Shortseller: Tesla Has No Moat Of Any Kind; Model 3 Backlog
Stanphyl Capital letter for the month of October 2018 discussing the Tesla stock and the Model 3 backlog.
We remain short stock and call options in Tesla Inc (TSLA), which I consider to be the biggest single stock bubble in this whole bubble market. The three core points of our Tesla short position are:
1) Tesla has no “moat” of any kind; i.e., nothing meaningfully or sustainably proprietary.
2) Tesla will again soon be losing a lot of money (yes, it temporarily made some in Q3- I discuss that below) and has a terrible balance sheet despite relatively light competition, but will soon be confronted with massive competition in every aspect of its business.
3) Elon Musk is extremely untrustworthy.
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In October Tesla reported (without yet—as of this writing—filing a 10-Q) a surprisingly good (based only on the headline numbers!) Q3 earnings report, showing a GAAP profit of $311.5 million (vs. my expectation of a small GAAP loss). It was also the best quarter Tesla will ever have. Here are my thoughts:
- First, I’m generously assuming that the Q3 numbers weren’t inflated by any one-time supplier rebates (even though Tesla demanded them) or utilized previously written down parts or inventory; however, we need the (still unfiled) 10-Q to confirm this.
- I expect that Tesla’s Q4 will be less profitable than Q3 but—thanks to a last-minute customer rush to grab the $7500 U.S. tax credit (which gets slashed in 2019) and the depletion of the last of the U.S. Model 3 backlog, earnings should still be GAAP positive. Everything I write about below refers to 2019 and beyond, using Tesla’s $312 million Q3 2018 profit as a baseline…
- It’s worth noting that Tesla’s much-heralded Q3 26% gross margin as Tesla defines it was awful for cars with estimated ASPs of $59,000 (Model 3) & $103,000 (Models S&X). The entire rest of the industry (unlike Tesla) includes in COGS 6% engineering costs and a 10% price haircut (by selling to its dealers—a cost Tesla instead recognizes in SG&A via its stores), and if you adjust for that Tesla gross margin was just 10%, a luxury car industry low. However…
- The real Q3 issue was with operating expenses, which (in declining from Q2 despite a massive sales increase) were obscenely low from the standpoint of customer service, and the resulting long repair and delivery lines, terrible logistical problems, etc. were all acknowledged by Musk himself on Twitter. To sustain Q3’s volume without alienating customers, SG&A & service center costs must be at least $75 million higher per quarter. I expect we’ll see some of this in Q4 and a lot more of it in Q1 2019.
- Let’s then assume for 2019 that Q3’s quarterly sales rate of 56,000 Model 3s continues despite the exhaustion of the U.S. backlog and the U.S. tax credit cuts but—on the plus side—with European sales beginning in March. Due to October’s introduction of a new $46,000 model, we can expect at least a $3000 ASP reduction (from $59,000 to $56,000) of which $1500 will be margin (the highest margin is from those lost options), and $1500 x 56,000 means losing $84 million in quarterly profit. (Eventually Model 3’s ASP will drop a lot more when a short-range version is introduced, most likely at $40,000 rather than the promised $35,000.)
- I then estimate that beginning Q1 2019 Models S&X sales will drop by 5000/quarter (from Q3’s 27,000) due to the U.S. tax credit slash, a drastic reduction in the Netherlands tax credit (where Tesla sold 2500 cars in Q3 alone) and competitive sales lost to 10,000 quarterly Jaguar i-Pace sales plus 10,000 quarterly Audi e-tron sales. (The i-Pace is already crushing Tesla in Norway, Tesla’s largest European market.) Those last 5000 S/X sales may each have $40,000 in incremental margin so that’s another $200 million in quarterly profit gone vs Q3. (The Models S/X erosion will be even worse in the second half of 2019 with the introduction of the Porsche Taycan and Mercedes EQC and a further reduction of the U.S. tax credit beginning July 1.)
- In 2019 the ZEV credit market likely goes away completely, as manufacturers have stocked up plenty to last until their own EVs generate enough for their fleets. So another $52 million of Tesla’s Q3 quarterly profit goes away.
- So unless Tesla continues screwing customers service-wise (in which case it will rapidly lose them), the right way to look at a sustainable earnings snapshot for 2019 is Q3’s $311.5 million less $75 million in additional SG&A less $84 million in reduced margin due to lower Model 3 ASPs less $200 million in lost S/X sales less $52 million in ZEV credits = a 2019 quarterly GAAP loss of approximately $100 million; i.e., a car company losing $400 million/year.
