TESLA’S TROUBLES
Tesla may have to pare production plans for the Model 3 or offer shares to creditors
Company’s current problems can be traced back to two decisions its CEO made in 2016
Tesla’s current troubles can be traced to two decisions made by CEO Elon Musk in 2016.
Back then the company was on solid financial footing and generating healthy growth selling its high-end electric cars to devoted customers. The two moves by Mr. Musk changed the direction of Tesla, leading directly to its growing financial distress and to the investigation by the Securities and Exchange Commission.
Despite all of his recent public statements, Mr. Musk does not appear to have learned from these mistakes. With investors still valuing Tesla as if its only trouble is keeping up with insatiable demand, the risk to the stock is very high.
At the start of 2016, the stock market was tumbling. Shares of Tesla were down and shares of Mr. Musk’s other public company, SolarCity, were down even more. SolarCity, like its competitors that sold solar panels to homeowners, was in severe financial straits.
Mr. Musk tried to reverse the declines. He unveiled the massmarket Model 3, which was supposed to sell for $35,000 (U.S.), potentially expanding the company’s market exponentially. Later, even before the Model 3 design was complete, he called the car “the biggest consumer product launch ever.” On a conference call with analysts that day, Mr. Musk said he expected that Tesla would make 100,000 to 200,000 Model 3s in the second half of 2017. Tesla’s shares nearly doubled in the next year. That number turned out to be about 4,000.
Mr. Musk’s other fateful decision that year was to merge SolarCity into Tesla.
That move quelled worries about SolarCity filing for bankruptcy, but saddled Tesla with another unprofitable business and stuffed $3 billion in extra debt onto its balance sheet. To sell investors on the deal, Mr. Musk pitched product ideas that have yet to result in meaningful revenue.
At Tesla, Mr. Musk’s promises forced the company to borrow an additional $1.8 billion and rush to boost production of the Model 3, which proved costly. After initial struggles, sales have grown rapidly but costs have risen even faster. The operating leverage—increasing profit margins on each extra dollar of revenue—that Tesla needs remains elusive.
Tesla is under increasing pressure to generate cash after burning through $1.8 billion in the first six months of this year. The company has about $1.3 billion in convertible debt due in November and March. It had $3 billion in accounts payable and just $2.2 billion in cash on hand as of June 30. Including capitalized leases, long-term debt tops $11 billion, according to FactSet.
Tesla’s suppliers are starting to worry about being paid what they’re owed. Mr. Musk grew so frustrated about the scrutiny his projections have received that he tweeted he had a deal in place to take Tesla private. That tweet and Mr. Musk’s optimistic projections for the Model 3 are under scrutiny by the SEC. Soon after he felt the need to email that Tesla was not going bankrupt.
Mr. Musk may have believed that letting SolarCity fail would dent the reputation he built at PayPal and his rocket company, Space Exploration Technologies. That could have hurt all of his businesses, including Tesla, which was regularly selling stock to fund its growth.
Tesla has several options to get out of its current jam. It could scale back production plans for the Model 3 to the point that it could produce them profitably. Tesla says it will turn a profit this quarter but given its history of overly optimistic forecasts, even persistently bullish analysts are skeptical, predicting it will lose $1.19 a share. But a profit is possible, largely because Model 3s are selling for $50,000 and more rather than the promised $35,000. A financial option, assuming the SEC lets it, would be to sell stock, but Tesla has repeatedly said it has no plans to do so.
Another riskier option is to persuade holders of the $1.3 billion in convertible debt who are due to be paid back in the coming months, to accept stock in Tesla instead of cash, according to Vicki Bryan, founder of research firm Bond Angle. She forecasts that move would minimize the dilution suffered by current investors while significantly reducing near-term debt, and give Tesla an extra sixto seven-month window to preserve its cash.
Whatever Tesla chooses to do, Mr. Musk needs to show that there has been a lesson learned. If not, investors should be skeptical of any plan he offers.