Tesla's competition in the electric vehicle market

1 Financial Analysis: Tesla, Inc. Background Firm Tesla, Inc. began as a niche-market provider of luxury brand, high-end electric vehicles (EVs) in the early 2000s. The company is currently attempting to break into the mainstream auto manufacturing market by producing a Model 3 for consumers with a $35,000 price tag—a goal the company has yet to accomplish. The first Roadster that Tesla produced sold for well over $100k. The Model X and Model S followed—both premium EVs, and the promise of an affordable EV—the Model 3—was made with some 500k pre-market orders placed with a reserve of $1k for each car—bringing in a quick, cool half a billion dollars (Morris, 2018). While production has begun on the Model 3 and the company recently reached a milestone in production with 5000 of the cars produced in a week (albeit, not without a fair amount of controversy—including a whistleblower and a lawsuit—regarding the conditions under which these vehicles were produced) (Wattles, 2018), the “affordable” base Model 3 is not yet available: those produced will be higher priced packages with longer-lasting batteries and other features that will keep the EV well in the premium range at $78,000 and out of reach of most retail car consumers (Trefis, 2018). Tesla is engaged in virtually every aspect of production—from seats to battery packs—and its recent acquisition of Solar City was meant to be facilitative of the firm’s entry into green technology (i.e., solar panels). But this acquisition was viewed by market observers as troubling, since Solar City was run by Tesla CEO Elon Musk’s cousin and the company was deeply in debt and had already been losing market share year over year (Bloomberg, 2018). Nonetheless, Musk has embraced the idea of going green and announced that Tesla’s current mission is to focus on “not only all-electric vehicles but also infinitely scalable clean energy generation and storage products. Tesla believes the faster the world stops relying on fossil fuels and moves towards a zero-emission future, the better” (About Tesla, 2017). Industry The EV industry is set to take off with all major auto producers stepping into the market, which will undoubtedly put pressure on Tesla’s aim to be the first to bring an affordable EV to market that couples class with advanced tech. Jaguar will be there with its I-Pace, a premium EV with a base model price under $70k. Audi is introducing its E-Tron Quattro E-SUV this year and an E-Tron Sportback next year. Porsche is bringing its Mission E Cross as its second EV. Mercedes plans a 2018 EQC Electric SUV. And then there are the lower priced models—the 2019 Hyunai Kona Electric, which will have a 250 mile battery charge range. The Chevy Bolt EV has a base MSRP of $37,495 this year. GM, Nissan and Volvo all have plans for EVs—as does Volkswagen, BMW, Toyota, Mazda, Infiniti, Peugot, Citroen and Ford. Virtually every major auto manufacturer is entering the EV space either this year or next—which means Tesla’s novelty is soon to be no more (Spiegel, 2018). Economy With the economy intimating a recession within the next 2 years (if an inverted yield curve is any indicator), and the business cycle feeling long in the tooth—as well as a trade war getting underway and a central bank (the Federal Reserve) initiating quantitative tightening in an attempt to undo the bubble economy caused by quantitative easing—the global economy is set for a rocky road in the short-term (Wheatley, 2018). Tesla grew during a period in which the Global Economic Crisis happened and the Federal Reserve began a policy of quantitative easing (essentially a bond buying program that saw bubbles grow in numerous sectors). Tesla likewise has benefitted from a tax incentive program to the tune of $7,500 (Spiegel, 2018) thanks to a federal government interested in growing the green economy. That incentive is about to expire, however, and the global economy is raising numerous question marks about its ability to endure on a steady footing for much longer. Outlook for the Future Tesla is a forward looking company and one of the reasons its stock has enjoyed such a significant run-up is that so many stakeholders view it as a growth company. Musk continuously sets high goals for the company and though they are not always met on time (Higgins, 2018), stakeholders are pleased with the forward-vision of the CEO. Tesla is viewed as having a high degree of interest in corporate social responsibility and the need for companies to “go green” so as to save the world from global warming and climate change. Musk has stated as much in the vision and mission statements of the company over the years. Tesla’s mission statement is: “to accelerate the advent of sustainable transport by bringing compelling mass market electric cars to market as soon as possible” (Tesla, 2013). By building its brand around the idea of sustainability, Tesla has identified both a market and a product for its aim. As Evans (2017) points out, “sustainability is the ability to meet the needs of the present without compromising the ability of future generations to meet their own needs.” From this perspective, Tesla aims to meet the needs of green consumers who want to remake the modern world in their image and likeness. The only problem is that they may be far more idealistic and utopian in their vision than reality will care to accept. Tesla’s CEO and supporters show no signs of being abated by reality, however. All the same—and the mission and vision of the company aside—Tesla faces significant hurdles in terms of liquidity, operating efficiency, capital structure and profitability. These are the real challenges that Tesla must address in order to achieve sustainability—not only for the planet but for its own business model. These points will now be addressed in turn. Short Term Liquidity of Tesla In March, 2018, Tesla’s credit rating was downgraded by Moody’s due to the firm’s incessant cash burn, failure to meet production goals, and the likelihood that it would soon need to raise more capital (Weinstein, 2018). Tesla bonds have been sinking ever since, with Smith (2018) reporting a veritable “free fall” with Tesla notes hitting “a low of 86 cents on the dollar.” Moody’s analyst Bruce Clark stated that Tesla “faces liquidity pressures due to its large negative free cash flow and the pending maturities” (Weinstein, 2018). Tesla is expected to undertake a substantial “near-term capital raise in order to refund maturing obligations and avoid a liquidity short-fall” (Weinstein, 2018). The problem is rooted in the fact that after 15 years of operating, Tesla has yet to make an annual profit. The $2 billion it will likely need to raise this year to cover its cash burn along with its $1.2 billion of debt due next year is putting pressure on its bonds, as investors are realizing that the company essentially burns through approximately “$6,500 every minute of every day” (Smith, 2018). Meanwhile, Musk has boasted via Twitter that the company’s liquidity is fine and that a capital injection is not needed in the short-term (Denning, 2018). According to Morgan Stanley’s projections, Tesla’s short-term liquidity crisis is just around the corner, as Figure 1 shows. Figure 1. Tesla’s liquidity crunch year over year.