- To be fair, normalized GAAP losses of $400 million a year are vastly better than earlier losses of over $1 billion, but so what? Profitable car companies currently have PE ratios of around 6.
- But what about China, the Model Y (small crossover/SUV) and the pick-up truck?
- First, lets assume that Tesla could generate a net profit margin of 4% on any incremental cars it sells. Why 4%? Because BMW (a far better company with comparably priced products) makes around 7.5% on its cars and electric cars have an inherent $10,000 powertrain cost disadvantage vs conventional cars and that figure—especially with the growing demand for battery raw materials—won’t meaningfully decline on any reasonable time horizon. This additional cost will be shared by customers (by paying higher prices for battery cars than comparable conventional cars) and by manufacturers (who will have to accept lower margins on battery cars.) So I’m using 4% as a guesstimate.
- Could Tesla sell $2 billion in stock (7 million shares) to fund a U.S. Model Y factory, and then in 2021 at a $53,000 ASP sell 300,000 a year combined Models 3&Y (with the “Y” heavily cannibalizing the “3”) between the U.S. & Europe, at a 4% profit contribution margin? If so this would be an incremental 76,000 cars annually (over the Model 3-only pace), and thus create additional earnings (vs. Q3 2019) of $161 million a year, minus an earnings deduction of $28 million due to a $3000 lower ASP (vs. my 2019 estimate of $56,000) on the 234,000 baseline cars. So net additional combined Model 3& Y earnings (over my 2019 estimate) would be $133 million.
- Could Tesla debt-finance a China factory and in 2021 build & sell 200,000 combined Asian Model 3s & Ys a year at a $48,000 ASP with a 4% profit contribution margin and create roughly $400 million a year in additional profit? Perhaps.
- Could Tesla sell $1 billion in stock (3 million shares) to finance a (niche) electric pick-up truck (perhaps built at the Gigafactory, or at Fremont with space freed up from Model 3 production when the Model Y begins cannibalizing it) and in 2022 sell 100,000/year at a $50,000 ASP with a 4% profit contribution margin, and make an additional $200 million a year? Perhaps.
- Combine all those assumptions and three years from now Tesla becomes a mature car company making $339 million a year (with the profits from the additional models offsetting the $400 million/year baseline loss) and, as noted above, mature car companies currently have PEs of 6. If we double that PE for Tesla to 12 it equals a market cap of just $4.1 billion. If we then assume 188 million shares (today’s diluted count plus the above-noted capital raises) and if all those models get built and all those profits come in, in three years TSLA would be worth just $22/share. Discount that back to today at 15% a year and you’ve got a current valuation of just $14/share.
- The beauty of these assumptions is that you can say “Spiegel, you’re crazy—Tesla will make TWICE that much money!” Okay, in that case in three years you’ve got a (then) mature car company that—even at 2x the current industry multiple—would be worth $44/share, which discounts back to a current value of just $28/share.
- Note that I’m not making any adjustments in those numbers for potential accounting fraud, despite multiple whistleblower claims that Tesla is deliberately mischaracterizing employee expenses to inflate gross margin, capitalizing scrap material rather than expensing it and took full payment for cars in Q3 and didn’t deliver them until Q4.
- I’m also omitting potentially massive “420 tweet” (see below) securities fraud lawsuit settlements, tens of thousands of $3000 “full self-driving” refunds (see below), thousands of $5000 “Model 3 Performance” refunds (see below), safety recalls that should have been done but weren’t, etc., yet maybe I shouldn’t omit these things, as although with a normal company they might be one-time items, with Tesla it seems to be part of the “business plan.” These items could easily total over a billion dollars in additional liabilities, thereby wiping out several years of the potential future profits discussed above.
- Bonus round: there’s now a developing FBI/DOJ criminal probe regarding false Model 3 production projections, a case meticulously laid out in this civil lawsuit. If Musk winds up ousted (or even in jail) for securities fraud, Tesla’s stock may see low double-digits almost instantly.
But lest you believe Q3 really did mark a significant and lasting turnaround for Tesla, keep in mind that no group has a better grasp of a company’s prospects than its executives, and yet their massive exodus continued throughout the entire quarter, with the departure of multiple key accounting, production, and engineering people. Rather than listing the never-ending stream of new departures here, please use this link to see the astounding full list. Many of these people left millions of dollars in unvested stock on the table, and one must ask why. Do they assume that stock will wind up worthless? Were they asked to do things they were “uncomfortable” doing? Or is Elon Musk just so difficult to work for that it isn’t worth the millions of dollars they left behind? None of the answers to those questions are favorable to Tesla. While a couple of low-level whistleblowers have come forward publicly to report on internal dirty deeds at Tesla, with that many high-level departures I have no doubt that myriad more significant whistleblowers are doing the same.
