Is Tesla’s downfall a case of over-investment?

Tesla’s stock fell by 6%, showing a few cracks in Elon Musk’s armour.

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After the recent announcement of the results for the first quarter of 2018, Tesla’s stock fell by 6%, showing a few cracks in Elon Musk’s armour. Is reality finally catching up to South Africa’s most famous entrepreneur abroad?

With his promises of a better and less polluted world, thanks to his electric vehicles, Musk has galvanised crowds and investors—self-driving hardware in all cars, space tourism and reusable satellite launchers—his futuristic ideas sell dreams.

A communication champion, Musk even sent his own roadster into space. Yet, it’s sometimes difficult to bring dreams to life, as Tesla’s difficulties in achieving its goals regularly remind us. After each disappointing announcement, Musk reassures investors about his perspectives and future targets for the firm. Musk’s ability to convince allowed him to propel Tesla to great heights in terms of market capitalisation. On 17 February 2018, the company’s market cap reached US$56.7-billion.

A worrying cash situation

When analysing Tesla’s cash flow statement provided with the Q1 2018 results (unaudited figures), it is not enough to look at the net position at the end of the accounting period: US$3.2-billion at the end of March 2018 compared to US$3.9-billion at the end of December 2017, which still represents a drop of US$745 million. It is more important to look at the cash generated by the firm’s operating activities (cash flow from operating activities), which stands out strongly negative at US$398 million at the end of March 2018.

In other words, on every car produced and sold, as well as on the energy-storage business, Tesla loses money. For comparison, in the last quarter of 2017, operating cash flow was positive at US$510 million. This means that Tesla burned through US$908 million just in operating. If the company manages to maintain a positive net cash position at the end of the period, it is only thanks to new borrowing and the issuance of shares, and a decrease in its investments.

With an overall gross margin level of 19% at the end of December 2017, Tesla generated a loss of US$1.96-billion.

At the end of March 2018, the gross margin on the automotive activity (80.2% of sales at the end of March 2018) stood at 19.7%; almost the same level, and Tesla posted a loss of US$710 million (against a loss of US$330 million at the end of March 2017).

What’s more worrying, in the press release announcing the results of the first quarter of 2018, Musk and Deepak Ahuja specify that the margin on Model 3 is still “slightly negative”. Despite this, they maintain their gross margin target will be 25% as soon as they can produce 5 000 Model 3 units per week.

But even if Musk says that the 5 000 vehicles per week will be reached in two months, the challenge is not yet met. The leader himself acknowledged, “We made a mistake by introducing too much robotisation too quickly”, and added: “In the medium term, we expect to achieve a slightly lower margin (than the 25%) due to higher labour content in certain areas of manufacturing where we have temporarily dialled back automation, as well as higher material costs from recently imposed tariffs, commodity price increases and a weaker US dollar.”

Despite his repeated use of the qualifier “slightly”, these cumulative elements are not reassuring about Tesla’s ability to post a positive short-term gross margin. For now, the gross margin on Model 3 is still negative.

Reduction in investments

Tesla said in its 2017 annual report that investments in 2018 would be similar to those of 2017, more than US$4.4-billion. Announcing the results of the first quarter of 2018, investment projections (capital expenditure or Capex) were revised down to less than US$3 billion. Musk insists he will not need additional funding.

But the group will have to face more than US$4 billion of payments between April 2018 and 2019 and with its negative operating cash flows and forecast investments, Tesla will clearly need additional cash soon. And on top of that, Tesla already has a debt of more than US$10 billion, according to a report in The Conversation.

Today, Tesla is in a critical situation. At the end of March 2018, its net financial debt stands at 213% (237% at the end of December 2017) and its total debt-to-equity stands at 512.7% (576% at the end of December 2017). All financial analysts are legitimately raising the question of its funding needs, an issue that Musk persistently refutes.

This time, however, his disdain toward financial analysts seems to have undermined market confidence.

Beyond the over-indebtedness of Tesla, this attitude could be one of the reasons leading to the fall of the share price on 3 May. Even if the share reached US$284.45 at closing, still valuing Tesla at nearly US$49 billion, the price is below the symbolic bar of US$300. And this first drop could well be a prelude to a much more brutal fall.

Leadership gaps

Tesla’s Treasurer and Vice-President of Finance, Susan Repo, left the company in March 2018, just after the resignation of the Chief Accountant, Eric Branderiz, on 7 March. Executive turnover certainly exists in all groups but can we really believe this is a coincidence? In February 2018, the Global Sales Manager had also left and a year earlier, the Chief Financial Officer, Jason Wheeler, resigned—a resignation that had been announced on the eve of the quarterly results communication.

Recent retiree, Deepak Ahuja, who was Tesla’s Chief Financial Officer for more than seven years, from August 2008 to November 2015, was then called to the rescue. Recall that in 2008, it was he who had saved Tesla from bankruptcy. Should we see a sign in his return? And why all these departures? A working environment loaded with adrenaline and stress?

Musk says he sleeps regularly at the Fremont factory in California and says the plant will be running 24-hours a day until the end of June. He reportedly sent an internal e-mail announcing that he would hire an additional 400 people a week from the Fremont and Gigafactory 1 factories—a new decision that may further increase costs, while margins are insufficient and even negative on the Model 3. On 14 May, Musk said there was a need for “flattening the management structure” and that he was “undertaking a thorough reorganisation”. It followed the announcement of the temporary departure of Doug Field, the Senior Vice-President of Engineering, at a crucial time.

Currently, the CEO of Tesla has still not managed to solve the production problems of Model 3.

His company is far from profitable, its over-indebtedness has not been reduced and the thorny problem of its financing remains. Despite the tremendous communication efforts, the varnish of the invulnerable superhero begins to crumble. 

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