Some Facts About Tesla And Its Bears – Tesla Motors (NASDAQ:TSLA)

There are a lot of misconceptions out there about Tesla (NASDAQ:TSLA) “bears.” The simple truth is we are just people who believe the odds of a lower Tesla stock price are much greater than the odds of a higher share price by the end of 2018. It is really just that basic. After 18 months of reading comments in the media and on sites like this in response to articles written by bearish writers, it is time to set the record straight. So let’s see if we can clarify a few things.

Elon Musk

You simply cannot hate the man. There’s absolutely no doubt he’s a visionary. His ideas flow like water from a natural spring. He can excite a product launch like no one since the late Steve Jobs.

Is he able to deliver on time and on a budget? Rarely. We can look back at each and every planned start date and not one I can find has been met. They all slide. Some products (Solar Roof) have still not been seen delivered to the public at large. Budgets? What are those? Musk does not seem to have a grasp on the concept much like the importance of profits. I intend to offer an explanation for this.

In the nearly two years this stock has been on my radar I have only seen Musk concerned with achieving a profit once, and that was in Q3 2016 ahead of what was an expected upcoming stock offering. Of the 10 goals laid out for him to receive in excess of 5,000,000 shares via options, not one is related to profitability. So why is anyone surprised when we see massive losses? He’s not motivated or compensated to avoid them. Investors have (up until now) been happy to keep buying shares even with expected losses of $1.4 billion or more in 2017. Tesla is not a start-up anymore. This company went public 7.5 years ago.

Let’s recap the 10 goals that were set for him in 2012 by the Compensation Board at Tesla:

10) Successfully complete the Model X alpha prototype. – Completed in 2012

9) Successfully complete the Model X beta prototype – Completed in 2012

8) Successfully build the first Model X production vehicle – Completed in 2015

7) Produce 100,000 total vehicles – Completed in 2015

6) Successfully complete the Model 3 alpha prototype – Completed in 2016

5) Successfully complete the Model 3 beta prototype – Completed in 2017

4) Successfully build the first Model 3 production vehicle – Completed in 2017

3) Produce 200,000 total vehicles – Completed in 2017

2) Produce 300,000 total vehicles – Will be reached in 2018

1) Maintain a gross profit margin of 30% for four consecutive quarters – Not yet in sight.

As we can all see, none of the board members saw fit to insert a goal of profitability. Why? My guess is Musk has influenced them as he has his employees and investors. That the goal of lifting humanity out of the bonds of a fossil-fueled existence is so important that what it will cost to achieve the goal is unimportant – that everyone should be happy to jump on his train. That costs and profits are concerns left to his small-minded competitors. In some respects, he’s absolutely correct but I think he has chosen the wrong way to reach the goal.

Elon Musk appears to have brought something with him to Tesla from SpaceX: The mindset of “cost-plus” pricing. When you are developing whole new systems, versus products, the schedules and methods are very different.

Normal scheduling for most projects is done using a “critical path method” or CPM system. This is one where each step of the project is working from known information and can be calculated for cost and time – ex. a 10,000 sq ft building foundation can be poured using x=number of trucks of cement and x=number of man hours and x=amount of prep work to arrive at the cost of the foundation completed in x= days. This item (foundation), becomes one segment in a CPM schedule. Link and add all the individual segments together for each step of building your four-story office complex and you can estimate the cost of completing the final project and how long it will take from breaking ground to the ribbon-cutting ceremony. This is how costs are determined for manufacturing or building pretty much anything, including cars.

But when you are developing new vaccines or building a new space vehicle for an entirely new mission (like going to Mars) you need a different type of schedule and mindset. One where all you can do before you begin is list each step you expect to need to complete to accomplish your goal. This type of schedule, used by the U.S. space program since inception in the 1950s until today is called Program Evaluation and Review Technique, or PERT scheduling.

Elon Musk was certainly using this system at SpaceX in the years before joining and buying into Tesla. It is my belief he is still using it today for managing both companies. The important distinction between these two very different systems is that costs and time are more or less irrelevant when operating in a PERT environment. Understanding that this is the typical mindset of a physicist like Elon Musk is critical to understanding his management style. NASA operates in this environment. That’s why each year NASA goes to Congress for money, and Elon Musk goes to the markets. When President Kennedy established the goal of “landing a man on the moon and returning him safely to Earth” before the end of the decade of the ’60s, no one had a clue what it would cost or if it could even be done using the technology of the period. In a miracle of American ingenuity and perseverance, the goal was accomplished in July 1969. The same principle applies to the SpaceX goals of reusable rockets and colonizing Mars. Costs? Who cares? It is all about the goal.

The public corporation sector does not operate this way in most cases. It is not designed or regulated in this manner. One of the few areas using PERT schedules in public companies is in the area of drug development, not the auto industry. That is why pharma startups are so risky. This is why bears are so perplexed with Tesla. Look at the articles written by bears on SA. They, like myself, are number-crunching pragmatists. We see things in black and white, profits and losses.

