Tesla Inc (TSLA)

[msmithgold]

Tesla: Over-Hyped, Lousy Company Destined for Bankruptcy (Vilas Capital)

Summary of Vilas Capital's short thesis

Summary

Tesla is an over-hyped, lousy company, from a financial perspective that is destined to go bankrupt
Contrary to the likely barbs and pitchforks we will receive, I do wish that global warming was not occurring and that polar bears and penguins could live undisturbed in their former environments
Tesla Background

Current revenue is roughly 99% automobile related and due to Model 3 introduction and projected sales, this ratio will likely remain similar for quite some time
Thus, Tesla is an auto manufacturer, plain and simple
Panasonic supplies TSLA with batteries and other companies provide TSLA with electric motors, tires, wheels, etc
Thus, with a few extraneous business lines, TSLA designs and assembles cars
Honda makes jet airplanes, ATV’s and boat motors – still, Honda is considered an auto company as the majority of its revenue is derived in that business
Until TSLA’s battery storage and solar equipment business become majority contributors, it will remain viewed as an auto company
Unfortunately for Tesla, none of these businesses are currently profitable nor do we see any possibility of them becoming materially profitable over any visible time horizon
TSLA has had a ton going for it: extremely cheap equity and debt capital, government loans, huge government subsidies, a manufacturing plant that was purchased for nearly nothing, a marketing oriented CEO who has an eye for beautiful cars, and a great idea to put a really big battery in high end electric cars so that it can go over 200 miles before needing to be recharged
However, with all of these positives, company has not made an annual profit despite catching the auto giants asleep at the wheel
Now, to help raise capital, they’ve shown large demand for electric cars (373,000 Model 3 reservations at last disclosure) and have placed a large bullseye on their back
Executives inside top 10 auto manufacturers now all need electric car strategy and what was once a niche market that Tesla could dominate will become far more competitive with time – there is no doubt or argument about this
Microeconomics 101

Due to their desire to be vertically integrated, Tesla stated that it must construct a large factory to manufacture enough batteries to supply their cars
Elon Musk stated that this factory would double the amount of production of lithium ion batteries worldwide and that for each 500k cars manufactured, another battery factory must be built
If it requires the tripling of lithium ion battery production to simply make 1 million electric cars per year, out of a ~90 million worldwide car market, will that not affect the price of the raw materials that go into battery production?
Since raw materials make up roughly 85% of batteries’ COGS, would that not overwhelm the potential for economies of scale of building a really big battery plant?
When US mandated ethanol and used roughly 30% of corn production to make it, price of corn rose roughly 3 or 4x for a significant period of time
We are talking about increasing production of lithium ion batteries by 200% to get to 1 million cars per year (roughly 1% of worldwide market share) – will this not cause the cost of batteries to rise? Will this cost inflation not hurt the economics for electric vehicles? Of course it will.
Valuation and Returns

TSLA has a significantly larger enterprise value than Ford – we will use Ford as an example as it is the only domestic auto company to avoid bankruptcy and is therefore selling at a premium to the rest of industry
TSLA has 176 million shares fully diluted; nearly $7B of debt; thus at $302/share, TSLA has an enterprise value of roughly $60B (Ford enterprise value is roughly $29B)
On an enterprise value to revenue basis, Ford trades at 0.2x
As a growth company with large capex and working capital needs, odds of TSLA paying material dividend or share repurchase in the next ten years are, for all practical purposes, zero
Stock must rise to provide the market-like returns, say 10% annually for the next 10 years
Could use higher expected returns on TSLA as I am sure few shareholders believe their future returns will be this low
At 10% per year for 10 years, TSLA’s share price will be $785/share; assuming 180 million shares outstanding vs. current 176 million shares to account for future stock option grants, this implies an equity market valuation of $140B in 2026
Ford, on the other hand, may not grow at all but could use its profits to continue paying the 5% dividend that is paying today while also buying back roughly $2B of its shares per year, creating a 10% return for shareholders
Thus, in 10 years, Ford would continue to have same revenues and same $45B market cap but would have far fewer shares outstanding, leading to a higher stock price
Capital Efficiency

Ford is far more efficient with its capital investments than Tesla – Ford generated $152B in revenue in 2016 while employing $60B in gross PPE
For Ford, this PPE vastly understates replacement cost scenario as many of these plants were acquired many decades ago
Tesla produced $7B in revenue in 2016 with $7B in gross PPE
We agree that asset efficiency will improve in time and will rise from $1 of revenue to $1 of PPE to a Ford-like $2.5 of revenue to $1 of PPE
However, TSLA’s current asset turnover is being helped immensely from the bargain purchase of the NUMMI plant in California
Also, TSLA is vertically integrating by owning their battery production facility, their dealers, and their refueling stations – which cost a tremendous amount of money
Assuming Tesla will be a relatively mature company in 2026 with similar profit margins to those Ford enjoys today, it stands to reason that TSLA will have a similar valuation to a mature auto company
Assuming EV/revenue of 0.2x, this implies that TSLA will need to have revenue of $735B in 2026, assuming they roll over their $7B in debt and do not take on additional debt
Quandary

