On May 2, after the announcement of the results for the first quarter of 2018, Tesla’s stock fell by 6%, showing the limits of the “super powers” of Elon Musk. Is reality finally catching up?
Elon Musk, human after all
With his promises of a better and less polluted world thanks to his electric vehicles, Elon Musk has galvanised crowds and investors. Self-driving hardware in all cars, space tourism, reusable satellite launchers...his futuristic ideas sell dreams.
A communication champion, Musk even sent his own roadster into space. Yet it’s sometimes hard to bring dreams to life, as Tesla’s difficulties in achieving its goals regularly remind us. After each disappointing announcement, Elon 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 February 17 the company’s market cap reached $56.7 billion.
For some, Elon Musk is all about Tony Stark, the brilliant and tech-savvy billionaire of the American comic book publisher Marvel. Wearing a combat armour of his design, Stark becomes Iron Man, a super-hero who is almost invulnerable.
Like Stark, Elon Musk is rich, passionate about high technology, daring...and condescending. Indeed, some of his recent comments to financial analysts irritated the analyst community. If his strategy has worked very well so far, that may no longer be the case. Here are four reasons that could explain the recent fall in Tesla’s share price.
1. 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: $3.2 billion at the end of March 2018 compared to $3.9 billion at the end of December 2017, which still represents a drop of $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 $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 $510 million. This means that Tesla burned through $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 issuance of shares, and a decrease in its investments.
2. Tesla cannot yet generate profits
With an overall gross margin level of 19% at the end of December 2017, Tesla generated a loss of $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 $710 million (against a loss of $330 million at the end of March 2017). More worrying, in the press release announcing the results of the first quarter of 2018, Elon 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 units Model 3 per week.
But even if Elon 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 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. Already in April, Elon Musk admitted that he wanted to automate Tesla too quickly:
3. Tesla will have to raise funds despite a reduction in investments
Tesla said in its 2017 annual report that investments in 2018 would be similar to those of 2017, more than $4.4 billion. Announcing the results of the 1st quarter 2018, investment projections (capital expenditure or Capex) were revised down to less than $3 billion. Elon Musk insists he will not need additional funding. But the group will have to face more than $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 $10 billion.
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 Elon 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 May 3. Even if the share reached $284.45 at closing, still valuing Tesla at nearly $49 billion, the price is below the symbolic bar of $300. And this first drop could well be a prelude to a much more brutal fall.
4. Accumulation of departures at the highest level and strong signals
Tesla’s treasurer and vice president of finance, Susan Repo, left the company in March 2018, just after the resignation on March 7 of the chief accountant, Eric Branderiz. Executives turnover certainly exist 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 on his return? And why all these departures? A working environment loaded with adrenaline and stress? Elon 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 May 14, Elon 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, 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. As of May 28, shares traded at $278.85. Investors are no longer fooled, but they have a lot to lose. The production results of the Model 3 at end of June 2018, will constitute a serious test for the supposed super-powers of Elon Musk...and may cause the fall of the man who had considered himself to be Iron Man.
Isabelle Chaboud, Professeur associé d’analyse financière, d’audit et de risk management, Grenoble École de Management.
This article first appeared on The Conversation.