(Denning, 2018)

Tesla’s working capital is negative—substantially so--$2.27 billion as of March, 2018 (Denning, 2018). The Economist estimated Tesla would need upwards of $3 billion in capital injection by the end of the year. Musk responded with taunting tweet: “The Economist used to be boring, but smart with a wicked dry wit. Now it’s just boring (sigh). Tesla will be profitable & cash flow+ in Q3 and Q4, so obv no need to raise money” (Durden, 2018). Regardless, Tesla’s free cash flow belies Musk’s claims, as shown in Figure 2. Figure 2. Tesla free cash flow 2011-2018.

(Durden, 2018).

In its 10-Q filed May, 2018, Tesla painted a much different picture of its liquidity issues than from that painted by Musk on Twitter, noting that at the end of March, the company had “$2.67 billion of cash and cash equivalents. Balances held in foreign currencies had a U.S. dollar equivalent of $882.5 million and consisted primarily of Chinese yuan, euros and Norwegian kroner” (Tesla Form 10-Q, 2018, p. 40). Sources of cash for Tesla were identified as “deliveries of vehicles, sales and installations of our energy storage products and solar energy systems, proceeds from debt facilities, proceeds from financing funds and proceeds from equity offerings” (Tesla Form 10-Q, 2018, p. 41). Tesla pointed out nonetheless: “We may need or want to raise additional funds in the future, and these funds may not be available to us when we need or want them, or at all. If we cannot raise additional funds when we need or want them, our operations and prospects could be negatively affected” (Tesla Form 10-Q, 2018, p. 41). The summary of the company’s cash flows are shown in Figure 3. Figure 3. Tesla summary cash flows.

(Tesla Form 10-Q, 2018).

