Tesla: A Case Study
Tesla’s financial position is weak due to ongoing and cumulative losses from operations. Because Tesla continues to lose money, it is reliant upon new capital to support its continued operations. The weakened financial position and growing capital needs put the company in a precarious position, with the very survival of the company left to the whims of the capital markets (the providers of capital).
With its lack of earnings and large cash burn, Tesla has relied on raising new capital at regular intervals to continue with ramping production. To date, the capital markets have obliged with fresh capital. In our assessment, capital markets have done so with very cheap credit, especially considering the company’s up-until-now single-B credit rating (this is very weak). With such a high equity market capitalization and no earnings, the company cannot consider (though we think it should) raising equity without driving share prices off a cliff. Successive investors would demand a more favorable entry price, and existing investors would seek to avoid dilution so that the stock price would respond adversely.
Without reasonable access to equity capital, Tesla is left to just borrow more. Except, creditors seem to have finally awoken from their slumber. Negative cash flow, limited value assets (again, negative cash flow), senior management departures (we counted three in March alone), quality control issues, ongoing failure to meet production targets, et cetera are causing creditors to rethink Tesla’s risk premium. Helping wake creditors, Moody’s downgraded Tesla’s senior unsecured credit rating deeper into junk territory from single-B to triple-CCC (B3 to Caa1), citing production shortfalls of the Model 3 and pending maturities of convertible bonds. We don’t think Moody’s is wrong in doing so because Tesla is precariously close to bankruptcy. The bond price collapsed, and yields spiked higher as a result.
Recent market activity – namely, bonds repricing for much greater risk – seems to have shuttered another door for much needed capital. As its cash burn continues, Tesla has a tall order ahead for replenishing liquidity. While we suspect Tesla has another trick or two up its sleeve to raise capital, each successive round will require ever more pounds of flesh, which comes at the expense of existing capital providers – both equity and creditor. Creditors assuredly woke up, and now, equity investors may be waking up too…
In the latest SEC 10-K filing (annual report covering the year ended 12/31/17), Tesla reported a net loss of -$1.96 billion attributable to common stockholders (its biggest ever loss) and cash flow from operations of -$60 million. The latter number seems almost refreshing when framed against the $4.97 billion accumulated deficit reported in the shareholders’ equity section of the balance sheet. This is because it implies Tesla is $60 small-million away from breakeven operations – from a cash flow standpoint anyways. But this figure comes before considering cash needed for investing activities. Even mature companies spend large sums refurbishing fixed assets just to maintain operations. During 2017, Tesla spent $3.41 billion on capital expenditures (how else would Tesla manufacture cars, if not with equipment?) and $660 million on other equipment purchases related to long-term sales financing of solar panels. (We won’t delve into solar financing, which is under the Solar City brand, here because the explanation is too wordy for purpose of this writing.) The combined automobile manufacturing and solar equipment expenditures totaled more than $4 billion. Because cash flow from operations has been negative in each year (with exception of 2013) going back to 2009, Tesla has relied on new capital to finance capital expenditures. Economic law dictates that (in the long-run) cash flow from operations must exceed capital expenditures if capital providers are ever to get their hard-earned money back. With ever increasing losses and continued cash burn, investors must make value judgments of when, if ever, and by how much cash flow from operations will exceed capital expenditures. Without such rational assessment, an investor is speculating – and likely to face – permanent loss on their investment.
Tesla’s current equity market capitalization is $42.5 billion, but it reached a high of $60 billion in January and February this year. As noted above, Tesla lacks earnings and positive cash flow, does not pay a dividend, and carries a credit rating of triple-C. For context, here are profiles of Tesla’s American competitors:
- General Motors (GM): net income of $10.6 billion, cash flow from operations of $17.3 billion, which exceeds $8.4 billion of capital expenditures for $8.8bn free cash flow. General Motors pays a dividend, currently yielding 4.25% at $35.70 share price. The credit ratings are triple-B (investment-grade). Market capitalization is approximately $49 billion.
- Ford Motors (F): net income of $6.4 billion, cash flow from operations of $18.0 billion, which exceeds $7.0 billion of capital expenditures for $11.0 billion free cash flow. Ford pays a dividend, currently yielding 5.55% at $10.80 share price. The credit ratings are triple-B (investment-grade). Market capitalization is approximately $43 billion.
We ask rhetorically, why should investors be willing to pay more for Tesla than General Motors and Ford?
In the old days, growth capital came from equity financing. Once an asset was proven to generate reliable cash flow, credit could be applied to the asset to create leverage and increase returns to equity. Nowadays, in the era of central bank monetary easing, credit has flowed easily and depressed risk premiums in both credit (low interest rates) and equity (high multiples) markets. Investors seemingly couldn’t find business ideas they didn’t like. In the case of Tesla, credit was applied to assets not yet producing reliable cash flows – more than $5.4 billion has been borrowed in the name of Tesla. Without cash flow, the creditors cannot be paid unless more capital is raised. In the old days, without payment to creditors, companies would go bankrupt, and assets transferred from common stock owners to creditor owners.
With Tesla’s current operating profile and capital needs combined with the company’s market price, we think of the situation as akin to running with a noose around your neck. Maybe you won’t trip and fall, but running is quite careless. In Tesla’s case, a stock priced for perfect operational execution (as we think recent price indicates) seems careless. Any operational tumble could result in that noose tightening and an air pocket like drop in stock (and bond price). We wonder if recent drops in price of Tesla’s stocks and bonds may be foretelling.
Producing the Model 3 (Tesla’s mass-market car) profitably and on (the new revised) schedule is, more than ever, critical to Tesla’s ability to raise more capital and continue as a going concern. Even if Tesla can deliver on said requirements, we are not convinced the equity is priced right for the ongoing risks of an immature company competing with established and mature titans – who have decades of manufacturing experience and greater financial fire-power.