is finally on track:
In the past seven days, Tesla produced 2,020 Model 3 vehicles. In the next seven days, we expect to produce 2,000 Model S and X vehicles and 2,000 Model 3 vehicles.
If this rate can indeed be sustained into April and even increased, then Tesla is just shy of its goal to produce 2,500 Model 3s/week by the end of March. Bloomberg’s independent model has production about a month behind that target. For Tesla, a month late is basically on time! Moreover, in light of this update, Tesla might only be a few weeks behind.
As always, it bears reminding that this is an arbitrary, self-imposed goal largely designed around motivating employees. It’s not required for any financial, competitive, or technological purpose. A line in the sand just has to be drawn somewhere.
Model 3. Photo by Carl Quinn.
Tesla says it doesn’t need to raise cash this year
Recent alarm about Tesla’s solvency seems to be misplaced:
Tesla continues to target a production rate of approximately 5,000 units per week in about three months, laying the groundwork for Q3 to have the long-sought ideal combination of high volume, good gross margin and strong positive operating cash flow. As a result, Tesla does not require an equity or debt raise this year, apart from standard credit lines.
Boom! That’s what I love to hear! Barring further delays, Tesla is about six months out from achieving massive positive cash flow from Model 3 sales. If targets are met, Model 3 will generate quarterly revenue on the order of $ 3.25 billion and quarterly gross profit on the order of $ 810 million. (That’s assuming a $ 50,000 ASP and 25% gross margin about a quarter after a 5,000/week production rate is achieved.) Previously, Tesla has guided that it will post sustained operating profits starting by the end of 2018, with a possibility of net profit before 2019 as well.
Based on my own review of the numbers, I think that Tesla’s cash “crunch” is being exaggerated. There are aspects of Tesla’s finances that are opaque to outsiders (such as the composition of accounts payable), however, so it is encouraging to get confirmation from Tesla on this. Here’s the basic math: As of the end of Q4 2017, Tesla had a cash balance of $ 3.37 billion. In Q4, it burned $ 277 million. At that rate of cash burn, it wouldn’t run out of cash until the beginning of 2021.
Several one-time factors contributed to cash burn for Q4 being so low, such as customer deposits for the Tesla Semi and next-gen Roadster. However, there were repeatable factors as well, perhaps most notably slowing discretionary capex. Tesla can slow expansionary spending to be in line with growth in revenue and gross profit. This makes particular sense when it comes to the sales, service, and charging infrastructure for the Model 3 fleet. We’ll have more hard data in about a month when Tesla releases its Q1 earnings.
The key here is the threshold beyond which Model 3 production goes from a net cash incinerator to a net cash generator. If all goes according to plan, by the end of this year, Tesla will likely have the ability to have positive free cash flow. However, that doesn’t seem to be the plan.
From the sounds of it, Tesla wants to finance capex for Model Y, Semi, Roadster, Solar Roof, Powerwall, Powerpack, and future products with debt and perhaps even equity, plus other sources of cash like customer deposits and securitizing leases. Note that Tesla says raising cash this year isn’t “required.” That doesn’t rule out raising discretionary cash to fund faster expansion.
Tesla has a total of $ 330 million in debt coming due in 2018. Given Tesla’s end of Q4 cash balance of $ 3.37 billion and ramping Model 3 production, $ 330 million is a manageable amount to repay. Heck, Tesla could probably wipe that debt away by collecting Model Y deposits. Because Elon Musk is a rock star.
Some convertible bonds to the tune of $ 920 million are set to mature in March 2019. The conversion price is $ 359.87. I can’t predict the ebb and flow of the markets, but it seems well within the realm of possibility that Tesla’s share price will exceed that $ 360 a year from now. If not, with approximately $ 810 million in quarterly gross profit from the Model 3, repayment will be no problem.
Tesla Semi. Photo by Korbitr.
Tesla’s internal data shows high Model 3 owner satisfaction
Finally, Tesla again shared internal survey data of Model 3 owners:
The quality of Model 3 coming out of production is at the highest level we have seen across all our products. This is reflected in the overwhelming delight experienced by our customers with their Model 3s. Our initial customer satisfaction score for Model 3 quality is above 93%, which is the highest score in Tesla’s history.
Although this is somewhat encouraging, Tesla is of course incentivized to present the Model 3 in the best possible light. Before I consider this matter settled, I want to see data from an independent source like Consumer Reports. Consumer Reports has yet to publish survey data on the Model 3. So, for now, we wait.
What is not particularly informative are anecdotes about Model 3 quality. If you, like me, believe in the Enlightenment values of science and logically rigorous thought, then you’ll agree that anecdotes plucked from large samples seldom reveal the truth and often mislead. Statistics reveal the truth. It is surprising and disconcerting to me that so much investment and media analysis — particularly of Tesla — seems to exist in a pre-scientific, pre-Enlightenment mode of thinking in which fact and conjecture are haphazardly mixed, cherry-picked anecdotes are held up as representative, and rumour and hearsay are credulously accepted. So much of what you’ll read and hear about Tesla is either essentially made up or grossly exaggerated because there is little to no application of Enlightenment criteria of truth.
The way I think about companies is to try to approximate as best I can the scientific method. Any way I can remove my own subjective bias is a relief. Hard data is always a breath of fresh air. So is any other empirical test that can serve to falsify an idea. Without scientific discipline, we will inevitably fool ourselves, and wander around in the darkness.
So, I don’t consider a photo of a Model 3 with egregious panel gaps to be informative. A photo of a Model 3 with seamless panels is equally uninformative. Ignore anecdotes. Find statistics. For now, we simply don’t know the level of quality of the Model 3.