In short, Tesla is facing a short-term liquidity crunch according to all major analysts and is the main reason its notes have been plunging since March and why the stock itself is the most-shorted in the market, as CEO Musk himself has pointed out. Investors expect Tesla to have to go looking for more capital by the end of the year. Operating Efficiency Tesla has income per employee of -52,244 on revenue/employee of 313,208—meaning that Tesla loses money on production. Its enterprise EBITDA is -36,279.01 (Tesla Financials, 2018). With the erection of an end-of-line open-air tent structure in the middle of the desert in order to meet a self-imposed, arbitrary production deadline of 5000 Model 3’s, Tesla has raised more than a few eyebrows with regard to its operating efficiency. In its 10-Q, Tesla acknowledged its own efficiency issues: “We have no experience to date in manufacturing vehicles at the high volumes that we anticipate for Model 3, and to be successful, we will need to complete the implementation and ramp of efficient and cost-effective manufacturing capabilities, processes and supply chains necessary to support such volumes” (Tesla Form 10-Q, 2018, p. 44). A number of critical assumptions underlie its forward looking progress and goals: · that we will be able to complete ramping high volume production of Model 3 at the Tesla Factory without exceeding our projected costs and on our projected timeline · that we will be able to continue to expand Gigafactory 1 in a timely manner to produce high volumes of quality lithium-ion cells to be integrated into battery modules and finished battery packs and drive unit components for Model 3, all at costs that allow us to sell Model 3 at our target gross margins · that the equipment and processes which we have selected for Model 3 production will be able to accurately manufacture high volumes of Model 3 vehicles within specified design tolerances and with high quality · that we will be able to maintain suppliers for the necessary components on terms and conditions that are acceptable to us and that we will be able to obtain high-quality components on a timely basis and in the necessary quantities to support high-volume production; and · that we will be able to attract, recruit, hire, train and retain skilled employees to operate our planned high volume production facilities to support Model 3, including at the Tesla Factory and Gigafactory 1 (Tesla Form 10-Q, 2018, p. 44-45). Tesla then goes on to note that “if one or more of the foregoing assumptions turns out to be incorrect, our ability to meet our Model 3 projections on time and at volumes and prices that are profitable, demand for and deliveries of Model 3, as well as our business, prospects, operating results and financial condition, may be materially and adversely impacted” (Tesla Form 10-Q, 2018, p. 45). With so much riding on production of the Model 3 in order to go from being a niche market player to a mainstream manufacturer of an affordable EV for the middle classes and thereby achieve its mission of bringing sustainability to the 21st century for the average commuter, Tesla’s operating outlook is based on a number of highly unlikely assumptions—namely: · That the company will be able to sustain 5000 Model 3’s a week: it cannot, based on the number of hoops it had to jump through just to meet this goal; · That expansion is even in the cards considering the cash burn it has gone through; · That the company will be able to retain skilled workers: an extraordinarily high rate of turnover, especially among executives at top levels of the company, has been well documented (Hull, 2018). Tesla, in other words, is not likely to overcome its poor operating efficiency anytime soon. Capital Structure Tesla’s capital structure based on ratio analysis begins with its debt to equity ratio, which at the end of 2017 stood at 2.5%—lower than industry standards but only because Tesla’s stock is overvalued with a forward P/E of approximately 150, which puts the company at 6x the average P/E of the Nasdaq. TSLA, in short, has an inflated stock price that is the result of a fan-following based on CEO Musk’s personality, promises, and appeal. The market cap shows that TSLA is absurdly priced. For a company that has no net profits yet, its value of 49 billion USD makes no sense. Such a market cap should be applied to a company that is actually company of making a profit in the relative ballpark of that figure. Tesla is not only nowhere near making that kind of profit—it actually has yet to make any profit. Its momentum in the stock market has been fueled by speculation and what can only be described as a bubble in the tech sector. This is the sign of a cult stock that will soon have the air let out of its tires. Its total debt to total equity is 286.29. Its long-term debt to equity is 263.19. Its long-term debt to total capital is 68.13. Its long-term debt to assets is 0.39. Capital expenditures were negative 4 billion in 2017 and the five year trend shows a worsening capital and cash flow year over year (Tesla Financials, 2018). Tesla’s total debt as of March 2018 is 12.57 billion USD. Its total liabilities are nearly double that at 21.55 billion USD. Its free cash flow is -4.14 billion USD for 2017. Profitability Tesla has a gross margin of +19.15 with an operating margin of -13.93 and a pretax margin of -18.79. Its net margin is -16.68. Its return on assets is -7.64 and its return on equity is even worse at -43.63. Its return on total capital is -13.20 and its return on invested capital is -14.25 (Tesla Financials, 2018). In short, Tesla is not profitable and has been a loser for investors in all ways (other than for stockholders). Compared to Ford, which is positive in terms of profitability with a +4.85 net margin, Tesla is a company that does not bode well for investors—and yet its stock is an investor’s dream (at least for some).