"Tesla. A Much Needed Reality Check (in depth)" - Julian Cox's Expert Analysis Posted

[PeterJA]

Elon Musk also stated in early May that he didn't expect to do an offering. Then about two weeks later he did it.

This is a common misconception. He actually said they had no CURRENT plans to do an offering, but they would be "opportunistic" about it if things changed. Then things promptly changed when the stock price shot up.

I'm not sure if his current guidance on capital raises is qualified in that way. Maybe we'll find out on Nov 5. Julian provides another argument against further raises, namely Elon doesn't want to dilute his shares and control of the company.

 

[ModelS8794]

All of it has everything to do with the cost of capital as well as the need for capital. Either your modeling of TSLA's pro forma financials includes external financing (capital) at some point (and cost) in the future, or it does not. Julian's model is predicated on Elon's statement that they *will* fund all of their expansion with cashflow from normal operations. This is what is so staggeringly hard to believe for almost anyone trained in normal cost structures for manufacturing enterprises, myself included. Yet, I find myself believing it.

Either way, the shares price that "pop out" of most models (with or without pro forma financials) are heavily dependent on future costs of capital and assume varying degrees of external financing.

Yet a seemingly crazy statement like Elon has made regarding the lack of need for additional financing OF ANY KIND (debt or equity) necessitates an equally unprecedented modeling of future financials. This is precisely what Julian has done. You can certainly disagree with the premise that there will not be a need to raise capital, but be sure you are disagreeing with the right thing. Julian never said the COST of capital was zero, he said the NEED for capital was zero:



From Julian's analysis:



Also ModelS8794, you have conflated cost of retained earnings applicable to shareholder requirements with cost of capital for funding and financing a business, and as Julian pointed out, these are not even remotely the same thing.

flux, I have no interest in debating mr. Cox by proxy, even if the proxy made a clear argument, rather than one using supporting evidence in direct conflict with the claims the proxy was making.

I wish you you the best in your endeavors.

 

[Jack6591]

Just paid to promote Julian's blog. A couple bucks well spent.

 

[Johan]

... but what if, just what if, JC is right when he argues that when it comes to cash-flow Tesla have a continuous positive flow, i.e. for every car sold they are "out cash" for a "negative" number of days (i.e. on average they sit on the whole revenue from the sale for a number of days before all the suppliers are paid)? And if so, if their gross margin is actually able to stay around 20% with the continued sale of Model X and they are able to grow the business (number of sales) with 100% or more per year, every year, until the introduce Model E (which may not achieve 20-25% gross margin) then the only question becomes if they will generate enough profit to cover all the expenses apart from vehicle manufacturing (i.e. sales, staffing, tooling, service centers, R&D) while at the same time increasing cash holdings in accordance how the total market cap grows. Impossible?

Also, the arguments that they would have to have, at all times, for example 2-3 months worth of operating expenses in cash to be able to negotiate favorable terms with their suppliers seems flawed. If I were a supplier, and I could see that in 10 years Tesla will be just as big, or bigger, than Ford, GM and Toyota and it was also clear to me that the risk of the business slowing or going belly up was next to nothing I would want to be their supplier and I would absolutely allowed them very good terms.

 

[Mario Kadastik]

So maybe this is different in the US, but at least in EU it seems that I will have to pay ca 30 days before I get the car for the car. Assuming production + delivery time it's probably still so that Tesla has to start building the car before it gets my money, but Tesla will get the money ca a month before I get the car. Just to add a data point.

 

[Palpatine]

... but what if, just what if, JC is right when he argues that when it comes to cash-flow Tesla have a continuous positive flow, i.e. for every car sold they are "out cash" for a "negative" number of days (i.e. on average they sit on the whole revenue from the sale for a number of days before all the suppliers are paid)? And if so, if their gross margin is actually able to stay around 20% with the continued sale of Model X and they are able to grow the business (number of sales) with 100% or more per year, every year, until the introduce Model E (which may not achieve 20-25% gross margin) then the only question becomes if they will generate enough profit to cover all the expenses apart from vehicle manufacturing (i.e. sales, staffing, tooling, service centers, R&D) while at the same time increasing cash holdings in accordance how the total market cap grows. Impossible?

The number to closely watch from Tesla over the next few quarters is cash or cash equivalents. In the absence of any new debt or equity offerings or repayments, is cash growing or declining as they scale up for Model X production? Plus they are still expanding production capacity of the Model S line. I would not be surprised if we see cash fall by some amount each quarter. It is not a cause of alarm or concern. It is a reasonable expectation that they can be "profitable" and still have cash burn. On an accounting basis they can put many of those items in the long term asset bucket, not the quarterly expense bucket. For a business doing $15 billion in sales, that is a lot more cash on hand than their current amount.

I want to stress again, I don't think they need to raise capital for 2014. They likely do have enough cash for everything related to Model S and Model X expansion and expected production volumes.
But Gen III is another exponential increase in scale for the company. That is a big jump in scale for everything across the company.