Panic and doomsaying about Tesla may never stop entirely. However, it has taken another step toward demonstrating that it has a sustainable business model capable of long-term growth and profits. A year from now, we will probably be having a very different conversation about this company. I look forward to it.
Disclosure: I am/we are long TSLA.
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.
(Reuters) – Tesla Inc sought to squash any speculation it might need to raise more capital this year on Tuesday, driving the company’s battered shares higher as it announced it built 2,020 of its cheaper Model 3 sedans in the last seven days.
The company’s reassurance that it does not need extra cash sent a wave of relief through investors who sold shares of the electric carmaker through a week of bad news about its credit rating and semi-autonomous driving technology.
In early trade on Tuesday, Tesla shares jumped as much as 6.9 percent, recouping a third of the past week’s losses. They were up 3.2 percent at $ 260 in midday trade.
Musk’s $ 50-billion dollar venture said it would also churn out 2,000 of the Model 3 cars next week and promised output would climb rapidly through the second quarter.
“Tesla continues to target a production rate of approximately 5,000 units per week in about three months, laying the groundwork for Q3 to have the long-sought ideal combination of high volume, good gross margin and strong positive operating cash flow,” the company said in a filing.
“As a result, Tesla does not require an equity or debt raise this year, apart from standard credit lines.”
Jefferies analysts had estimated that Tesla needed $ 2.5 billion to $ 3 billion of fresh equity to fund the Model 3 rampup and several other Wall Street brokerages have predicted the company would need more funds this year.
Some analysts said there were signs that the company might have prioritized the cheaper car, seen as crucial to its profitability, over its Model X SUV and more-established and expensive Model S sedan.
Tesla said first-quarter deliveries totaled 29,980 vehicles, out of which 11,730 were Model S and 10,070 were Model X.
Both were lower from the previous quarter and the first quarter a year ago.
“Maybe Elon Musk switched staff from Model S and X to Model 3 to get better production numbers for Model 3,” said analyst Frank Schwope from NORD/LB.
Musk himself has taken direct control of Model 3 production and the company says it already has about 500,000 advance reservations from customers for the car.
The Model 3 is the most affordable of Tesla’s cars to date and is the only one capable of transforming the niche automaker into a mass producer amid a sea of rivals entering the nascent electric vehicle market.
Tesla’s consistent failure to meet its production targets – it had promised 2,500 Model 3s would roll off its assembly lines per week by the end of March – has made Wall Street broadly more skeptical about Musk’s promises.
Several criticized as “tone deaf” an April Fool’s tweet from the billionaire that joked his company, which has $ 10 billion in debt, was “totally bankrupt”.
Tesla shares peaked at $ 389 last September and have been declining steadily since.
Analysts, however, are giving the company the benefit of the doubt as a big bet on the future of high-tech electric and self-driving vehicles.
The production numbers, while short of Tesla’s own target, are far above the 793 Model 3s built in the final week of last year.
“The company appears to be near the point of turning the corner on meeting guidance and production performance,” said William Selesky from Argus Research.
(Corrects to show production was for last seven days, not last seven days of March, in paragraph one)
Reporting By Alexandria Sage and Sonam Rai; Additional reporting by Munsif Vengattil; Editing by Patrick Graham, Bernard Orr
(Reuters) – Tesla Inc (TSLA.O) was reported to be making 2,000 of its Model 3 sedans per week, enough to ease stock market nerves around billionaire Elon Musk’s electric carmaker on Monday after a week dominated by news of a crash involving its semi-autonomous autopilot.
Musk told employees in a company-wide email on Monday that Tesla had just passed the 2,000 per week rate, according to auto website Jalopnik.
That was short of its 2,500 per week target but a big increase on the 793 Model 3s that the company built in the final week of last year. It produced 2,425 of the cars in the whole fourth quarter. [nL4N1OY42A
Tesla shares recovered from an 8 percent loss before the Jalopnik report filtered into markets to trade down 3.5 percent on the day. bit.ly/2uFdEBr
The company did not immediately respond to requests for comment.
Jalopnik also quoted Musk in the email to employees as saying: “If things go as planned today, we will comfortably exceed that number over a seven day period!”
Reporting by Sonam Rai in Bengaluru, Editing by Peter Henderson and Patrick Graham
Tesla (TSLA) continues to struggle with Model 3 production. The company went through similar machinations with the Roadster, Model S and Model X, though this time things were supposed to be different. Why does the company continue to command a premium valuation considering their ongoing difficulties? Investors in the company – both long and short – would be wise to understand this valuation dynamic and how it is likely to change going forward as more electric cars, from more manufacturers enter the market.
Tesla is an exceptional company. The market assigns a value to Tesla similar to that of General Motors (GM) though Tesla only makes a tiny fraction of the cars GM does. Tesla isn’t making money (overall) at the moment, and while their reported manufacturing margins have been high compared to those of many legacy carmakers, those margins alone are insufficient to justify the high premium enjoyed by Tesla shares.
A purely economic analysis of the company based on reported results cannot justify the current share price. Many analysts have performed this kind of evaluation of Tesla again and again going back all the way to Tesla’s IPO. Currently on Seeking Alpha, analyst EnerTuition is looking to see a $ 1 billion loss for Tesla in Q1, David Trainer suggests TSLA holders bail because the company will never earn enough to justify its price, and reliably pessimistic (and short) Montana Skeptic points us to another analyst’s record loss prediction.
The simple fact is that Tesla shares have never been worth the price based on the company’s financials. The market has always, and continues to factor future expectations into the price of Tesla shares. For investors, this means that understanding Tesla’s financials alone is not enough. Sound investment decisions about Tesla also require an assessment of how the market will view the company and its vision for an electric vehicle future going forward. This kind of market sentiment assessment is by its nature qualitative, not quantitative.
