Devils advocating...from someone who shorted TSLA

[pfq1982]

Based on Tesla's last SEC Filing warranty accrual rate is below 3% of revenue. That is among the lowest rate of the industry equal to japanese and much lower than my german friends.

I find it hard to believe that such a young company with a basically new and unproven technology can achieve anything close to that, especially considering the fact that they have a 8 year warranty on the battery.

You can make your own calculation if real warranty expenses are 10% of revenue. The effect on the profit margin is severe. Interesting to note during Roadster production accrual rate was 6%. And that car was plain simple in comparison to the Model S.

I wonder about the warranty as well. Looks low to me too. SEC filings have shown Tesla doesn't always get their books right, so I think you are fair to question this.

Having said that, what really goes into the warranty accrual? If there is a bad inverter (hum), is that expense on Tesla for bad assembly or on the part manufacturer for a defective part? I don't know.

BTW, from the SEC filings, this does show that Tesla warranty accrual isn't apples to apples vs. other manufacturers, since they have the additional layer of dealer profit to work through. On the other hand, some of that expense might show up as SG&A at the service center instead of a labor component of warranty COGS expense:

"Further, we believe that by owning our sales network we will avoid the conflict of interest in the traditional dealership structure inherent to most incumbent automobile manufacturers where the sale of warranty parts and repairs by a dealer are a key source of revenue and profit for the dealer but often are an expense for the vehicle manufacturer. "

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The financial impact of warranty claims do become an issue when rising beyond the calculated provisions.

The Model S has serious major issues. Just browse through this forum, the car is not on a competitive level regarding quality. And you cannot sort it out from one Day to the next. It takes years to get it right. Most failures in the car industry happened because of quality issues.

The over optimistic view on demand and technology, the competition and the overall weak financial condition are other points, still the warranty claims are the major factor the market seems to overlook for the moment.

The valuation is far beyond any reasonable approach. But since were are in a bubble it could become 300 before turning to 50 and lower. In the long term I see very little chance for Tesla to survive.

Unless their cars are discovered to cause cancer, Tesla is well past the "are they going to survive" part. They did that when they won Consumer Reports and grabbed big mindshare and exploited a niche market (the long-range EV sedan) that the big guys still refuse to compete in.

Think about it, they created a luxury brand. The only one that has really done that in ages is Lexus. And Lexus sells like crap in Germany - I bet Tesla surpasses them in short order.

 

[Electroman]

Tesla doesn't cause cancer ?

I thought JP said it did.

 

[brianman]

Based on Tesla's last SEC Filing warranty accrual rate is below 3% of revenue. That is among the lowest rate of the industry equal to japanese and much lower than my german friends.

I find it hard to believe that such a young company with a basically new and unproven technology can achieve anything close to that, especially considering the fact that they have a 8 year warranty on the battery.

Point of clarification - Are you saying they:
(1) Are lying in the SEC report?
(2) Have bad data when doing their math.
(3) Fail math.
(4) Something else.

If (4), please elaborate.

Thanks.

 

[NigelM]

Point of clarification - Are you saying they:
(1) Are lying in the SEC report?
(2) Have bad data when doing their math.
(3) Fail math.
(4) Something else.

If (4), please elaborate.

Thanks.

He's simply saying that he feels their forecast of 3% is risky given what he perceives to be unproven technology.

 

[bhuwan]

The way the stock has been behaving lately, realist *MIGHT* actually be right to have short'd the stock !

 

[Realist]

I believe Tesla is trying to show the best EPS report they can. They are not lying or doing anything illegal. They are just stretching their accounting method up to a very aggressive point. It’s just a non-conservative Report.

Still, there is reason to believe that the warranty accruals are too low. The consumer reports are not a reliable resources because the Model S is a very young car. Yes an electric car has less parts than any ICE but this is not protecting you from any flaws. A modern ICE engine will need new fluid after 20.000 miles and that’s it. Warranty claims have come down dramatically in that proven technology. It’s the minor points that cause the problems, software, hardware, doors, windows, sunroofs, tires, brakes, Suspension.

