Tesla (TSLA) short thesis

The short Tesla trade is extremely crowded.  60%+ of the float is sold short and the borrow was over 90% at one point.

I believe the main reason to short Tesla is because it has historically lost a huge amount of money every year.  For every dollar in revenue, it has had at least a dollar of GAAP losses.  The valuation is also ridiculous.  The market cap is roughly $3B for a company that has less than $300M in book value ($62M as of June 30 2012, which is before the latest secondary offering).

One big question regarding Tesla is whether or not it can generate the volume needed to be profitable.  Management has indicated that it should be free cash flow positive if it is selling 20,000 Model S sedans per year.  Beyond that Tesla could theoretically turn a profit and be able to justify its market cap.  I believe that it is extremely unlikely that Tesla will sell anywhere near 20,000 cars / year on a consistent basis.

Tesla’s original product was the Tesla Roadster, an electric sports car.  Financially, this product was a huge failure if you look at all the GAAP losses that Tesla has been reporting in the past few years.  Retained earnings stand at -$864M, most of which can be attributed to the Roadster (some of the losses are R&D costs for future cars).  No more than 2500 Roadsters will ever be sold as Tesla has stopped production of the model.  From its latest 10-Q filing:

In January 2012, we concluded the production run of our current generation Tesla Roadster at 2,500 vehicles. Through June 30, 2012, we had delivered over 2,350 Roadsters to customers and we plan to sell our remaining Tesla Roadsters during 2012 primarily in Europe and Asia until our inventory is depleted.

The Roadster was not economically viable and now Tesla is now betting on the Model S sedan.  Here are some comments from analysts at IHS Automotive regarding the Model S’s potential:

The high price will limit sales, says Rebecca Lindland, an analyst with IHS Automotive. She doubts Tesla will reach its goal of selling 20,000 Model S sedans in 2013. Nissan has sold just under 30,000 all-electric Nissan Leaf sedans since they went on sale at the end of 2010. But the Leaf is little more than half the price of a Model S.
http://phys.org/news/2012-06-tesla-sedan-company.html#jCp

Says Aaron Bragman:

But the idea that Tesla could sell tens of thousands of Model S sedans in the U.S. is folly. The most popular vehicles in that segment only sell a few tens of thousands themselves, with some models–Audi A6, Jaguar XF, Lexus GS–well below 10,000 sales a year.

Remember that hybrid vehicles themselves, which are far easier to own and operate than pure electric cars, are still just 2 to 3 percent of the total U.S. market. And a recent Deloitte & Touche research note suggests that whether car buyers actually want electrified vehicles is still a matter of some debate.
http://www.greencarreports.com/news/1067021_2012-tesla-model-s-electric-sedan-industry-analyst-weighs-in

Reuters has an article on the economics of other electric vehicles (Insight: GM’s Volt: The ugly math of low sales, high costs).  It reports that other manufacturers have low volumes and are losing huge amounts of money on their electric models.

On the other hand, Tesla reports in its prospectus that it does have around 13,000 customer deposits for its Model S.  A few of these deposits will be refunded as customers are asked to make a commitment (e.g. to choose the car’s options and to sign a contract).  I believe it is likely that Tesla will sell at least 13,000 Model S sedans.

Liquidity

Tesla loses money at a high rate and is constantly in danger of running out of liquidity.  It was in breach with its covenants on the loan from the Department of Energy.  However, this may not necessarily be that dangerous to Tesla since the DOE may have no idea on how to run a business or how to auction off business assets.  It would also be politically poisonous for the DOE to have a loan default as it would draw negative press and comparisons to Solyndra.  The DOE will likely continue to renegotiate the loan to make it easier for Tesla to stay in compliance.  It will make uneconomic decisions.

If Tesla is able to continually sell its shares to raise money, then waiting for the short thesis to play out could take a while.  It was able to raise >$193M recently on Sept 28 2012 in a secondary offering (see the SEC filing).  That money may potentially only last Tesla for a year (e.g. if it burns through cash at something close to its historical rate) before it has to find another source of capital.