This article explores something even fuzzier – the overall circumstances against which Tesla’s vision will be seen and assessed. I believe it is important to look at this topic now because the world of players and rules surrounding the company is changing and this will likely change the way the market looks at Tesla. Investors who continue to view Tesla as playing in a world without significant competition are likely to reach different assessments of coming market sentiment and perhaps suffer as a result.
Tesla – What Success Looks Like
To be successful enough to justify the current market valuation, Tesla must grow to many time its current size, perhaps 50-100 times current unit volume. This implies that the vision of a successful Tesla is of a carmaker producing 5 million to 10 million cars and trucks annually within a decade or so. A successful vision of Tesla growth might look something like this.
Presented in isolation, this kind of growth for Tesla appears impressive indeed. And, it really doesn’t matter too much whether peak of the curve is 5 million or 20 million units. This is a story of exponential growth and many investors will want to be along for the ride. There are and will always be naysayers who believe the company will implode, collapse or retire to bankruptcy court, but those folks don’t buy the stock. What matters is that the kind of growth scenarios that inspire investors to purchase Tesla shares look something like this, and presented in isolation, such growth projections look spectacular.
The change that is coming for investor expectation is significant BEV offerings emerging from large legacy carmakers. Volkswagen (OTCPK:VLKAY) for instance has made major commitments to new battery-powered models and recently concluded $ 25 billion in battery supply contracts. General Motors has publicly committed to 100% electric cars, with 20 new models by 2023. Audi, BMW (OTCPK:BMWYY), Hyundai (OTCPK:HYMTF), Jaguar (NYSE:TTM), Kia (OTCPK:KIMTF) and Nissan (OTCPK:NSANY) are introducing new or updated electric cars to the US this year.
Improved battery manufacturing processes are lowering battery cost and in some cases circumventing supply barriers such as that of limited cobalt supplies. This means that quite soon, Tesla will not be operating, or viewed by investors, in the same degree of isolation as in the past. The following graph illustrates why this matters.
In this chart, the same Tesla growth is shown as in the first chart. Notice how this growth that looked so spectacular when viewed in isolation looks more subdued in the context of a market with other players. These two charts show exactly the same, arguably spectacular, Tesla growth scenario, but the “gut level” impact is very different when the context changes from Tesla operating in isolation to participating in a larger market with other players. And, this difference in perception is, in the case of Tesla, quite important. Because as pointed out earlier, the price of the company’s shares reflects market perception more than it does Tesla’s hard operating results.
Neither of these charts represent deep analysis, nor should they be taken as prediction of specific outcomes either for Tesla or for the car market generally. They are intended only to illustrate how differently Tesla’s “story” is likely to be perceived as the context surrounding the company changes and more electric cars from more carmakers enter the marketplace.
We should perhaps remind ourselves that Tesla can become very, very successful without making all, or even most of, the world’s cars. Tesla does not need to drive GM or Volkswagen or Toyota (NYSE:TM) or any other carmaker out of business to handsomely reward shareholders. For all the company’s trials and tribulations, Tesla continues to move ahead. There is plenty of room in the car market to allow Tesla to succeed in the end.
Tesla investors in the near to medium term will look more to perceptions about how the company fits into the overall car market than to company performance and vision seen in isolation. This is a different investor viewpoint from the one that has driven Tesla’s share price in the past.
It may be better for the stock price, or it may be the opposite. That will depend most likely on what specific news about the company emerges over time. Investors should be attuned to the idea that the market will begin to view Tesla news from a different point of view than in the past. Because, investors who see things most clearly are often the ones who come out on top.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in TSLA over 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.
Additional disclosure: These writings about the technical aspects of Tesla, electric cars,components, supply chain and the like are intended to stimulate awareness and discussion of these issues. Investors should view my work in this light and seek other competent technical advice on the subject issues before making investment decisions.
Trump Tax Plan’s Effect on Inflation and Interest Rates
As everyone now knows, President Trump got his corporate tax reduction bill passed in late December, lowering the tax rate on domestic business from 35% to 21%. Thus far, most investors and pundits have focused on how the lower corporate rate is a boon to big companies nationwide. Obviously, lower taxes should lead to higher profits, all else remaining equal. However, what has received a bit less attention is the effect that the tax plan will have on future interest rates and inflation. According to the Congressional Budget Office, the tax plan will add an additional $ 1.4 trillion (yes, that’s $ 14 followed by 11 zeros – or, if one prefers, 1,400 stacks of $ 1,000,000,000 each) to the federal debt over the next decade. Clearly, with the economy already strong and with debt levels already high, the tax bill should almost certainly result in higher levels of future inflation and, hence, higher future interest rates.
Indeed, it took only a month and a half after the tax plan’s passage for investors to feel the first jolts from higher inflation, as CNN reported on February 6th:
Be careful what you wish for.
Wall Street partied hard while President Trump pushed for huge business tax cuts that the economy didn’t really need. Tax cut euphoria carried the Dow a breathtaking 8,000 points to levels never seen before.
Now comes the hangover. Investors are remembering that giving lots of medicine to an already healthy economy can have side effects, namely inflation.
Those inflation fears are suddenly rocking Wall Street. They sent the Dow plummeting 1,800 points in just two trading days. The losses wiped out a quarter of the gains since Trump’s election.
For months, investors basically ignored the threat that the tax cuts might backfire, causing bond yields to spike and raising the likelihood that the Federal Reserve will have to raise interest rates faster to fight inflation.
“We have an infinite capacity for self-delusion as investors,” said Bruce McCain, chief investment strategist at Key Private Bank. “When we feel good, we don’t want to be bothered by reality.”