Also, the arguments that they would have to have, at all times, for example 2-3 months worth of operating expenses in cash to be able to negotiate favorable terms with their suppliers seems flawed. If I were a supplier, and I could see that in 10 years Tesla will be just as big, or bigger, than Ford, GM and Toyota and it was also clear to me that the risk of the business slowing or going belly up was next to nothing I would want to be their supplier and I would absolutely allowed them very good terms.

Suppliers will likely be very eager to do business with Tesla. Tesla will likely be able to negotiate reasonable terms. But I don't see Tesla getting "magical" terms that don't make sense for the suppliers. If Tesla is running the business with insufficient capital, that is risky for everyone. These companies all operate with letters of credit. Once you get bankers and MBAs involved, they won't have the flexibility of letting Tesla slide on the balance sheet health issue. Tesla will have to have sufficient cash in the bank to support the overall enterprise.

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This is a common misconception. He actually said they had no CURRENT plans to do an offering, but they would be "opportunistic" about it if things changed. Then things promptly changed when the stock price shot up.

I have no doubt that by 2015 things will change again from whatever his current statements are.

I'm not sure if his current guidance on capital raises is qualified in that way. Maybe we'll find out on Nov 5. Julian provides another argument against further raises, namely Elon doesn't want to dilute his shares and control of the company.

That is true in every scenario for a secondary offering. The current owners don't want to be diluted. It still happens. Sometimes dilution makes sense. My guess of $1.5 billion needed capital would be about 7.5% dilution to current shareholders. But accepting that 7.5% dilution means that Tesla can grow from $4 billion in sales (Model S & Model X combined) to $15 billion in sales (add Gen III). Would you accept 7.5% dilution to grow sales and profits by a factor of 3x to 4x? Yeah, I would, even though Gen III is likely lower profit margin per car, it still makes sense.

 

[EVNow]

Julian, I don't think the auto industry functions as your believe. Auto manufacturers get paid right away by auto dealers. The cars that are building in inventory on auto lots "finished goods" are not carried on the books of any manufacturer.

Well, it is a bit more complicated than that. Yes, the manufacturers get paid quickly by the dealers - but - manufacturers reimburse some of the cost of carrying inventory by the dealers. IIRC, the way this is done is to give dealers a flat xx number of days (30 for eg.) worth of interest on the inventory cost. One of the reasons dealers really like fast moving cars - they get paid even when they don't have much of an inventory cost.

 

[MikeC]

Maybe early Gen3 profit will pay for later Gen3 production.

They aren't going to jump into 300,000 units right away, they'll start slow and scale up like with the MS. Gross margin may be thin at first, but I presume they will still make money on each one, so I take Elon at his word that they see a path to doing it without dilution. Of course, if they determine that dilution is necessary to reach a higher goal, I can accept that, too.

 

[dha]

It looks like Julian's post got picked up by Reddit:

Tesla: A Much Needed Reality Check : investing

It would be helpful to have some more voices countering the misinformation being spewed in the comments.

 

[Palpatine]

It looks like Julian's post got picked up by Reddit:

Tesla: A Much Needed Reality Check : investing

It would be helpful to have some more voices countering the misinformation being spewed in the comments.

One of the Reddit comments raised a valid point that might puncture the expectations of Julian Cox.

"Regular people (not just the first 10,000 proud tesla model S owners), will not be pre-paying for their vehicle and waiting months for it."

The person got the number wrong, it appears that Model S and Model X owners are willing to do that.
But he is correct that the Gen III market might not function the same way. That type of buyer might be more insistent on "kicking the tires" prior to buying it.
Tesla might have to shift to a model with more cars on hand.

 

[Julian Cox]

The number to closely watch from Tesla over the next few quarters is cash or cash equivalents. In the absence of any new debt or equity offerings or repayments, is cash growing or declining......

Yes, exactly. Except that I would say a few quarters is just procrastination.

Nov 5 (or whatever the exact date of the Q3 earnings call) if cash at bank is still around $750M especially if it is even a fraction up not down from Q2 despite bringing Europe and Asia on stream IMO you and the rest of the market will have the answer.

P.S. Nov 5th is fireworks night in the UK.

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One of the Reddit comments raised a valid point that might puncture the expectations of Julian Cox.

"Regular people (not just the first 10,000 proud tesla model S owners), will not be pre-paying for their vehicle and waiting months for it."

The person got the number wrong, it appears that Model S and Model X owners are willing to do that.
But he is correct that the Gen III market might not function the same way. That type of buyer might be more insistent on "kicking the tires" prior to buying it.
Tesla might have to shift to a model with more cars on hand.

Sorry, whoever said that was dreaming / a complete idiot. The reservation list for Gen III will be a phenomenon perhaps never before seen in the history of economics.

Electric BMW 3 series equivalent that can be charged at home on the cheap and looks and drives like an Aston Martin with free access to interstate / intercontinental travel at the price of a Nissan Leaf. Please - what could possibly persuade the typical consumer to waste $35~50K on anything else.