Perhaps the most important ongoing Tesla story is the evaporation of North American Model 3 backlog. Despite Q3 production averaging just 4100 Model 3s per week (far short of the anticipated 5000 per week and Musk’s near-term goal of 6000), Tesla built up substantial Model 3 inventory and had to hold large lot sales and offer free Supercharging (lifetime for the “Performance” model and a year for the lesser models) to get rid of it. Then in mid-October Tesla began offering a slightly shorter-range (260 mile) Model 3 with a $3000 price cut vs. battery production savings I estimate at just $1500; in other words, Tesla is taking a $1500 per car margin hit. It also slashed the price of its AWD model by $1000 and cut the price of its most fully-equipped “Performance” model by $5000, thus causing thousands of Q3 (and early Q4) Performance buyers to scream in protest and thereby force Musk to promise them $5000 refunds.
Many people argue that “truly massive” Model 3 demand will be unleashed when Tesla offers an even shorter-range, lower-priced version in mid-2019; here’s why I think that’s wrong… First, I can’t see any way that a short range (approximately 220-mile) base car can be priced at less than $40,000 (including Tesla’s $1200 delivery charge) vs. Tesla’s original promise of $35,000 (a price which has now been scrubbed from Tesla’s web site). After all, the current base car with an 80 kWh battery sells for $50,000 (including the delivery charge). If Tesla cuts that battery size by 1/3 (25 kWh) it will only save around $5000, and if it then accepts a 10% cut in gross margin (to probably near-zero on an un-optioned base model), it would have to price the shorter-range car at around $40,000. Now let’s put that in perspective…
Tesla recently sat with piles of unwanted long-range (310 mile) rear-wheel drive Model 3 inventory at a net customer base price of $42,500 ($50,000 minus a $7500 tax credit); in fact, after it ran through over two years of order backlog in Q3, demand became so low for that model that Tesla has now eliminated it completely, mandating the purchase of all-wheel drive with the largest Model 3 battery pack. So if a small-battery Model 3 with 90 fewer miles of range will cost $40,000 (my estimate) and only come with an $1875 credit beginning in July (and no credit at all beginning January 2020), why would there be door-busting demand for a $38,175 ($40,000 in January 2020) 220-mile car when there was a glut of 310-mile cars at $42,500? When financing a car, who wouldn’t pay an extra $2500 for an extra 90 miles of electric range? And yet Tesla’s North American backlog of those buyers is gone. The real mass-market Model 3 demand was at $35,000 with a $7500 tax credit—a fictional product that Musk lied about to do massive capital raises in 2016 and 2017.
Meanwhile, the Model 3 continues to reveal itself to be a complete lemon, with the latest survey from True Delta ranking it dead last among all available vehicles. And in September British magazine What Car? ranked overall Tesla reliability so low that it’s in “a league” of its own. And speaking of lemons, although the latest Consumer Reports survey doesn’t have enough Model 3 data to provide a reliability estimate other than “average,” it downgrades the Model S to “worse than average” and thus “unacceptable” while the Model X is once again rated “much worse than average” and makes the “coveted” “10 Least Reliable Cars” list.
On the last weekend of September (following the publication of our September letter) Musk settled the “420 case” (his fictional tweets about a $420/share Tesla buyout) with the SEC by agreeing to pay a $20 million fine, step down as chairman for three years, appoint two new independent directors, and have all his Tesla-related communication reviewed by a special committee. He then proceeded almost immediately to ignore the latter provision by taunting the SEC on Twitter by calling it the “Shortseller Enrichment Commission” and then a few weeks later tweeting that his $20 million fine was “worth it.” Additionally, the “420 tweets” triggered an onslaught of lawsuits with a billion-dollar plus liability from investors who bought stock anticipating that buyout, and none of that (nor the aforementioned DOJ investigation) is going away with this settlement.
In October (in a move likely forced by SEC or DOJ regulators) Tesla withdrew a $3000 option for “future full self-driving” that it offered since 2016 despite every expert in the field of autonomy saying was years from being possible and unlikely to occur with Tesla’s no-LiDAR hardware suite. If this vaporware product had 20% buyer uptake, it means Tesla now owes around $150 million in refunds and loses a nice ongoing source of gross margin. Additionally, Tesla is open to massive lawsuit claims from people who bought their $100,000 car only because they anticipated receiving “full self-driving” capability, something Musk claimed since 2016 was right around the corner; thus the liabilities for this fraud could run into the hundreds of millions.
