Are Tesla Management Asleep At The Wheel?

August 29, 2018
Editor(s): Lachlan Hall
Writer(s): Alvin Hidayat, Kevin Wang, Matthew Trachevski

The multibillion-dollar automaker Tesla is no stranger to headline-making controversies. From Musk’s impulsive and controversial tweets, to the company’s worsening financial health, Tesla is seemingly trapped in one of its worst financial years. As uncertainty surrounding the company continues to grow, we can only wonder what led the company to where it is now.

Tesla is hailed for pioneering the development of electric cars. Though Tesla is not the first to produce electric vehicles, it is known for proving to buyers everywhere that electric vehicles can be as efficient as gasoline-powered cars, if not more so. It managed to win customer loyalty, receive a myriad of awards, and grow exponentially in market capitalisation to heights on-par with that of Ford and Fiat Chrysler. So where did it all go wrong?

Renegade Musk  Everywhere But Is That a Good Thing for Tesla?

CEO Elon Musk’s recent erratic behaviour on Twitter is repeatedly stealing the spotlight. For instance, after the Thailand cave rescue mission in July, Musk took matters to the social media platform. Irritated and bitter, he labelled one of the British divers involved in the rescue a “pedo” after he called Musk’s “mini-submarine” impractical and likely to be “a PR stunt”. Tesla’s share price fell by 3.5% following the incident. James Anderson, Tesla’s fourth-largest shareholder, criticised the impulsive reaction by Musk. The tweets, however, have since been deleted and were followed by an apology.

Figure 1. Elon Musk’s time in the spotlight has been a source of volatility in Tesla’s share price…

One major incident was Musk’s announcement that he was thinking of privatising Tesla on, yet again, Twitter. “Am considering taking Tesla private at $420. Funding secured.” he tweeted. Tesla’s share price subsequently rocketed on the news, with the $420 per share making it the largest privatisation ever at US$72 billion. Besides it being uncommon for CEOs to announce such a major decision on social media, unless Tesla had already disclosed the price sensitive information to the market, it would also have breached the Securities and Exchange Commission’s (SEC’s) “fair disclosure” rule.

The phrase “Funding secured.” however, intrigued analysts and attracted more public scrutiny. Given the company is currently loss-making, many questioned the significant premium priced in and which investors would be willing to put forward the large sums required to make Musk’s tweet a reality. Many analysts and market commentators pointed out that if Musk could not provide evidence that he had a reasonable basis to assume funding was indeed secured, he could face counts of securities fraud. In fact, the SEC subsequently subpoenaed Tesla and launched an investigation on the veracity of Musk’s claims.

It has now become clear that the promised funding was supposedly to be sourced from Saudi Arabia’s sovereign wealth fund as the country attempts to diversify its economy and reduce its reliance on oil. Such a deal, however, has not been confirmed to take place. Indeed, at time of writing Musk has announced that investors convinced him not to take the company private. However, there are doubts over whether the deal was ever on in the first place, with advisors named by Musk (i.e. Goldman Sachs and Silverwater) denying involvement, and Musk’s hatred for rampant short sellers being cited as a potential catalyst for the tweet.

Operational Issues Continue to Plague the Company

Production flaws in the company’s electric cars have also drawn waves of public attention. Earlier this year in March, Tesla’s Model X was involved in a driving death due to a car crash while utilising the car’s autopilot feature. This led to a subsequent 8.2% plummet in Tesla’s share price to its lowest level since February 2017, translating to a market value loss of more than US$5 billion. It also triggered consumer distrust in automated driving systems — one of the defining features of Tesla’s cars. Within the same month, Tesla was forced to recall 123,000 Model S cars after observing “excessive corrosion” on affected units’ power steering bolts. Although the defects were an easy fix, Tesla could have better spent its time and effort on the production of its Model 3 cars.

Figure 2. Tesla remains cash flow negative as the accumulated losses continue to mount…

In fact, Tesla is facing difficulties in achieving production targets for its Model 3. The company allowed customers to deposit $1,000 to obtain a place on the waiting list. As customers grow impatient, order cancellations are on the rise. Analysts have speculated that the rate of refunds was eclipsing the deposit-taking rate for the company. Despite Tesla’s counterclaim, these statements drove its share price down by 2.5% in July 2018. Shareholders were increasingly worried of the company’s ability to retain its customers. This is a major concern for shareholders since the Model 3 is the company’s means of delivering its products to the masses and translating popularity to profits. Thus, failure to make a positive first impression certainly introduces greater uncertainty as to whether the company is able to survive in the mass market.

Financing Activities Called Into Question Given Cash Flow Negative Position

Bad publicity and production controversies are just the tip of the iceberg. Tesla’s more alarming problem is its growing illiquidity. The company has been burning through cash in an attempt to bring Model 3 production levels back on target. Cash reserves have declined by US$1.3 billion since 2016, coupled with debt increasing from US$8.2 billion to US$10.7 billion in the past year. Its cash flow (after capex) is negative for the sixth consecutive quarter and has accumulated to a deficit of more than US$1 billion.

Consequently, Tesla has reportedly sought refunds from suppliers for payments made in advance. Although it is common practice for firms to negotiate with suppliers for discounts, directly asking for their money back potentially signals creeping financial distress. The company’s share price fell by more than 3% following the request. Not only does this further damage Tesla’s reputation, but cash collected from said refunds can only assist the company in the short-term. Regardless of Tesla’s profit, insufficient cash is a recipe for bankruptcy if the company cannot secure the medium- to long-term funding required to get the Model 3 online and get into the black.

With its US$1.7 billion debt due in the next 16 months, one can’t help but wonder if Tesla needs to raise more equity by the end of the year. The company is simply unable to borrow more funds to pay off its coming obligations given its deteriorating balance sheet. Moreover, with revenue inflow sluggish due to the Model 3 units’ incomplete delivery and delayed revenue collection, it appears Musk might have to change his mind about not tapping the equity capital markets this year.

Figure 3. Tesla’s ballooning debt may be more of an issue than Elon Musk’s Twitter habit…

Numerous financial institutions have also become increasingly concerned with Tesla’s financial health. According to Bloomberg, the company is at risk of running out of cash by the end of the year.  Upon announcing Model 3 production delays, Moody’s downgraded Tesla’s senior notes from B3 to Caa1, reflecting speculation of greater risk of defaults and placing the company further into ‘junk bond’ territory.

These past 12 months have been some ride for Tesla. Shrouded in negative publicity, swamped by debt obligations and beleaguered by dissatisfied customers and sleep-deprived shareholders, Musk’s decision to privatise is perhaps not so surprising. However, in order for Tesla to regain its mojo and deliver on its potential, the company will have to do a lot more than take away Elon’s iPhone.

The CAINZ Digest is published by CAINZ, a student society affiliated with the Faculty of Business at the University of Melbourne. Opinions published are not necessarily those of the publishers, printers or editors. CAINZ and the University of Melbourne do not accept any responsibility for the accuracy of information contained in the publication.

Meet our authors:

Lachlan Hall

Alvin Hidayat

Kevin Wang

Matthew Trachevski