The Tesla Model 3 Can’t Justify Tesla Stock Price
Tesla Inc (NASDAQ:TSLA) closed the second quarter of 2017 with adjusted revenues of $2.79 billion. That’s up some 135.1% from the previous year. At first glance, such results look great. At second and third glance, after a soothing glass of port, not so much. Tesla “Model 3” news notwithstanding, the company ended the quarter with a net loss of $336.4 million. Compare that with the still-raw $293.19 million in the second quarter of 2016. Such results highlight the insanity of the Tesla stock price.
The problem starts and ends with perception. Most investors, particularly the fanatical ones, see Tesla as a Silicon Valley company and stock. It’s not. Tesla is a car manufacturer. Whether its motors are electric, internal combustion, rocket, or hyperdrive, it is an automotive stock. It belongs in the same category as Ford Motor Company (NYSE:F) and General Motors Company (NYSE:GM), rather than Apple Inc. (NASDAQ:AAPL) or Microsoft Corporation (NASDAQ:MSFT). Thus, investors make the mistake of ignoring the context in which it operates. That’s dangerous. It’s as if a paraglider trained to fly by swimming in the ocean: not the same thing.
David Einhorn, chairman of American Greenfield Capital fund, has become frustrated. He recognizes Tesla as a car company. He appears to be frustrated with the automobile sector as a whole, from an investor’s perspective. He sees GM as having failed to meet expectations. But, of greater concern is the fact that he considers Tesla way overvalued. He sees its stellar stock price as unable to survive, given its as-yet unproven ability to generate profits. Einhorn does not mince words. He says Elon Musk has “hypnotized” investors. (Source: “Einhorn, nursing losses on Tesla, says investors ‘hypnotized’ by Musk,” Reuters, May 3, 2017.)
Even Einhorn has suffered a little bit of that hypnosis, but now he repents: “Tesla is one of our worst investments, we will lose everything.” Tesla’s shares continue to grow in value for the launch of the new Model 3 at the end of the year, but Einhorn believes it’s all in the eye: “We’ll do the dot of the dot-com bubble in 2000. Tesla’s actions are a ready-made bubble To burst, we do not know when, but it will happen.”
The loss per share was $2.04. Excluding extraordinary items, the loss per share was $1.33. But—and here’s the clincher—because Tesla managed to “beat” analyst estimates, Tesla stock continued to climb towards the sky. Investors decided to reward it for having somehow managed to stave off the projected loss of $1.88 per share that analysts had predicted. (Source: “Tesla reports a smaller loss than expected, says Model 3 production is on track to hit targets (TSLA),” Markets Insider, August 2, 2017.)
The Mysterious Case of the Tesla Cash Flow
The Tesla Model 3 production has barely started. But, if you were to look at Tesla’s stock chart, you would be forgiven for thinking that it has become a staple of the automotive market with no competitors in sight. There’s nothing rational about the way Tesla stock has performed since it first went public. As for TSLA’s performance over the past year, surreal is one of the first words that comes to mind.
Chart courtesy of StockCharts.com
In fact, Model 3 deliveries so far amount to a surprising number. So surprising, in fact, that you might want to grab a chair with a seatbelt and strap yourself in: Tesla has delivered 30 Model 3 vehicles. Musk added a personal touch by showing up for the handing-over-of-the-keys ceremony. But that’s all part of the smoke and mirrors to mask the fact that Musk faces a Tour de France-style uphill battle to deliver some 20,000 Model 3s by December.
To make it interesting, Tesla Inc, a ravenous addict of government subsidies, has also made its first acquaintance with that traditional companion of automobile manufacturing in the United States: unions. What, a union? But, Tesla Inc doesn’t have a union, you say! It’s a tech company based in pious, eco-green and ultra-egalitarian San Francisco. That’s where, after you arrive, you’re supposed to wear a flower in your hair, as the famous song said.
Instead, San Francisco is not just for the tech “nerds” any longer. The unions are coming and they’re warning that the rush to increase Model 3 deliveries will lead to “production hell.” (Source: “Tesla’s pro-union workers say a skipped step with the Model 3 could lead to injuries during ‘production hell’,” Business Insider, August 9, 2017.)
That’s not all.
Tesla has also been acquiring component manufacturers in Europe, where manufacturing workers’ rights and privileges far exceed anything in Detroit. Strikes and disruptions could become part of the Tesla experience if benefits and wages don’t move in step with the more traditional standards for luxury automobile manufacturers.
After all, the one Tesla you can buy and expect within a reasonable time frame is the “Model S.” The Model S starts at about $100,000 for well-equipped models, thus it competes directly against Mercedes Benz, Audi, and BMW (not to mention Lexus, Infiniti, Cadillac, and Lincoln). Thus, Tesla wants to catch up really quickly to build some inventory over the next four months. It’s starting to experience the same obstacles as every other company in the business. But it still wants to present and consider itself as special.