How Inflation Swindles the Equity Investor
So, what does all this mean for shareholders? Back in May 1977, Warren Buffett wrote an article for Fortune magazine (full article linked here) entitled “How Inflation Swindles the Equity Investor”. Given that we now appear to be heading into an era of higher inflation, it pays to take a look back at Buffett’s thoughts on the subject from nearly 41 years ago. How does Buffett describe the relationship between inflation and equities in the Fortune article? First, he refutes the previously accepted view that equities act as an effective hedge against inflation:
There is no mystery at all about the problems of bondholders in an era of inflation. When the value of the dollar deteriorates month after month, a security with income and principal payments denominated in those dollars isn’t going to be a big winner. You hardly need a Ph.D. in economics to figure that one out. It was long assumed that stocks were something else. For many years, the conventional wisdom insisted that stocks were a hedge against inflation. The proposition was rooted in the fact that stocks are not claims against dollars, as bonds are, but represent ownership of companies with productive facilities. These, investors believed, would retain their value in real terms, let the politicians print money as they might. And why didn’t it turn out that way? The main reason, I believe, is that stocks, in economic substance, are really very similar to bonds. I know that this belief will seem eccentric to many investors. They will immediately observe that the return on a bond (the coupon) is fixed, while the return on an equity investment (the company’s earnings) can vary substantially from one year to another. True enough. But anyone who examines the aggregate returns that have been earned by companies during the postwar years will discover something extraordinary: the returns on equity have in fact not varied much at all.
Basically, Buffett takes the view that equities are disguised bonds that pay around 12% on par value (i.e., book value, or shareholders’ equity). Thus, stocks are hurt just as much as bonds when inflation rises because the price-to-book ratio (and, consequently, price-to-earnings and price-to-sales ratios) for stocks must necessarily decrease just as a bond’s price decreases in inflationary times. Conversely, the lower the relative level of inflation, the higher bond prices rise and the more P/B, P/E, and P/S multiples for stock expand (all other things being equal).
Buffett goes on to identify a key additional characteristic of low inflationary environments: they favor companies that reinvest their earnings (versus paying them out via dividends). Why? Because when stocks are trading at 3.4X book value, as they are today, every $ 1 of cash from operations that gets reinvested in said book value should translate into an incremental $ 3.40 in market value for the shareholder (versus worth just $ 1 when paid out as a dividend, or even less after payment of taxes thereon). Buffett explains further:
This characteristic of stocks – the reinvestment of part of the coupon – can be good or bad news, depending on the relative attractiveness of that 12%. The news was very good indeed in the 1950s and early 1960s. With bonds yielding only 3 or 4%, the right to reinvest automatically a portion of the equity coupon at 12% was of enormous value. Note that investors could not just invest their own money and get that 12% return. Stock prices in this period ranged far above book value, and investors were prevented by the premium prices they had to pay from directly extracting out of the underlying corporate universe whatever rate that universe was earning. You can’t pay far above par for a 12% bond and earn 12% for yourself.
But on their retained earnings, investors could earn 12%. In effect, earnings retention allowed investors to buy at book value part of an enterprise that, in the economic environment then existing, was worth a great deal more than book value.
It was a situation that left very little to be said for cash dividends and a lot to be said for earnings retention. Indeed, the more money that investors thought likely to be reinvested at the 12% rate, the more valuable they considered their reinvestment privilege, and the more they were willing to pay for it. In the early 1960s, investors eagerly paid top-scale prices for electric utilities situated in growth areas, knowing that these companies had the ability to re-invest very large proportions of their earnings. Utilities whose operating environment dictated a larger cash payout rated lower prices.
We note here that the 30-year Treasury bond yield has jumped up recently, appreciating about 45 bps over the past six months to the ~3.20% level (source):
Granted, we are not even remotely close today to the ~15% level of the early 1980s, however, for equity investors, we currently appear to be moving in the “wrong” direction, at least if one buys into Buffett’s thesis. Indeed, looking at the very long view, it appears that the ~35-year bond bull market may finally be ending (source):
Now, we know why investors have been in love with so-called “growth” companies (especially big tech companies) during the recent moderate growth, low interest rate, and low inflation environment. These tend not to pay dividends but rather reinvest all their cash flows into existing or new operating businesses. Consider Amazon (AMZN) for a moment. All operating cash flow is plowed back by Jeff Bezos either into the existing retail business or in newer businesses such as Amazon Web Services. Unfortunately, the higher interest rates rise, the lower the relative benefit of the reinvested dollar for shareholders, and the less attractive “growth” stocks look compared to stodgy dividend payers like AT&T (T) or General Motors (GM) (again, other things being equal).
Buffett notes that a “reversal” phenomenon took hold in the mid-to-late 1960s just after major institutional investors had stampeded into growth stocks at nosebleed valuations:
This heaven-on-earth situation [regarding the superiority of growth stocks in low interest rate environments] finally was “discovered” in the mid-1960s by many major investing institutions. But just as these financial elephants began trampling on one another in their rush to equities, we entered an era of accelerating inflation and higher interest rates. Quite logically, the marking-up process began to reverse itself. Rising interest rates ruthlessly reduced the value of all existing fixed-coupon investments. And as long-term corporate bond rates began moving up (eventually reaching the 10% area), both the equity return of 12% and the reinvestment “privilege” began to look different.
