$2 Zip Ties

Tesla is run by a visionary leader, Elon Musk, who is a graduate from the PayPal Mafia to start three companies that have billion dollar valuations. Solar City has a $6.5b valuation, it’s rumored that SpaceX is raising financing at a $10b valuation, and Tesla currently trades at a market cap of $32b.

Advancements in all three of these companies are very important to alternative energy innovation, models of energy efficiency and space exploration (for Space X the ability for relaunch of a rocket which would be needed to explore Mars) and a good thing for a more progressive society. There are three reasons that I believe Tesla stock is advancing at a pace that might be unsustainable and a sensible stakeholder should consider the following three items:

Resale Value Guarantees

In 2013 the Company began offering a resale value guarantee to all customers who purchased a Model S. Under the program the customer has the option of selling the vehicle back to the Company for a period of 36 months for a pre-determined resale value. It’s another quirky accounting method that allows the Company to gross up the balance sheet and then amortize both the sale and cost of sale over the 36 month period through lease accounting. The disparity between the asset and liability that will eventually need to be expensed through the income statement is currently ~$150m. This also resulted in a 2013 increase in a deferred revenue of ~$270m, and without this add-back the Company would have once again reported a negative cash flow from operations, which they have done since inception.

Patents

Musk recently announced that they were taking down the patents that sit on the wall of their lobby in Palo Alto. He praised their internal decision as a benefit to all car makers in the industry that Tesla wanted to encourage innovation for electric vehicle manufacturing to address the carbon crisis. While he is correct that there is a carbon crisis I think Musk failed to acknowledge or disclose that he needs the big car manufacturing companies to adopt the electric model to help build out the infrastructure (charging and super-charging stations) required for sustainability in the market place. Right now they are going at it alone and that is reflective in their free cash flow. As we pointed out earlier that without their one time accounting add-back for the Resale Value Guarantees they would have reported yet another negative cash flow from operations and that would have resulted in $250m or more in negative cash flow for each of the last three years. In the first half of 2014 alone the Company has reported negative cash flow in excess of $250m. Is the patent decision a sign of Musk’s true entrepreneurial spirit or a cry for help? The capital infrastructure is being funded by suspect investment banking convertible notes (http://www.sec.gov/Archives/edgar/data/1318605/000119312514084484/d686051dex101.htm) and not by internally generated free cash.

http://www.teslamotors.com/blog/all-our-patent-are-belong-you

Final Straw (or Zip Tie)

And Finally. The Company recently announced that they were extending their warranty on the Model S to eight years and infinite miles. Musk said that this should be viewed as the Companies belief that they produce the most reliable cars on the road but comes on the back of two negative consumer reports. Including one from Edmunds that had a very extensive list of services required over their 17 month test drive (worth a look in the review below, there are about 28 issues) resulting in a conclusion from Edmunds that it will be hard for them to recommend buying the car. The spin is on though over at Duetsche Bank who has a $310 price target on the stock that the cars will be recalled for a $2 zip tie to be installed on the drive train costing $400 per replacement. The estimate that if half of the Company’s 39,000 cars built to date require this warranty fix they will only take a $7-$9m hit to future earnings. The sensible thing to do would be to compare that thought process with how Musk is internalizing the reality of the Edmunds reports and what the real impact of future warranty costs might do to consumer demand without an all out infinite mile protective measure. That’s not a typo, the Duetsche analyst actually chalks up the 28 issues in the Edmunds report to a $2 zip tie.

http://www.edmunds.com/tesla/model-s/2013/long-term-road-test/wrap-up.html

A final note and food for thought

In Q2 2014 Tesla delivered 7,579 cars whereas GM delivered over 2.5m. Tesla has a market cap of $32b and GM has a market cap of $55b. Do the math.

Have another look at the picturesque story in the Edmunds report where the driver was able to stop off on the beautiful Highway 1 on the California coast and then think about being late to your kids soccer practice and in need of that charger. A successful electric car company is absolutely crucial to the carbon footprint crisis were are in, but the problem needs a Company like GM to address it.

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