Meanwhile there’s an onslaught of luxury EV competition about to rip the face off sales of Tesla’s most profitable models, the S and X. First, the new Jaguar I-Pace electric crossover (which has received fabulous reviews, handily beating Tesla in comparison test after comparison test) is now available in Europe (where it’s already crushing Tesla in Norway, its largest market) and the U.S. for $13,000 less than the Model X and $7000 less than the Model S, gaps that will widen substantially as Tesla’s tax credits begin phasing out in January. I’ve driven the Jaguar and can assure you that no objective person will say it isn’t much nicer than any Tesla.
In December in Europe and April in the U.S. comes the Audi e-tron, an all-electric SUV with roughly the same estimated EPA range as the 237-mile base Model X but with a much nicer interior and a price that’s over $8000 lower before the Audi’s tax credit advantage. When the Audi arrives in the U.S. it will receive a tax credit that’s $3750 better than Tesla’s, thus stretching its price advantage to almost $12,000, and that advantage will grow to almost $14,000 in July when Tesla’s credit is reduced to just $1875 vs the full $7500 for the Audi.
The Mercedes EQC all-electric SUV will be available in Europe in mid-2019 and in the U.S. in early 2020, with an EPA range nearly that of the base Tesla Model X (an estimated 225 miles vs. 237 for the Tesla) at a cost that’s approximately $25,000 less, as the Mercedes will sticker at around $65,000 and get a full $7500 tax credit while the Model X starts at $83,000 and will get no tax credit when the Mercedes arrives. (As an aside, by 2022 Mercedes will have ten fully electric models, covering nearly all its model lines.)
Although the Model X is larger than the Mercedes and Audi (and has optional third row seating and for $99,500 can take its range up to 295 miles), it had previously been the only luxury electric SUV, leaving buyers with no choice in that category. Now there are alternatives for those who prefer a smaller, easier-to-park vehicle with a much nicer interior and vastly better service facilities, as well as more practical doors than the Tesla’s oft-malfunctioning “falcon wings” (which prevent the ability to mount a rooftop storage unit, something both the Mercedes and Audi can do). I thus expect buyers will flee en masse from the “X” to the nicer and much less expensive Audi and Mercedes, while the Jaguar—more of a crossover than an SUV—will provide terrific competition for both the Model X and the Model S.
Next in luxury EV competition for Tesla will be the Autobahn and Nürburgring-tested Porsche Taycan, which will be available next year with a base price similar to that of the base Model S, and thus will likely be less expensive with the advantage of the tax credit Tesla will soon lose. Hmmm, Tesla or Porsche… tough choice!
Meanwhile Tesla continues to downsize its SolarCity division while a civil securities fraud case accusing Musk of using Tesla to bail out his (and his family’s) interests there proceeds; earlier this year Zero Hedge included an excellent summary of the suit by Twitter user @TeslaCharts in this story about SolarCity’s latest retrenchment which will undoubtedly help fuel that fraud case, as will this later story describing how Tesla sales people have no idea when the solar tiles or PowerWalls used to justify that merger will ever be available. (Remember that when Musk was promoting that merger he used fake solar tiles on a fake house at a movie studio… How appropriate!)
Finally, Tesla is increasingly besieged by a wide variety of lawsuits for securities fraud, labor discrimination, worker safety, union-busting, sudden acceleration and lemon law violations, and new ones appear on a regular basis.
So here is Tesla’s competition in cars (note: these links are continually updated)…
And in China…
Here’s Tesla’s competition in autonomous driving…
Here’s Tesla’s competition in car batteries…
Here’s Tesla’s competition in storage batteries…
And here’s Tesla’s competition in charging networks…
Yet despite all that deep-pocketed competition, perhaps you want to buy shares of Tesla because you believe in its management team. Really???
So in summary, Tesla is losing a massive amount of money even before it faces a huge onslaught of competition (and things will only get worse once it does), while its market cap tops that of Ford and GM’s despite selling approximately 300,000 cars a year while Ford and GM make billions of dollars selling 6 million and 9 million cars respectively. Thus this cash-burning Musk vanity project is worth vastly less than its over $65 billion diluted enterprise value and—thanks to its roughly $31 billion in debt and purchase obligations—may eventually be worth “zero.”
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