Are we on the precipice of a new downward revaluation of stocks, given looming inflation? Today, stocks trade around 3.4X book value, compared to 2.0X book value in 2009 and just 1X book value in 1980. Let’s take an extreme scenario where interest rates are rising significantly and investors are only willing to pay book value for the S&P 500 again, as they did at the conclusion of the last bond bear market. Obviously, a growth company that trades today at 10X book value pays no dividends and earns 15% return on equity has much more potential downside than a dividend payer trading at 1.5X book value also earning 15% return on equity, since, even if the former were to trade at a consistent 3X the market multiple of book value (as it does now), it would still lose 70% of its value in the adverse scenario (i.e., its valuation would be reduced from 10X book to 3X book). In comparison, the dividend payer now trading at 1.5X book value might trade down to 1X book in the adverse scenario, meaning it would only have 33% downside, or less than half that of the growth stock.
Wither Tech Stocks Post-Trump Tax Reform?
We find that Amazon trades at 26X, Tesla trades at 14X, and Netflix trades at 34X book, or an average for the three of about 25X book value. This represents a multiple of over 7X the overall market’s (already historically high) P/B ratio. Moreover, none of these companies pays a dividend, so they receive maximum credit from investors for the fact that all cash (including cash sourced from incremental debt) gets reinvested in the underlying business at book value. As interest rates have relentlessly fallen during the current 9-year bull market, investors have logically marked up the equity valuations of these three to higher and higher multiples of book value. If Buffett is correct, however, these will be the very companies whose valuations contract the most when inflation and interest rates rise, as should occur in an era of higher and higher government spending and deficits.
Moreover, the likes of Amazon, Tesla, and Netflix are also the type of companies helped the least by the Trump tax cuts. For one thing, they are either unprofitable or marginally profitable, so cutting their tax rate yields minimal to no gain for them in terms of immediate earnings and cash flow. Second, the value of any deferred tax assets on their balance sheets is lower, since going forward, the amount of taxes they will be able to offset with their DTAs will be lower under a 21% tax regime than a 35% tax regime (for example, Tesla had $ 2.4 billion in DTAs on its balance sheet as of the end of 2017). Finally, the current market valuation for all three companies is largely based on investors’ expectations of massive profits many years down the line (under typical sell-side analyst DCF analyses, near-term profits for these companies remains subdued to nonexistent and then explodes to the upside in the out years, similar to a hockey stick effect). Yet if the tax cuts lead to higher interest rates, the present value of these out-year profits will necessarily be less, as the discount factor applied to them will be higher. Thus, we find that the Trump tax cut has a triple negative effect on companies such as Amazon, Tesla, and Netflix.
Indeed, media outlets noted the initial negative tech investor reaction to the tax bill:
Of course, certain highly profitable large-cap tech players such as Apple (AAPL), Google (GOOG) (NASDAQ:GOOGL), and Microsoft (MSFT) should benefit from the Trump tax plan, as their cash taxes should decrease significantly going forward. In addition, they will be able to repatriate billions of overseas profits at favorable rates. Thus, not all tech companies should be put into the same boat.
The passage of the Trump tax plan looks to be a major negative for companies like Amazon, Tesla, and Netflix. Not only do they fail to benefit immediately from the lower corporate tax rate (since they generate minimal to no profits), the present value of their future profits is less if higher government deficits lead to higher long-term interest rates (a process which seems to be already well underway). Not only that, but if Warren Buffett’s analysis is to be believed, higher rates will necessarily cause price-to-book multiples to contract market-wide from the current (historically high) 3.4X level. As a group Amazon, Tesla, and Netflix trade at a massive 7X the overall market’s P/B ratio, indicating that the downside risk from such a contraction could be significant. To be sure, the valuation of any individual company depends on many variables, including the quality of management and products, revenue versus expense growth, market share dynamics, etc. However, the truly scary thing for Amazon, Tesla, and Netflix shareholders about the Trump tax bill is that the negative knock-on effects for these companies, as outlined in this article, are completely outside their and their company managements’ collective control.
Disclosure: I am/we are long GM, AAPL.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: We are also short TSLA and NFLX.
SEATTLE (Reuters) – PepsiCo Inc (PEP.N) has reserved 100 of Tesla Inc’s (TSLA.O) new electric Semi trucks, the largest-known order of the big rig, as the maker of Mountain Dew soda and Doritos chips seeks to reduce fuel costs and fleet emissions, a company executive said on Tuesday.
Tesla has been trying to convince the trucking community that it can build an affordable electric big rig with the range and cargo capacity to compete with relatively low-cost, time-tested diesel trucks.
Early orders reflect uncertainty over how the market for electric commercial vehicles will develop. About 260,000 heavy-duty Class-8 trucks are produced in North America annually, according to FTR, an industry economics research firm.
PepsiCo’s 100 trucks add to orders by more than a dozen companies such as Wal-Mart Stores Inc (WMT.N), fleet operator J.B. Hunt Transport Services Inc (JBHT.O), and foodservice distribution company Sysco Corp (SYY.N). Reservations to date are at 267 Tesla trucks, according to a Reuters tally.
PepsiCo intends to deploy Tesla Semis for shipments of snack foods and beverages between manufacturing and distribution facilities and direct to retailers within the 500-mile (800-km) range promised by Tesla Chief Executive Elon Musk.
The semi-trucks will complement PepsiCo’s U.S. fleet of nearly 10,000 big rigs and are a key part of its plan to reduce greenhouse gas emissions across its supply chain by a total of at least 20 percent by 2030, said Mike O‘Connell, the senior director of North American supply chain for PepsiCo subsidiary Frito-Lay.
PepsiCo is analyzing what routes are best for its Tesla trucks in North America but sees a wide range of uses for lighter loads like snacks or shorter shipments of heavier beverages, O‘Connell said.
Tesla did not immediately reply to a request for comment.
Tesla unveiled the Semi last month and expects the truck to be in production by 2019.