I’m something of a rarity. I grew up with a father with the exact same mindset as Elon Musk, who spent most of his working years at NASA at installations around the globe. My mother, who I take after, controlled the budget and kept the household running smoothly. The conquest of space was all-important to him. Growing up with parents of completely different mindsets taught me to recognize the difference. Musk has my late father’s exact same perspective where attaining the goal(s) is all that matters, forget the cost.

We see this in Musk with every Tesla presentation and analyst conference call. His exasperation and irritation at analyst questions. His mindset is his reasoning for not talking about reservation levels, monthly sales, or forward guidance (which he stinks at predicting). He only began reporting quarterly production when he was forced to do so. He sees all of us as nitpicking at details and missing the bigger picture. In that respect he’s correct. But it was also his decision to take Tesla public in 2010. He has only himself to blame for the irritation we all cause him and others like him.

Tesla, like SpaceX, should have remained a private company. This way Musk could have functioned like NASA and just gone to the private sector for new cash each year. It was a huge mistake to go public. Since August, SpaceX has raised $450 million in new equity funding. No one is publicly asking questions about the finances, production targets, or profits. It is the perfect environment for Elon Musk.

Public companies absorb a lot of institutional money. Many of the funds invested in Tesla today are doing so with pension funds and individuals’ IRA and 401K retirement funds. Tesla is not the place for this type of money. It is way too risky an environment with a CEO such as Elon Musk. That is why many investors like myself question and track institutional investments in this company. When an investment fund holds 15,000 shares they can easily liquidate in a matter of one transaction in seconds. When they hold many millions of shares like Fidelity and others liquidation is not nearly as easy or as fast. In a share price meltdown, billions in market share could be lost before these funds could liquidate their positions.

While we can banter over whether Tesla is a car or tech company, no one can deny they are attempting something not done in nearly one hundred years. That is building a company dependent on technology that’s not widely accepted by the buying public. A company narrowly focused on just one subset of technology at that: Plug-in, battery energy. While practically every other car company is hedging their bets with all three forms or propulsion – gasoline, hybrid, or battery-only – Tesla choose just one high-cost, high-risk, unproven avenue.

It is the one Elon Musk sees as the best for the environment. Whether he is right is debatable. Future impacts that would be placed on global electric grids are still not fully understood. U.S. annual electricity demand has been falling since 2007 resulting in power plant closings. With the years it takes to approve and build new power plants a sudden surge in demand for recharging vehicles could overwhelm grids not only here but around the globe.

The fate of Tesla rests on Musk’s ability to convince the public at large he is right and that Tesla has the best product solutions. That’s going to be a monumental uphill battle.

Products

While many credit Musk and Tesla for bringing the idea of vehicle electrification front and center, not everyone agrees the technology is the future of transportation. Many see the current tax incentives at the national and state levels as supporting a very small number of wealthy buyers to purchase products from very select few companies. Essentially the government is viewed as picking winners and losers at the expense of all taxpayers. I agree with this position. Buyers must have a substantial amount of earned income in the year of purchase to use the entire $7,500 FIT credit. So if you make that kind of money and want to purchase an environmentally friendly, fuel-saving mode of transport that’s great. But do it on your own dime, not the taxpayers’ dime.

Tesla buyers have proven to be a forgiving group of consumers. I do not need to go into all of the issues with Autopilot 1 and 2, or the falcon wing doors on the Model X. I do frown at still seeing body panel alignment issues on Model S cars received as recently as a few days ago at my local delivery center.

(source: author)

By now things seen in the above pics on a brand-new unit last week should have been rectified after five years of production. Musk and his followers appear to believe these are minor issues that should be ignored by buyers for the “greater good.” One of the biggest problems with this greater good thinking is the cars are not achieving their goals. Many used CPO listings show four and five-year-old cars with less than 30,000 miles. If the cars spend most of their time parked in garages of wealthy buyers for bragging rights they simply are not making an impact on the environment. The vast majority of new BEVs being produced today are being built and sold in China where these cars can be found for as little as $6,000 and are actually being driven. The least expensive new Tesla vehicle is $50,000 at this time.

The new Semi actually could make sense. Even with its short daily range, it could have a significant impact on set, daily routes from distribution centers to stores. These routes are in urban and suburban areas of high congestion, with great PR value and visibility. All of the announced early reservations are to these type of retailers from Anheuser Busch to Wal-Mart. It will be several years after introduction before these trucks can truly prove whether their high entry cost is worthwhile and the stated performance goals are achievable.

That brings us to the Model 3. While it has had its well-documented production hiccups, I believe there are other factors at work impacting the ramp-up.