German car manufacturers have rates above 5% of revenue. Reason for this is the higher complexity of the cars. A full loaded Panamera has more technology under the hood than a Chevy spark or a Ford Pickup. Therefore German car companies warranty accrual rates have always been higher. Tesla want’s to undercut these rates right from the start with faster and less complex production times. Still the Model S is not a simple car. It’s a very different animal to the Roadster which was essentially a Lotus Elise.
A warranty rate of 7% would be a great achievement for Tesla. This is 4,5% higher than the actual accrual rate. Assuming 3b revenue in 2014 4,5% additional warranty expenses gives you 135 mil. $ extra cost each year. 10% warranty rate gives you more than 200 mil $ extra cost, essentially wiping out any credit feasibility within one year.

I don’t say they will hit a wall soon but these numbers show you that there is indeed still serious risk to the business since the company virtually has no capital reserves at all.
For comparison. The Fiat Group with a market value 50% of Tesla reported 1 billion net profit yesterday and 20 billion cash $ on hand. There is debt of course but market cap is below book value. Tesla is worth app. 15x book value.
Pretty insane number.

 

[NigelM]

German car manufacturers have rates above 5% of revenue. Reason for this is the higher complexity of the cars.

There is a certain logic to the argument that a more complex car has higher warranty costs, however I also think that the Model S is overall much simpler than an ICE and there is some Roadster history to validate the technology. IMO, the big factor that you're missing is that the dealers make a huge chunk of their income from warranty costs and this means two things:

• Dealers have a vested interest in finding warranty-covered problems
• The auto-manufacturers warranty costs include the dealer profit margins

Tesla's stated modus operandi is not to profit on service and so their fully owned Service Centers will effectively be much lower cost to the company than traditional warranty costs going via a dealership.

 

[Mario Kadastik]

I can understand your worry for the warranty, but I doubt this will be reason enough for a $50 price target. With regard to Fiat group I'd have to guess the reason the price is below book value is that in the future the market expects the company to not only not grow, but actually shrink in size. You cannot compare a fast growing young company to that of a long term company with many legacy expenditures attached to it. Yes the efficiency in process might be higher in an old manufacturer, but so are long term liabilities.

The share price of Tesla might have appreciated faster than people expected and it does value in good execution on the management part over the 5-7 years, but with good execution the value is actually still low with plenty of room to grow. I agree that there are risks that might hit them square in the face, but they've so far proven they can overcome those well in advance (like the battery supply risk that got resolved for the next few years at least with the recent press release). I seriously doubt they have demand issues for years to come still as the general market is huge and capturing just a few percent of it leaves a huge upwards trend. If the car were so-so I'd be worried, but the car is so good that it really sells itself. Demand is always a function of delivery time, I for example was waiting for the Model S for many years too, but didn't even contemplate buying one until they started rolling on the streets and I could see realistic timelines while many people did reserve (the early adopters). Now we are getting to the phase where curious people with loads of free cash or ability to raise the cash are starting to pick up the car after seeing it in action and this will roll out in an exponential exposure as more cars appear on streets. Add to it global expansion and demand as such will not be an issue up to 100-200k MS/MX per year. So for now and the next 3-5 years I'd say Tesla will always be supply limited, which is an excellent position to be in. The expansion is easily paid for by the cars themselves and I fully expect Tesla to be barely profitable while it grows hard meaning that we will see high P/E numbers purely because the E part will be compressed due to R&D and CapEx allowing for faster and faster expansion. Once Tesla reaches a critical level of exposure (most of EU, parts of Asia etc) the CapEx will start to slow down somewhat and the EPS will rocket up reducing the P/E to more standard ranges.

I hate AMZN valuation, but it is a good example where rapid expansion at close to no net profit is reasonable. I think the AMZN train is going on for too long as it's now well past a decade, but there are reasonable expectations that AMZN should keep expanding with every $ that they make therefore showing no real profit. With Tesla I think it won't be quite net zero game, but will show regular profit, but I fully expect this to be small and would say that a better valuation would be to consider pure car sales profit removing warranty costs as the basis for EPS to value the company because that is a better indicator. Tesla could decide to not build a single new store or supercharger for one quarter and show blowout EPS, but instead they invest the money for the future.