O‘Connell declined to say how much PepsiCo paid to reserve its trucks, when it placed its pre-orders, or whether it plans to lease the trucks or buy them outright. Tesla initially asked $ 5,000 per truck for pre-orders but that amount has since risen to about $ 20,000.
Reporting by Eric M. Johnson in Seattle; Editing by Peter Cooney
Prior to Tesla (TSLA), I attempted only one short position, and it wasn’t based on any fundamentals. Rather, it was based on a personal dispute with a corporation (seems as though I forgot the Buffett adage that a stock’s feelings aren’t hurt when I short it). Needless to say, I lost money on the bet, albeit less than $ 100 in an options trade. A year has passed, and I’ve taken on my second and more informed short position, via buying put options against Tesla.
There are three primary reasons I entered into a short position with Tesla, which I’ve outlined below:
- David Einhorn copycat position – Often times I rely on smart value leaning hedge funds for position ideas. Einhorn – founder of Greenlight Capital – wrote one of my favorite investing books on his short position battle with Allied Capital called Fooling Some of the People All of the Time, a Long Short Story. The book details his research style as well as methods of identifying potential short candidates. In “short” (pun intended), Einhorn clearly does his research, and he does it thoroughly. So I feel pretty good riding the coattails of his research and following him into the position. However, the book reminds me that short positions can take years to pay out, as was the case with Allied Capital’s ponzi scheme.
- The second reason is that the market is generally overvalued right now, according to the Buffett market value indication of Wilshire 5000 total market index to GDP. In this market, I have found it difficult to find conservative value stocks, so I am exploring the short side. In the event of a market downturn, this gives me some exposure to profiting from the correction.
- The last reason is based on my own research of Tesla – I’ve highlighted a few points below:
- Tesla has managed to pay stock-based compensation to management of $ 872 million while managing to have negative $ 10.8 billion in free cash flow since inception (2010), having never once yielded a profit on an annual net income basis (see 10-year financial results).
- Questionable accounting techniques – like capitalizing IPR&D costs and not listing any allowance for doubtful accounts in 2016 10-K (see page 68 and page 67).
- Management incentives – the majority of this article will compare the management incentive plans for Tesla and General Motors (GM). As you will see, Tesla management has no direct incentive to earn profits or cash flow, unlike GM.
As of the winter of 2017, David Einhorn has two high-profile auto manufacturer positions: General Motors and Tesla. I will spend some time comparing management base salaries and milestones that trigger bonus incentives from the two companies.
Below is a copy of Tesla’s management and CEO stock option plan in the 2016 10K (page 92 of the PDF):
CEO Stock Option plan 2012:
In August 2012, our Board of Directors granted 5,274,901 stock options to our CEO (the “2012 CEO Grant”)…
Each of the ten vesting tranches requires a combination of one of the ten pre-determined performance milestones and an incremental increase in our market capitalization of $ 4.0 billion, as compared to the initial market capitalization of $ 3.2 billion measured at the time of the 2012 CEO Grant.
As of December 31, 2016, the market conditions for seven vesting tranches and the following five performance milestones were achieved and approved by our Board of Directors:
Successful completion of the Model X Alpha Prototype;
Successful completion of the Model X Beta Prototype;
Completion of the first Model X Production Vehicle;
Aggregate vehicle production of 100,000 vehicles; and
Successful completion of the Model 3 Alpha Prototype.
December 31, 2016, the following performance milestones were considered probable of achievement:
Successful completion of the Model 3 Beta Prototype;
Completion of the first Model 3 Production Vehicle;
Aggregate vehicle production of 200,000 vehicles; and
Aggregate vehicle production of 300,000 vehicles.
A close reading of the incentives for CEO Elon Musk shows that none of his 5.2 million of stock option grants are based on actual earnings or cash flow generation for the business. Rather, the CEO incentives are based on prototype and production goals, all of which – as Tesla shareholders and analysts have seen – drain cash at an alarming rate. With these types of CEO incentives, it is no wonder that Tesla has raised $ 4 billion in cash from equity raises and $ 8.4 billion in cash from debt offerings since 2007. In light of the fact that the company has yet to turn any sort of profit in any fiscal year of existence, I find it shocking that shareholders are not up in arms regarding these management incentives. It seems like Tesla shareholders are swooned by Musk’s refusal to accept his CEO’s salary compensation of $ 45,760 cash, due to the California law that requires employees be paid minimum wage. I look at this gesture – like Musk’s high-profile vehicle prototype reveals – as a red herring, obscuring the fact that Musk continues to lead an operation that runs on cash from financing activities and not from cash from operations. Indeed, Musk pays himself – via stock options – with equity and debt financing from investors solely from achieving milestones that are financed through shareholder dilution and debt leveraging.
To make matters worse, the 2016 Proxy statement states that Elon Musk’s interests “align” with shareholders because he owns 22% of shares outstanding. That seems to explain why the CEO’s compensation package is indirectly related to shareholder profits since his vote represents nearly a quarter of voting power. For critics of this view, I should point out that Musk is not on the compensation committee of Tesla’s board. Nevertheless, I find it hard to believe that he doesn’t have any weight with the milestones created by the compensation committee when he holds 22% of the stock.
In theory, stock options are generally shareholder-friendly ways for compensation committees to align shareholder and management interests. In Tesla’s case, however, the theory does not align with the practice because Tesla’s achievement milestones that trigger stock options are not profit or cash flow milestones. In truth, Tesla’s compensation milestones are highly capital intensive. The milestones incentivize management to burn cash, which is exactly what management is doing.
By contrast, I compared Tesla’s compensation package to that of General Motors, David Einhorn’s long automotive investment. Below I copied a screen shot from GM’s 2016 proxy statement that outlines the STIP (short-term Incentive plan) for GM’s executive team. Admittedly, none of the GM executive management team is so austere as to accept a minimum wage base salary of $ 45K, like Elon Musk. Nonetheless, I believe the overall GM STIP is far more aligned with shareholder interests than Tesla’s.