The whole Model S phenomenon is just a giant advertising campaign for that event.

 

[Palpatine]

Yes, exactly. Except that I would say a few quarters is just procrastination.

Nov 5 (or whatever the exact date of the Q3 earnings call) if cash at bank is still around $750M especially if it is even a fraction up not down from Q2 despite bringing Europe and Asia on stream IMO you and the rest of the market will have the answer.

They likely don't have significant costs yet for Model X. They are still in the mule stage for those. They likely have not yet even started building the production line in Fremont.
But they have had significant startup costs for all of the new stores, service centers and Superchargers. So it will be interesting to see the Nov release numbers. But I would expect cash burn to be heavier in 2014.

 

[Julian Cox]

It looks like Julian's post got picked up by Reddit:

Tesla: A Much Needed Reality Check : investing

It would be helpful to have some more voices countering the misinformation being spewed in the comments.

Cannot see how to comment there. Would someone who does please clarify to that group specifically that "Julian" is not claiming that there was a zero cost to any capital raised to reach critical mass, nor would there be a zero cost for any capital raised in the future. Simply that 2014~2018 one has to defy guidance and ignore the cash flow positive nature of this business model to enter any new capital raise in that period - hence entering a row of zeros from 2014 through 2018.

 

[PeterJA]

The whole Model S phenomenon is just a giant advertising campaign for [the Gen3].

And was intended to be, from the very beginning of Tesla.
The Secret Tesla Motors Master Plan (just between you and me) | Blog | Tesla Motors

 

[Alpha]

Julian, Bravo on your recent article! How do we get it posted on SA? The short blitz campaign on SA is really rattling me (not the mention the market.) Q3 earnings report ought to put that to a stop, but would like to see more bull articles like this hit the mainstream!

 

[Julian Cox]

But I would expect cash burn to be heavier in 2014.

On what basis?. As far as I can see they have been tuning production and consolidating the supply chain in order to hit the sales pedal hard in 2014, 2013 is the lean period, not 2014.

Don't take my word for it. Musk: "We will test the ceiling of demand in 2014". One other thing, how many times does Musk have to thank folk for buying Model S "because it helps pay for the launch of their affordable vehicle" before folk actuality get the message.

 

[FluxCap]

Julian, Bravo on your recent article! How do we get it posted on SA? The short blitz campaign on SA is really rattling me (not the mention the market.) Q3 earnings report ought to put that to a stop, but would like to see more bull articles like this hit the mainstream!

I suspect the best thing to do with Julian's article is spread the word and link to it from anywhere and everywhere you can, if you so choose. It won't be posted on SA for a variety of reasons, but nice thought.

Glad you and others here are enjoying and finding Julian's work compelling!

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Cannot see how to comment there. Would someone who does please clarify to that group specifically that "Julian" is not claiming that there was a zero cost to any capital raised to reach critical mass, nor would there be a zero cost for any capital raised in the future. Simply that 2014~2018 one has to defy guidance and ignore the cash flow positive nature of this business model to enter any new capital raise in that period - hence entering a row of zeros from 2014 through 2018.

I'll work on that, but the denizens of reddit are not easily swayed -- as reddit audience has grown, so have the uninformed trolls. Still, it's nice to see more exposure!

 

[brianman]

Don't take my word for it. Musk: "We will test the ceiling of demand in 2014". One other thing, how many times does Musk have to thank folk for buying Model S "because it helps pay for the launch of their affordable vehicle" before folk actuality get the message.

Hm. So you're predicting Model S will no longer be production constrained sometime in 2014?

 

[Palpatine]

On what basis?. As far as I can see they have been tuning production and consolidating the supply chain in order to hit the sales pedal hard in 2014, 2013 is the lean period, not 2014.

Don't take my word for it. Musk: "We will test the ceiling of demand in 2014". One other thing, how many times does Musk have to thank folk for buying Model S "because it helps pay for the launch of their affordable vehicle" before folk actuality get the message.

I have been around this since 2008. I was a Roadster buyer. He was thanking us for buying that to fund the Model S. So perhaps I am a bit more immune to the Elon Musk charm. Elon is not above basic cash flow and capital costs. I am just repeating myself so I won't bother typing it all out again. Time will tell. But don't be shocked if they need to raise more cash. Just my opinion.

 

[tumbledog]

Either way, the shares price that "pop out" of most models (with or without pro forma financials) are heavily dependent on future costs of capital and assume varying degrees of external financing.

Julian Cox and yourself have conflated the need to raise capital with the cost of capital. They are not the same thing. A zero percent cost of equity means that you would buy Tesla shares with an expectation of earning 0% on that investment in the future (IE giving your money away, and earning less than you could on a riskless Treasury bond). Since the current price of Tesla is close to Julian's 0% cost of capital modelling on Damodaran's website, it is implied that the current stock price reflects a future return of 0%.