So taking 2014 40k sales at ASP $95k (still expanding to new markets with first cars mostly high value high option) and profit margin of 25% (I think they will target 30%) gives ~$1B profit and a forward P/E of 20. That's not too bad for a company growing at 100+% YoY. And I left out the CapEx and R&D costs on purpose as I expect Tesla to take almost all of the profit to expand as already outlined. If we assume 50k MS and 30k MX in 2015 with 100k ASP (MX will be 10% higher cost and initial year will be higher config + signatures) we get $2B profit barring any expansion costs with forward P/E if it remains as it is just 10. Doubling that again for 2016 (realistic, but will require substantial capital, which I've not computed if it'll be doable from net income purely) we get P/E of 5 with static stock price.

Yes, I'd have to discount those numbers back 1,2,3 years, but at 5% rates that wouldn't be too big a change, possibly adding 1 to the P/E number so for a simple exercise I left that out and the whole capital usage part would need a separate investigation, but looking at pure income I don't see TSLA as grossly overvalued. It just values in reasonable growth over the next 4-5 years. And I'd even say that it's not fully pricing in Gen-III, it can be reached with purely MS, MX sales.

Just my $0.02

 

[pfq1982]

I believe Tesla is trying to show the best EPS report they can. They are not lying or doing anything illegal. They are just stretching their accounting method up to a very aggressive point. It’s just a non-conservative Report.

Still, there is reason to believe that the warranty accruals are too low. The consumer reports are not a reliable resources because the Model S is a very young car. Yes an electric car has less parts than any ICE but this is not protecting you from any flaws. A modern ICE engine will need new fluid after 20.000 miles and that’s it. Warranty claims have come down dramatically in that proven technology. It’s the minor points that cause the problems, software, hardware, doors, windows, sunroofs, tires, brakes, Suspension.

German car manufacturers have rates above 5% of revenue. Reason for this is the higher complexity of the cars. A full loaded Panamera has more technology under the hood than a Chevy spark or a Ford Pickup. Therefore German car companies warranty accrual rates have always been higher. Tesla want’s to undercut these rates right from the start with faster and less complex production times. Still the Model S is not a simple car. It’s a very different animal to the Roadster which was essentially a Lotus Elise.
A warranty rate of 7% would be a great achievement for Tesla. This is 4,5% higher than the actual accrual rate. Assuming 3b revenue in 2014 4,5% additional warranty expenses gives you 135 mil. $ extra cost each year. 10% warranty rate gives you more than 200 mil $ extra cost, essentially wiping out any credit feasibility within one year.

I don’t say they will hit a wall soon but these numbers show you that there is indeed still serious risk to the business since the company virtually has no capital reserves at all.
For comparison. The Fiat Group with a market value 50% of Tesla reported 1 billion net profit yesterday and 20 billion cash $ on hand. There is debt of course but market cap is below book value. Tesla is worth app. 15x book value.
Pretty insane number.

Realist, I think you are missing something important. Auto manufacturers pay their dealers for parts and labor related to warranty issues. This is a major source of profit to the auto dealers. Tesla saves on this margin by doing the work themselves at the service center. It's all contained within one entity.

So you have to adjust for this markup to make a real comparison. I don't know what the markup is, but lets use 40% as an example (labor is probably a cash cow for dealers). Simplistically, if a dealer charges $100, that's what the Germans accrue for warranty, but the real dealer cost is $60. Tesla would accrue the true cost for warranty since they do it themselves, so $60. That's 40% less than the Germans.

Tesla 3% warranty accrual happens to be 40% of the 5% accrual you mention.

Is it conservative? Probably not, but I also don't think it's crazy.

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Tesla refurbishes pretty much every part. Battery problems are dirt cheap to warranty, as you only have to replace what is bad.

I haven't heard of this before. Are you saying they would cut open a pack and replace a bad group of cells, then re-seal it?

 

[bonnie]

I haven't heard of this before. Are you saying they would cut open a pack and replace a bad group of cells, then re-seal it?

