Rarely a day goes by that you don't read something about Tesla Inc. (TSLA) . It is Tesla, after all. Everything matters, and there seems to be news every day. Much of that news is generated by CEO Elon Musk's tweets, which have gone from the conveyance of hyperbolic predictions that rarely have come true to a series of nasty, ad hominem slams against his perceived "enemies list."
Newsworthy or not, Musk's comments have zero to do with valuing Tesla as a public company, an exercise that some of us still undertake. With sales of the company's former bell cow, the Model S, declining sharply amid clear signs of cannibalization from the Model 3, it is obvious to an unbiased observer (if there are any on Tesla) that this company's future is completely tied to the success of the Model 3.
That's where the order book for the Model 3 comes in, and in the midst of Tesla's horrendous cash burn and signs of the slow and painful death of SolarCity, that order book is the rock to which Tesla bulls cling. It's a big rock, too, as Tesla's current enterprise value sits at $60 billion, a number that couldn't possibly be justified by any impartial financial analysis.
Keep in mind that the future will be filled with competition from battery electric vehicles (BEVs) and autonomous vehicles (AVs) produced not just by traditional car companies, but also by tech companies such as Alphabet Inc. (GOOGL) , Uber and Baidu Inc. (BIDU) with capitalizations that are magnitudes greater than Tesla's.
To own Tesla shares, one must believe that the company has orders for 420,000 Model 3s -- the number specified in Tesla's last press release -- and that it can deliver them profitably to customers quickly. Time is of the essence as the federal tax credit on purchase of a Tesla declines from $7,500 to $3,750 on Jan. 1, 2019, and then further to $1,875 on July 1, 2019.
I'm not going to go into a rant about Tesla's terrible manufacturing record here, although the tent in the parking lot at the Fremont, California, plant has kept my industry observers amused for the past few weeks. No, I'm going to focus on the net order book, and for that figure to bolster the longs' arguments, it must hold true that those supposed 420,000 willing buyers who've put $1,000 reservations down on their vehicles will take delivery of their cars.
This week, Needham and Co. analyst Rajvindra Gill noted his belief that the cancellation rate for the Model 3 had doubled from the 12% rate that was alluded to by Musk during the company's August 2017 earnings call. If that's the case and nearly a quarter of Model 3 reservation holders are choosing to have the $1,000 refundable portion of their deposits returned to them rather than follow through with their purchases, it would be brutal for Tesla's business model.
If that 420,000-unit order book turned into 320,000 orders instead, Tesla would lose all appeal as a long-term play, and the need to refund deposits -- especially in the third quarter, when the semiannual interest payment is due on Tesla's $1.8 billion in 5.3%, 2025 senior notes -- would put this company in serious jeopardy of not being able to meet its debt obligations. Those obligations include a $230 million conversion due in November (which is old SolarCity paper and converts at the fantastical price of $560.64 per Tesla share) and the big kahuna, Tesla's $920 million, March 2019 note, which converts at $359.87 per share.
So, for Tesla's convertible notes to work, Tesla's Model 3 order conversion rate will need to hit at least 90% by my calculations, and any data points in the opposite direction would be harmful to a Tesla long position.
I was a sell-side autos analyst for 11 years, and I asked more than my share of tough questions on quarterly earnings calls, so hopefully Tesla's analysts will show such fortitude on Tesla's Aug. 1 call. They need to pin Musk down on the Model 3 conversion rate; RBC's Joseph Spak tried on the last conference call and was rebuffed.
Markets are driven by information, and market participants deserve to know how many Model 3 order holders are turning into Model 3 buyers.