The Tesla Model 3 Cost
Somehow, Tesla doesn’t make cars. It makes and sells environmental, soul-saving alternatives to cars with internal combustion engines. You can have your cake and eat it too with Tesla. That’s the promise. The Tesla Model 3 cost is appealing. It’s being listed for $35,000 thanks to abundant subsidies courtesy of the U.S. taxpayer. Without tax subsidies, as sales in Denmark have demonstrated, Tesla’s sales could experience a power outage—or even a blackout.
The Danish government announced a revised electric car incentive policy. That is, it eliminated subsidies and the unfair competition these encouraged. The result was a massive short circuit of Tesla sales. (Source: “It’s Confirmed: Without Government Subsidies, Tesla Sales Implode,” Zero Hedge, June 12, 2017.)
This is the secret behind the Tesla Model 3 cost. Without incentives, this allegedly mid-priced sedan would start approaching a price prohibitive to most people. In other words, the big Tesla plans could come to a screeching halt, should any government (state, federal, or international) decide to cut subsidies. And many taxpayers view such subsidies with suspicion at best.
The taxpayer “addiction” at Tesla has another equally sneaky companion. It’s called debt. Or rather, it’s debt financing. That’s right, Tesla is funding its expansion less on actual sales volumes and good old-fashioned earnings—as noted above, earnings per share were negative—and more on debt.
Unlike other niche market car manufacturers, Tesla has decided to skip a few steps. Companies like Ferrari or Porsche started out with low volumes. They presented their cars as luxurious and exclusive and did not apologize for it. Nor did they take big subsidies. Rather than encourage sales of such cars, many governments went out of their way to penalize them with high taxes, speed limits, and gas-guzzler penalties.
They built a strong following, advertising and building their reputation through motor sport rather than on vague promises of “saving the world.” Eventually, as sales and earnings reached a certain stability, both manufactures, to different extents, decided to expand production. But they did so within established limits and not by offering artificial sticker-price shock absorbers, courtesy of John Q. Public, taxpayer.
Boosting Production Needs Cash, Plenty of It!
Increasing production, as any capitalist who’s done his Adam Smith homework knows, doesn’t come cheap. Moving from niche to mass market implies a major expense. That’s why such moves come gradually and cautiously. If there’s one thing for which Elon Musk deserves praise, it’s that he has kept that childlike optimism that allows children to dream. Musk sees no obstacles.
Yet, the Tesla Model 3 production ramp-up could be extremely costly. Without earnings, selling the Model 3, even at its subsidized $35,000 base price, will be a challenge. After all, many forget—or choose to not to see—that the giant and experienced car manufacturers are catching up fast to Tesla.
What could be more Motown than Ford and General Motors? They’re both about to enter the electric vehicle market. For these automotive giants, which sell several million cars every year, producing Tesla’s most ambitious target of 500,000 cars a year is the proverbial drop in the bucket.
In Europe, there are many mainstream manufacturers making a successful progression to electric. BMW—not Tesla—tops the sales charts. (Source: “Europe Electric Car Sales Up 54%,” Clean Technica, July 30, 2017.)
How can Tesla even survive as the automotive giants start encroaching on its niche with cheaper models and exponentially bigger sales and maintenance networks built over decades of experience?
For now, the answer to fuel Tesla Inc’s ambitions has been debt financing, as it were. Tesla plans to raise the modest sum of $1.5 billion in funding for what will be its first bond sale. This will be an unsecured senior bond. Interest rates and other details have not yet been defined, the company said, announcing the decision barely a week after the first 30 Model 3s were delivered amid Silicon Valley pomp and circumstance. (Source: “Tesla issuing $1.5B in debt to fund Model 3 production,” USA Today, August 7, 2017.)
It’s not unusual for companies to be in debt after investing in major production increases. But, typically, such debt is covered by sales of other existing models, which have established solid production figures.
Instead, Tesla is using debt directly to generate liquidity. The Model 3 has, to give credit where it’s due, attracted well over 500,000 orders. Tesla suffered about 60,000 cancellations for Model 3 orders. This is neither unusual nor unexpected and could have resulted from any number of reasons. Some Model 3 customers may have decided to get a Model S, because it was available at the dealer or because many are coming up in the used market.
Politics and trade unions are closing in on the hedge around the car industry. Tesla will not be immune to the effects of this collusion. Making cars requires billions of investments. Tesla’s ambitions might prove too large to survive the pressure to lift subsidies and the competition with many established brands coming after its market with a vengeance. Nobody is suggesting Tesla has no place in the industry. It does, and a strong one at that. The problem is with the value of Tesla stock, given the company’s potential and challenges, not Tesla Inc.