As a stock holder, I hope so. It makes sense to refurbish.

As a Roadster owner who had a battery replaced, I know so. At least for Roadster batteries. (But no 'cut open', just 'open'.)

 

[Realist]

Realist, I think you are missing something important. Auto manufacturers pay their dealers for parts and labor related to warranty issues. This is a major source of profit to the auto dealers. Tesla saves on this margin by doing the work themselves at the service center

I don't know if Tesla has a real cost advantage here. The car makers cannot afford to give away to much profit to the dealers.

Furthermore Elon Musk always had a strong focus on the best possible service + generous warranty.

When taking about complexity ICE vs. Tesla Model S. We all know that the Model S is a great handling machine with it's low centre of gravity and the battery sitting on the floor. But the battery is also exposed to damages from the ground.

If you touch the ground in a conventional ICE there's nothing to worry about but hitting a serious bump in the Tesla can damage the battery. I believe this might also become an issue on insurance.

This is just one example of things that can happen in a completely new car.

 

[anticitizen13.7]

Still, there is reason to believe that the warranty accruals are too low. The consumer reports are not a reliable resources because the Model S is a very young car. Yes an electric car has less parts than any ICE but this is not protecting you from any flaws. A modern ICE engine will need new fluid after 20.000 miles and that’s it. Warranty claims have come down dramatically in that proven technology. It’s the minor points that cause the problems, software, hardware, doors, windows, sunroofs, tires, brakes, Suspension.

This is all speculative. And it addresses none of the other points I raised earlier.

If you touch the ground in a conventional ICE there's nothing to worry about but hitting a serious bump in the Tesla can damage the battery. I believe this might also become an issue on insurance.

Nothing to worry about?

Have you ***ever*** worked underneath a petrol car? Oil pan, exhaust system, fuel tank… just some of the things that grounding out can seriously damage. There's a reason why Jeep and Subaru owners buy skid plates if they anticipate driving over rough terrain.

The kind of driving or mishap that would damage the Model S battery would also cause massive and expensive damage to a petrol car.

You cannot be serious. I'm done with this thread.

 

[Discoducky]

I don't know if Tesla has a real cost advantage here. The car makers cannot afford to give away to much profit to the dealers

Ah, but they do and that is a delta. Dealerships in the US are typically very profitable for their owners and good salesman (I have first hand experience)

But the battery is also exposed to damages from the ground.

If you touch the ground in a conventional ICE there's nothing to worry about but hitting a serious bump in the Tesla can damage the battery. I believe this might also become an issue on insurance.

Taking the same debris and impacts to an ICE would do considerable more damage to the car overall and is much less protected. The armour plate protecting the battery is a model of sufficient engineering and that hypothesis has been demonstrated in the field.

Also, I think that your focus on the risks and dangers facing TM and the Model S are good to call out. But I'm still waiting to hear about something that proves to be a real negative to the overall business model for current or future. Currently, I haven't heard one. When I visit this thread I still feel compelled to invest more in TM as your advocating is not very persuasive.

 

[Realist]

Have you ***ever*** worked underneath a petrol car? Oil pan, exhaust system, fuel tank… just some of the things that grounding out can seriously damage. There's a reason why Jeep and Subaru owners buy skid plates if they anticipate driving over rough terrain.

The kind of driving or mishap that would damage the Model S battery would also cause massive and expensive damage to a petrol car.

The difference is that people know how to handle petrol cars and their damages. There is no experience on a design like the Model S.

It's a risk, nothing more.

I think that Tesla's business model can succeed but the financial risk do not justify the market cap. The valuation dicsounts the best possible world in about 4-5 years from now.

 

[mershaw2001]

This is all speculative. And it addresses none of the other points I raised earlier.




Nothing to worry about?

Have you ***ever*** worked underneath a petrol car? Oil pan, exhaust system, fuel tank… just some of the things that grounding out can seriously damage. There's a reason why Jeep and Subaru owners buy skid plates if they anticipate driving over rough terrain.