The issue is, how is TSLA going to pay for the capex to manufacture $735B/yr of stuff? Cars, solar gear, and batteries are not software
Again, Ford has roughly $60B of PPE
If Tesla had similar fixed asset turnover in the future as Ford (despite the vertical integration), it would mean $294B of gross PPE
Given that TSLA is losing money and will likely do so for the foreseeable future, where is the additional $287B of capital to invest in PPE going to come from?
Further, this ignores the very real need for working capital to fund raw material purchases and salaries for workers prior to the sale of cars
It is clear that Tesla cannot sell $287B of equity over the next 10 years; TSLA will not earn $287B and they will not be able to borrow $287B
TSLA will not be able to grow to $735B in revenue in 2026 as they will not have the PPE to do so
Therefore, TSLA cannot return 10% per year or anywhere close to that number
Even keeping the stock flat would be a herculean effort: TSLA would have to increase revenue by 40x to simply grow into their current EV in 10 years (ignoring effects of additional dilution from equity sales or taking debt into account)
Even this would require roughly $110B of additional PPE
Where is this $110B coming from? Not Mars.
Either Tesla has to miss estimated growth rates badly or they have to raise an insurmountable amount of money
History Lesson

There are those that will say that we are crazy for this “low” estimate of EV to revenue multiple
If we look at past crop of very exciting, high growth, glamour companies such as Cisco, Sun Microsystems, EMC, Yahoo, AOL, Microsoft, etc, as they matured, they all fell to very low mundane multiples a decade after their rapid growth phase
In fact, these companies who once collectively traded at roughly 5-10x the multiples of stodgy IBM and HP, dramatically underperformed IBM and HP from 2000-2002
Each glamour company witnessed extreme multiple contraction, if they had earnings and/or remained independent, and eventually sold at roughly 10-12x earnings a decade later, similar to IBM and HP
Glamour companies lost their entire valuation premium over the decade from 1999-2009
Outlook

Due to the fact that TSLA has not made money on its high end, highly optioned and highly priced cars, odds of them making money on the Model 3 are slim
Profit margins on high end cars are far higher than mass market cars
Due to Model 3 needing a similarly large battery to their higher end cars, it is unlikely that the costs of this car will be proportionately lower to its sale price; in fact, could make a strong argument that costs of producing Model 3 will fall far less than the sale price when compared to the Model S
Additional competition is coming and coming fast
Contrary to common wisdom, electric car is vastly easier to design and build than a standard internal combustion car
Majors just didn’t think that people would buy an all-electric car that took a long time to recharge and focused on hybrids – this was a short-term marketing error, not a capability differential
For those that believe TSLA has a huge technology lead, remember that Elon Musk gave away all their patents to the world for free (indicated to us that these were not valuable patents)
For those who will focus on remaining 1% of the business, battery storage business is a low margin business and the solar equipment business is very, very difficult
Tesla has over $6B in debt that will be coming due over the next 5 years
Tesla is a poorly capitalized company, compared to the competition, operating in a low margin and highly capital intensive, cyclical business
What if a recession were to occur and Wall Street capital is no longer available? By the way, it is not an “if” question but a “when”
When market figures out Tesla is extremely capital intensive, low margin, cyclical, and unable to grow into its valuation, the stock will fall dramatically
This will make it nearly impossible to raise equity capital; with a credit rating of B- and a depressed stock, believe that debt markets will close for Tesla
Given capex needs, working capital needs, debts to be repaid, purchase commitments and residual value guarantees, which total nearly $17B, it is highly likely that Tesla will, at some future point, struggle to remain current on all of their obligations
We believe that over the next 5 years, odds of a standalone TSLA becoming insolvent and requiring the filing of a bankruptcy petition are over 90%
Only salvation would be to find a “Time Warner”
Conclusion

Tesla is merely one of a huge crop of companies who sell “the future” to the markets, both private and public, and rely on the “there is a pot of gold at the end of the rainbow” storyline
There is a reason for GAAP; there is a reason for valuation and cash flow analysis; there is a reason for competitive strategy analysis; there is a reason for consistent profits; there is a reason for conservatively managing a company’s balance sheet
Even though Tesla buys batteries from Panasonic and most other components from other suppliers, thus not creating a technology but using widely available parts in a somewhat novel way, how did true innovators, Wilbur and Orville Wright, and their company do? Let’s just say that there was a little airplane company in Seattle (now Chicago) that did somewhat better
Tesla is mainly owned by growth investors with little experience or understanding of the capital intensity, or cyclicality, of the auto business. People defer purchases of cars in recessions, especially expensive cars
A hard lesson will be learned by the “trees can grow to the sky” crowd