Tesla has around $133M in customer deposits.  These deposits are refundable as the customer can take back their deposit and lose their place in line for a new car.  Most of these deposits are not held in segregated accounts so Tesla can use this “float” for any purpose.  In theory, a mass exodus of customer deposits could cause liquidity problems for Tesla.  Delays in ramping production (or fears regarding Tesla’s liquidity) could lead to some customers refunding their deposits.  I do not believe that refunds of customer deposits will be a big issue for Tesla now as its equity raise should provide enough liquidity for several months at least.

Management forecasts are overly optimistic

The latest 10-Q states:

We currently expect to reach free cash flow (defined as cash flow from operations less capital expenditures) break even in the fourth quarter of 2012 based on present assumptions including our goal to deliver 5,000 Model S vehicles to customers in 2012
http://www.sec.gov/Archives/edgar/data/1318605/000119312512332138/0001193125-12-332138-index.htm

The same information can be found in Tesla’s shareholder letter for the quarter (which is more promotional than the 10-Q).  However, in the subsequent month, Tesla made the following disclosure in its preliminary prospectus:

We now anticipate that we will deliver between 200 and 225 Model S vehicles to customers in the third quarter and between 2,500 and 3,000 Model S vehicles in the fourth quarter.
http://www.sec.gov/Archives/edgar/data/1318605/000119312512402291/d411968d424b5.htm

The expected deliveries for 2012 have been cut to (almost) half.  I do not place a lot of credibility on Elon Musk, Tesla’s CEO.

The “Risk Factors” section in Tesla’s filings is worth reading.  Granted, these sections always contain doom and gloom.  However, the section does point out technological risks (e.g. techniques that “have not been widely adopted in the automotive industry”) and points out that Tesla can miss its production targets and gross margin goals.

In addition, for Model S we are introducing a number of new manufacturing technologies and techniques, such as aluminum spot welding systems, which have not been widely adopted in the automotive industry, and Model S has a number of new and unique design features, such as a 17 inch display screen, newly designed retractable exterior door handles and a panoramic roof, each of which poses unique manufacturing challenges. Model S production will continue to require significant investments of cash and management resources and we may experience unexpected delays or difficulties that could postpone our ability to achieve full manufacturing capacity for Model S, or cause us to miss planned production targets, any of which could have a material adverse effect on our business, prospects, operating results and financial condition. Even if we are successful in developing our high volume manufacturing capability and processes and reliable sources of component supply, we do not know whether we will be able to sustain such high volume production or to do so in a manner that avoids significant delays and cost overruns, including as a result of factors beyond our control such as problems with suppliers and vendors. Any such issues could cause delays in Model S production.

Looking into the future

The biggest factors as to whether Tesla will be profitable are demand, ability to ramp production, and gross margins.

  1. Demand will not be the easiest to predict.  There is a novelty factor to the car and demand could taper off once the early adopter market is tapped out.  To sell 20k cars/year, Tesla will have to make 20k reservations a year (or 5K / quarter).  Historically it has never made reservations at that rate.  It will need to greatly expand its SG&A spending on new stores, service centers, advertising, etc.  It is unclear if additional demand at the 5k/quarter level will materialize.
  2. Tesla’s ability to ramp production so far has not been a success.  It has already placed some blame on its suppliers: “Certain suppliers have experienced delays in meeting our demand and we continue to focus on supplier capabilities and constraints.”  This is happening even though Tesla has only produced a few hundred cars and is currently at very low volumes.
  3. Gross margins will be difficult to predict.  It is mentioned in the Risk Factors of Tesla’s 10-Q/10-K filings that the Roadster had a negative gross margin when it was first produced.  This suggests that Tesla’s management miscalculated its margins and may potentially do so again with the Model S.  The ever-confident Elon Musk has said that the gross margin target is 25%.  I think that it is likely that he is being overly optimistic and that gross margins will be lower.

In summary

  1. Tesla’s products have had good reviews.  But it has lost a huge amount of money anyways.  The business model may simply be unviable.
  2. Management has had a terrible track record in cars.
  3. The valuation seems ridiculous.
  4. The economics of electric cars has been a disaster for all the players.
  5. This is not a great short because the trade is so ridiculously crowded.

*Disclosure: I am short Tesla common stock.

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