The kind of driving or mishap that would damage the Model S battery would also cause massive and expensive damage to a petrol car.

You cannot be serious. I'm done with this thread.

Don't be done with this thread. I am glad to hear arguments from shorts, even though they are specious, and have someone like you point out how they are wrong. I don't work on cars enough to know that you could buy skid plates etc.

 

[Mario Kadastik]

Don't be done with this thread. I am glad to hear arguments from shorts, even though they are specious, and have someone like you point out how they are wrong. I don't work on cars enough to know that you could buy skid plates etc.

I bought a skid plate for my Evo X. Was told by a guy who builds rally cars from them that every Evo should have a skid plate because there are many fragile details down there, that people have gotten 30-40% car price repair bills from running over a simple brick while cars height dropped (i.e. coming down and turning up on the road) or just hitting a curb. I had recently to swap the pump for 4-wheel drive and it cost me 15% of the car market value. For a freaking simple pump!!!

 

[anticitizen13.7]

Don't be done with this thread. I am glad to hear arguments from shorts, even though they are specious, and have someone like you point out how they are wrong. I don't work on cars enough to know that you could buy skid plates etc.

Ok, I will stay around!

The difference is that people know how to handle petrol cars and their damages. There is no experience on a design like the Model S.

It's a risk, nothing more.

I think that Tesla's business model can succeed but the financial risk do not justify the market cap. The valuation dicsounts the best possible world in about 4-5 years from now.

Here's my response:

For the majority of drivers who are NOT going off-road, there is no difference in how a driver handles a petrol versus a Model S automobile. In either case, drivers MUST if possible avoid driving over debris on the road, or risk damage to undercarriage components. Any type of car that strikes serious road debris is at risk for very expensive damage.

It is true that battery packs are expensive to replace if they are damaged today. However, several years from now, economies of scale and advances in technology will likely lower costs substantially. Remember what LCD monitors cost in the early 2000's? Now LCD monitors cost very little as they are a mass produced, mature technology.

With regards to the market cap: yes, the price reflects a lot of risk, but this is the nature of relatively new companies. Looking 4-5 years down the road, we still don't have a good idea of what Tesla's potential will or won't be. 2017-2018 should be around the time of the G3/Model E launch. Nobody knows for sure what the demand or profit will be when Tesla goes for 300k+ units/year. Trying to quantify this is largely futile in 2013 because anything could happen. In my estimation, you either have faith that the product and people will succeed in the long run, or believe that they won't succeed. Predicting exact results or valuation is impossible.

I think the odds are good that Tesla will change the automobile industry permanently. I don't aspire to own any more petrol cars. Children I know all want a Tesla. People pose for photos with the Model S at Tesla stores. The only other product line I can think of that generates this kind of craze is the iPhone.

 

[eidco]

In the long term I see very little chance for Tesla to survive.

It's crazy statements like this that cause people to snap back at Realist. "Very little chance"?? How about "a chance it won't survive" or even "little chance"?

Obviously you're entitled to your opinion, but really...that's over the top.

 

[Jonathan Hewitt]

It's crazy statements like this that cause people to snap back at Realist. "Very little chance"?? How about "a chance it won't survive" or even "little chance"?

Obviously you're entitled to your opinion, but really...that's over the top.

I agree. Realist has stated many possibilities but makes it sound like they are absolutes. There are a ton of possible risks but none of them may materialize. Maybe a year ago it was worth shorting the stock, but Elon has proved he knows what he is doing so IF things go horribly wrong I attribute it more to bad luck, not inherent flaws.

At this point I think it's more likely GM will go bankrupt (again) than for Tesla to go under.

 

[Robert.Boston]

The best evidence against Realist's short case, to my mind, comes from Tesla's successful recruitment of senior executives. You don't leave top positions--dream positions, really--at established companies like Apple and Aston Martin without doing your homework, very carefully, about Tesla. These executives know more about the car business than any of us, and they have better access to Tesla corporate details. Undoubtedly a large part of these gentlemen's comp package is in ATM options, so if they thought these options were going to be worthless, they wouldn't have joined Tesla. But they did. QED.