The first STIP measure is EBIT – earnings before interest and taxes. This is a levered measure of profitability. The second GM STIP measure is adjusted FCF (free cash flow). As many readers know, free cash flow measures cash flow from operations minus capital expenditures, an important denomination for capital intensive industries like automotive. Many investors consider free cash flow the gold standard of profitability because it is a shareholder consideration of the cash left over in a business after reinvesting in capital projects. The last two measures of the GM executive incentive plan are around global market share and global quality, again both of which align to shareholder interests, albeit not necessarily directly profit related.
There have been many great critical pieces written about Tesla, especially from the Wall Street Journal. Elon Musk publicly attacked journalists and editors that wrote the negative pieces about Tesla in the Q3 earnings call, ultimately attacking their journalistic and personal integrity, calling “shame” upon them. Frankly, I found Elon’s Q3 opening response quite odd, not to mention hypocritical in light of his aforementioned compensation package. Indeed, Elon’s behavior in the Q3 earnings call reminded me of Allied Capital’s management to short sellers in Einhorn’s book Fooling Some People All of the Time.
Looking at the cost benefit of a straight short sale vs. buying put options, I found that the options strategy was more attractive for me. For one, a small and or individual investor is usually not intending to impact the stock price by selling short. Moreover, I agree with the general proposition from Mohnish Pabrai: “Why take a bet where the best return is 100% and the downside is unlimited?” With buying long-term put options, you can capture downward movement of the stock without knowing exactly when (or if) the stock will move. Furthermore, you are risking less capital through options leverage to potentially make more than 100% of the invested capital. Below is a basic analysis I put together comparing an outright short sale of Tesla versus buying long-term put options (the January 2019 contract):
I purchased the 280 strike price because 280 is around a recent support line for the stock, using technical indicators. I made the purchase in October 2017, when Tesla was trading around $ 340. As the table above demonstrates, a price of about 240 yields an even return percentage from an outright short sale compared to buying the 280 put options. Thereafter, the put options leverage starts to kick in, and the yield of the options are far more attractive. Additionally, the capital risks with a put option limit the amount of capital you can lose.
In terms of selecting which option contract to buy, I used basic technical analysis. Looking at the chart below, if Tesla falls through the 280 support price, then it has a long way to go down to the next support price (see chart below):
In the spirit of a Pabrai/Buffett style value investor, don’t sell short. However, if you’re going to be a value investor and take short positions, consider buying put options on stocks with the following characteristics: a company with no profits, a leveraged balance sheet, lots of cash burn in a highly capital intensive business, double-digit negative ROIC, and a management with incentives to spend cash (as opposed to making profits). For what it’s worth, that’s how I found myself short Tesla.
Risks of Tesla Short Position
Headline for an article from Electrek: “Elon Musk teases Tesla shorts who lost an estimated $ 5 billion since the beginning of the year.” – Fred Lambert – June 8, 2017
There are inherent risks being short Tesla. While buying long-term put option contracts limits capital lost to the cost of the premium on the option, there is still a chance it never materializes. As the Fred Lambert headline suggests, many have been short Tesla and lost plenty of money on the trade. As of November 26, 2017, Tesla short percentage of float is 26%, and it has been in that percentage range all year.
In anticipation of the Model 3 ramp, the stock has managed to run up 61% in a year when TTM net income is negative $ 1.4 billion and TTM FCF is negative $ 4.8 billion. You just don’t know when bubbles are going to pop, and the past year’s Tesla stock price is evidence to that point. Of course, I could be wrong about Tesla, and it might not be a bubble. The Model 3 ramp could be perfectly successful, and the company could turn a profit whereby the current $ 315 price is supported by a realistic valuation metric like P/E, EV/EBITDA, DCF, etc. A simple look at Tesla’s financials since IPO show no evidence that this will happen, but it is a possibility.
Generally, I believe that people are motivated by their incentives. While it certainly is possible that Tesla could switch from a cash burning corporation to one with positive cash flow streams, I would point out what I’ve been saying in this article: Tesla management incentives are not designed for profitability. I would argue that management incentives are designed for high profile showmanship – the like of Steve Jobs would be proud of – for expensive and fancy cars that burn shareholders’ cash.
In closing, I would like to point out that eight years after the Apple (NASDAQ:AAPL) IPO, the company made $ 400 million of net income in 1988 with $ 545 million in cash and $ 1 billion of total liabilities on the balance sheet. With all the comparisons between Elon Musk and Steve Jobs, those financials suggest that Steve Jobs ran his company more like GM (post 2009 government bailout) than Tesla.
Disclosure: I am/we are short TSLA.
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.
I’m sure this will change in the months to come, but after Tesla’s (TSLA) initial Model 3 delivery event in July, sales are not off to an impressive start in August. In the morning of September 1, General Motors (GM) reported August month sales for the Chevrolet Bolt EV – the main competitor for both the Tesla Model 3 and Model S.
GM managed to sell 2,107 units of the Chevy Bolt EV in the U.S. market in August. It has not yet reported global sales, which would include Canada and Norway (where it is sold under an Opel Ampera label).
In contrast, the authority on U.S. plug-in car sales reporting, Insideevs.com, reports that it has estimated Tesla Model 3 sales at a grand total of 75 units for August. Yes, seventy-five. I kid you not:
That means that in the U.S. market in August, the Chevrolet Bolt EV out-sold the Tesla Model 3 to the tune of 28:1. Yes, for every Tesla Model 3 sold in the U.S. in August, General Motors sold 28 Chevrolet Bolt EV cars.
