Tesla Motors: Moments from Collapse
The idea that Tesla would bring to fruition a silicon valley meets Detroit fusion is an enchanting one, without a doubt. An inspiring tale as much as an enchanting one; if you look at Tesla’s share price, closing at $266.13 (March 29, 2018), investors are surely inspired by something. To be sure, however, investors are enchanted by a fantasy that will not come to fruition— at least, not before the looming credit crunch comes to fruition. As most market observers would know, Tesla is missing a key ingredient of bringing this fusion fantasy into reality, production. After all, theoretical innovation is not innovation at all.
The troubles facing Tesla run unbelievably deep; financially, structurally, technically, fundamentally, and philosophically. It’s hard to know where to begin. I have spent hours analyzing the SEC filings, specifically its credit structure, and can assure you that this is a company on the precipice of crisis. A credit or liquidity crunch is weeks away, with the chances that it averts this slim. As well as irrelevant, considering it would only amount to pushing the can down the road.
Henry Ford is often credited with revolutionizing manufacturing with the development of the assembly line, taking advice from Adam Smith, the economist, that emphasized the importance of the division of labour in production. The assembly line was revolutionary in terms of increasing capital efficiency. All too forgotten, however, is the contribution that Toyota made to The Motor City.
The philosophy of the Japanese, while placing priority on high-volume output, although not at the cost of allowing defective products off of the production line to be “reworked” off the production line. At every workstation in Toyota production plants, a cord hung from above to be pulled at the first indication of any defect. The entire production line would be halted at once until the defect was repaired. Importantly, this would ensure that mistakes made by preceding stations along the line would not be continuously repeated if such mistakes were a contributing factor to such a defect.
As it turns out, it is not only less expensive to repair defects on the production line, but it also contributes to greater workplace morale; thus, greater productivity of labour.
All of that to say, the Japanese and the Toyota Production System (TPS) saved Motor City following the 70s and 80s.
Elon Musk has explicitly indicated that he does not see the TPS model as a good fit for his factories. You can read the transcript of the 2017 Q4 analyst call here. His profound arrogance is apparent in his language with his rejection of industry wisdom, it is worth a read.
After 15 years, Tesla has never turned an annual profit and for over a year now, has reliably demonstrated their inability to hit their own production targets for the Model 3. Despite the fact that these targets have been revised downward since then, from 5,000 units per week to 2,500. (I suppose we are expected to just ignore the strangeness inherent in weekly production targets?)
Suffice it to say, Tesla’s production ills are not temporary; but rather, symptomatic of deeper managerial and philosophical pitfalls. The sooner that investors realize this, the better.
Take this scoop, reported by Dana Hull, as a demonstration of how deeply troubled management at Tesla is. In an email sent by Doug Field, the engineering chief, he urged factory workers and volunteers (yes, volunteers!!) to “prove the haters wrong,” speaking of short-sellers on Wall Street. (Disambiguation) In the email, he continued, “I find that personally insulting, and you should too. . . Let’s make them regret ever betting against us.” As if Tesla factory workers are more insulted by “haters” and not management’s assumption that the fleeting productivity has more to do with workers being slow and not the defective equipment they are being forced to work with.
Financially Unsustainable is the Brand
Tesla has a balance sheet, market cap, and cult-like following that has been pouring billions of dollars of liquidity into the firm every quarter to keep up with its cash flow woes; all of the makings of a competitive car manufacturer. Well, aside from its inability to produce a car.
Tesla burns through cash like no other company before; its complete insanity. The company reliably burns $1 Billion every quarter. In August 2017, Tesla raised $1.8 Billion in the form of unsecured debt. As you will see below, it has seemingly vanished at the close of Q3, September 2017.
Does anyone remember the Tesla unveiling event of the new Tesla Truck concept in November 2017? I could hardly forget because I was laughing hysterically at a man clearly on the verge of a mental breakdown. To quote Musk, the unveiling will, “blow your mind clear out of your skull and into an alternate dimension.”
Instead, what blew my mind was Musk’s talented ability to enchant his cult following to pull out their checkbooks, no questions asked. In fact, Musk refused to take questions. Very few have been willing to call a spade a spade. Not I; Musk is as greedy as he is a liar— dramatic rhetoric and hyped-up unveilings have been vital to financing Elon Musk’s $2.6 Billion compensation package. Correction, lying and hype is baked into the pie of the corporate strategy at Tesla.
The Financials are Disastrous
It is best if I start with Q3 2017, focusing on its cash constraints. Obviously, because Tesla is months away from a credit crunch that will likely take the entire company down if Musk is unable to raise the capital. A challenge that should prove to be near impossible unless management performs the accounting magic necessary. (AKA, obscuring reality in footnotes and other disclosures.)
Tesla has set a corporate goal for its gross margin at 30% and as you can see above, they are claiming a gross margin of 18%.
Let's take a look at Tesla's revenues. Despite the fact that Tesla saw an 18% increase in units from 22K in Q2 to 26K in Q3, revenues have barely moved. It would then stand to prove the extensive discounting that Tesla has been offering for the Model S and Model X. You see, Tesla had to discount the average selling price almost 20% just to boost the weak demand in the market.
Would anyone care to explain to me how a company can report the same revenues as the previous quarter, yet report a large increase in SG&A? Does not look good. If this is where all of those discounts to drive sales are being reported, then I would just like to point out that this would appear to be the "accounting magic" I referenced earlier. In other words, those discounts should be accounted for in the gross margin rather than the net margin, but does it really matter at this point?
Despite the accounting magic, the truth reveals itself in the (-22%) net profit margin.
The Balance Sheet
Again, the cash burn is actually impressive. Tesla sells $1.00 for $0.75 like no other company has before.
Now, it was not only aggressive discounting that pushed Q3 and Q4 sales. There was also fear that the new tax bill would eliminate EV tax credits. This demand-pull drew down Tesla's posted inventory. And yet, AND YET, one would think that this would benefit Tesla's working capital. Nope. Take a look at working capital: Current liabilities from current assets leaves $0.6 Billion in working capital. How?
And this is simply to close. This is Tesla's market capitalization as a portion of the vehicles delivered. How absolutely ridiculous.
Either this is the biggest accounting scandal since Enron or this is a major opportunity to short this stock. Although Tesla has done some questionable "accounting magic," if this fraud, they are terrible at it. Tesla will not make it another year.
*Attribution to Jay Van Shiver, for the opening quote.