Any CEO worth their pay understands the markets they operate in are just a global chessboard. Where to position your pieces, when to attack, which pieces to sacrifice to achieve a win, all the while looking a dozen or more moves ahead are a routine part of the job. These are all proven strategies of the masters. The same rules apply here for Tesla.

By my calculations, at this time Tesla still has thousands of unsold new Model S and X units in the U.S., Europe and China where EV incentives are being reduced. Here in the U.S., the important EV federal tax credit is about to hit a key metric in early 2018 for Tesla – the delivery of its 200,000th unit. I went back 10 months to find the linked article from Insideevs.com. Their predictions for 2017 U.S. sales appear to be on target. Tesla now has to be careful in its timing for the delivery of number 200,000 and how best to target sales to those most likely to be able to use the full credit. In my most recent article, I wrote about the stockpiling of Model 3 units in Marina Del Rey, CA. I believe the reason is simple. I agree with Insideevs.com opinion that Tesla is targeting April 1, 2018, to reach the milestone, giving it a full six months after that to deliver as many units as possible to those eligible to use the full credit.

This will benefit Tesla in three ways. 1) It allows time to deliver more higher-margin Model S and X units to buyers known to have average incomes in excess of $200,000 and capable of using the full credit. 2) It gives Tesla more time to work out the kinks in the production ramp since they must now limit U.S. sales for the next three and a half months. If Tesla were to hit number 200,000 in say mid-February they would then only have until the end of June to deliver cars to buyers hoping to use the full credit. 3) Stockpiling cars to be delivered in December rather than in November will make the growth of sales appear more impressive for any capital raise in Q1. But we can expect sales to not ramp much at all in Q1, as Tesla gets close to that magic number because it simply is not in their best interest to do so. The alternative would be to begin export shipments to LHD countries ahead of any further U.S. sales.

I would guess once it became obvious that the ramp could not meet a target of January 1 for delivery of No. 200,000, Tesla had little choice but to slow production and push the date to as close to April 1 as possible. While early buyers may not be thrilled with the approach of delaying deliveries, in the long run, more buyers could benefit and Tesla will have a chance to sell additional higher margin S and X vehicles from existing inventory in Q1. Just pieces on a chessboard.

The downside to this strategy is any delays in deliveries gives the competition a chance to steal Tesla sales. Every company except GM (GM) has huge quantities of units that can be sold that will be eligible for the full credit (if it survives the new tax plan making its way through Congress now). At lower price points, targeted to mass-market buyers, it is still unclear how much of an impact the reduced incentives would affect the Bolt and Volt sales. Because Tesla only sells BEVs they will be the first manufacturer to hit 200,000 U.S. sales. GM will be able to sell Bolts and Volts eligible for the full credit well into late 2018 at the current rate of growth in Bolt sales.

The stock price

For six weeks now the stock has been range-locked between about $300-$320. Baked into the stock price was the promise of 100,000 or more deliveries of Model 3 in 2017, by which time production would reach 5,000 per week. We all now know that’s never going to happen. The common belief is that the ramp is merely being delayed by a few months and will then continue on up to the promised 10,000 units per week by the end of 2018. In my opinion, that also is never going to happen.

First, Tesla cannot achieve 10,000 weekly units of production of the Model 3 with its one production facility. In an official application to the state treasurer of California, approved on 12/13/16, Tesla stated their intended purchases of Model 3 equipment to be used in California would only achieve an average annual rate of production of 226,563 units over five years, which is more or less 5,000 per week excluding vacations shutdowns.

Second, Tesla stated they are expecting an average selling price for Model 3 of $43,000. That average price is equal to the maximum price of a fully loaded GM Bolt Premier which will be eligible for the full FIT credit months longer than the Model 3, well into 2019. By this time additional competition will be coming from both domestic and foreign manufacturers.

Conclusion

As a serious investor, I do not allow my love of a product to influence my research of a company’s stock price. Bulls should not either. Each must be measured on its separate, individual merits.

Elon Musk has done a phenomenal job of bringing BEVs into the minds of millions of people. But whether Tesla will have the resources to bring all of its advertised products to market and how many buyers will be moved to purchase Tesla vehicles remains to be seen.

Whether Tesla will be the company to carry the torch to the finish line is in doubt at this time. Intense competition from Chinese manufacturers intent on a global presence, with their government’s backing, has yet to hit our shores but is coming before the end of this decade. Their big advantage is they started out building inexpensive cars and are now climbing the pricing ladder and growing profits. Tesla, starting at the high end, and never profitable, must now prove it can even build a $35,000 Model 3 with a positive gross margin. If it can, it may have a chance of climbing out of the huge financial hole it has dug. If not, well it is already six feet down. 2018 will be Tesla’s make or break year but it is the last place 401k or pension money should be invested. In my opinion, the only stock riskier than Tesla today is Bitcoin.

Disclosure: I am/we are short TSLA VIA OPTIONS.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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