I can hear the objection already: But the Model 3 is just ramping up right now! You just wait another month, and it will clobber the Chevy Bolt EV!
Yes, I know. That may very well happen that at some point starting in the next few months. After all, the U.S. is the market where Tesla will focus its sales once it hits 200,000 cumulative U.S. deliveries, so as to maximize the number of units it can sell that are eligible for the (up to) $ 7,500 federal tax credit.
If Tesla hits 200,000 on the first day of a quarter, it will have a grand total of six quarters with an unlimited number of U.S. sales eligible for a federal tax credit. Yes, you heard that right: An unlimited quantity of cars. Every single one it produces, it can sell in the U.S. market and allow the customers to attempt to qualify for the Federal tax credit. If Tesla sells 500,000 units per year – as it has said it will do in 2018 – six quarters at that 125,000 a quarter pace, all directed at the U.S. market, it would mean 750,000 cars milking the Federal treasury, over and above the 200,000 before the trigger.
Furthermore, if you assume that during those 18 months (six quarters) Tesla manages to increase production slightly, that 750,000 number might look more like 800,000, and when it’s all said and done Tesla’s customers would have collected up to a grand total of 1 million federal tax credits of up to $ 7,500 apiece (in the last few quarters, they decline to $ 3,750 and $ 1,875).
Given this focus, and given Tesla’s seemingly perpetual willingness to sell a dollar for 75 cents, the Model 3 proposition is very good for the consumer and should lead to greater U.S. Model 3 sales than the Chevrolet Bolt EV some time in 2018 and/or 2019. So yes, I do expect the Model 3 to beat the Bolt EV in terms of U.S. sales at some point possibly starting within only months from now.
However, the current 28:1 ratio in favor of the Chevy Bolt EV is a deep hole for Tesla from which to climb. Tesla bulls think that it will all happen in September 2017, and if not in September, then in October for sure. Perhaps it will. Otherwise, in November, December… or January 2018. Or at the very least, some time in 2018 or 2019.
In the meantime, GM doesn’t look so bad. It beat the Model 3 to market by almost a year, and so far it’s beating it in U.S. sales to the tune of at least 28:1. Let’s put it this way: I don’t think we’ll ever get to the point where the Tesla Model 3 will beat the Chevy Bolt EV in sales to the tune of 28:1!
But wait, there’s more!
The Chevrolet Bolt EV doesn’t only compete with the Tesla Model 3. It also competes with the Tesla Model S. After all, the Bolt’s passenger interior space is the same (94.4 cubic feet) as the Model S (94.0 cubic feet) and they have similar driving range for the base Model S (238 miles for the Bolt vs 249), even if the Model S of course costs about twice as much.
Looking at the 3Q-to-date U.S. sales numbers (July + August combined), here is how the Tesla Model S compares with the Chevrolet Bolt EV, according to Insideevs:
Tesla Model S: 3,575 units
Chevrolet Bolt EV: 4,078 units
So there you have it. Chevrolet Bolt EV didn’t just out-sell the Tesla Model 3, but also the Model S.
But wait, there’s even more!
We have established that the Chevrolet Bolt EV out-sold each of the Tesla Model 3 and Model S in the U.S., but what about the Model 3 and Model S “combined” for July and August?
Tesla Model S plus Model 3: 3,680 units
Chevrolet Bolt EV: 4,078 units
It turns out that the Chevrolet Bolt EV can play simultaneous chess – or perhaps simultaneous ping-pong? – in that its U.S. unit sales for July and August beat the Tesla Models S and 3 combined.
For a car that’s sometimes so maligned in the media, that’s not bad for the Chevrolet Bolt EV – outselling the Tesla Models S and 3 combined for the cumulative two first months of this quarter. The Bolt EV is definitely the Rodney Dangerfield of the U.S. electric car industry: It gets no respect!
The Chevrolet Bolt EV has not expanded its sales reach much beyond the U.S., Canada and Norway (where it is sold under the Opel Ampera label) yet. One might also question what will happen to the Bolt now that the PSA Group acquired the Opel business from General Motors on August 1. We will just have to see if, when and how the Bolt EV (Opel Ampera) gets rolled out in Switzerland, Germany and beyond. I fear the worst, but hope for the best.
Instead, the Tesla Model 3 is more likely to face a bigger international threat from Nissan (OTCPK:NSANY), with its all-new LEAF 2.0 that is scheduled to be unveiled on September 5 in Japan. This electric car will be made in three factories on three continents, and could be available in more geographies far more quicker than not only the Chevrolet Bolt EV (Opel Ampera) but also the Tesla Model 3.
As such, one might reasonably assume that Nissan will dominate European and Asian electric car sales in 2018, as a result of widespread global availability of the all-new LEAF 2.0 starting in late 2017 or early 2018.
Of course, it is possible that Tesla will juice its September 2017 U.S. sales as a result of massive discounting. We have news reports this morning of Tesla slashing its prices by up to $ 30,000 per car:
For perspective, that means that Tesla’s discounts per car will exceed the expected base price of a Nissan LEAF 2.0, which is estimated to be somewhere around $ 29,000.
With discounts that huge, Tesla should be able to move a lot of units. What if Nissan decided to cut its prices by $ 30,000 as well, so that the car would be completely free?
One might logically conclude that Tesla will see a massive margin decline in the September quarter. As the saying goes, perhaps they will make it up in volume.
Disclosure: I am/we are short TSLA.
Additional disclosure: At the time of submitting this article for publication, the author was long FCAU and GOOGL, and short TSLA. However, positions can change at any time. The author regularly attends press conferences, new vehicle launches and equivalent, hosted by most major automakers.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
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