Tesla (TSLA) will be self-funding! I was re-reading a Jefferies report that made that prediction for Musk's company in 2019, and of course Tesla's concurrent equity and convertible debt offerings have proven that not to be the case. When the Jefferies report was released on December 8th, 2018, the stock closed at $374.77 and the analysts set a revised price target of $450.
I can attest to the pain that is doled out to a sell-side auto analyst - I was one for 11 years - after such an errant call, but I am not writing this column to bury Jefferies. Crowing about correctly calling Tesla's desperate need for capital (as I did as recently as this week) is not something I choose to do here. What's is more important for investors to understand is why Musk's monstrosity is NOT self-funding, and thus constantly in need of fresh capital.
The clue was given on a "broad investor call" featuring Tesla management that was sponsored Thursday by Goldman Sachs and Citigroup to pump up support for Tesla's offerings. I was not invited to the call, so I will have to rely on the always excellent reporting of CNBC's Lora Kolodny to determine key statistics. She noted:
One person asked what Tesla could do to improve its gross margins from the approximately 20% reported in the first quarter of 2019. The company previously promised it could achieve 25% margins.
Musk told investors Tesla would try to improve efficiency in its supply chain, but would feel good about 20% gross margins moving forward.
I had to utter a John Madden-style "Bam!" after hearing that quote. Tesla just reduced its profitability goal by a massive 500 basis points. This is the car business, my bailiwick, and let me tell you, basis points of margin are hard-earned in this consumer arena.
So, Elon just walked back an enormous amount of money. How much? New Tesla CFO Zach Kirkhorn noted on the company's earnings conference call last week that the average selling price for the Model 3 in the U.S was about $50,000 in the first quarter.
So my model assumes that Model 3 gross margins are lower than those of the S and X - and Bernstein analyst Toni Sacconaghi estimated that Model 3 margins ran at only 15% in the first quarter. I further assume - analysts assume, that's what we do - that Tesla's demand forecast is mostly right and the company will sell 380,000 cars in 2019 (the midpoint of management's 360-000-400,000 guidance range, which Kirkhorn reiterated on yesterday's call) and that Model 3 sales will represent 300,000 of those units. In that scenario, the difference between a 25% and a 20% gross margin is $2,500 per car.
That's $750 million in profit giveaways. The net proceeds (before greenshoe exercise) from the stock component of Tesla's offering as disclosed in this morning's 424B filing would be $737 million. Bam!
That calculus obviously excludes the $1.6 billion ($1.84 billion with the shoe) Tesla is assuming in net proceeds form its concurrent convertible note offering. Those notes will carry a coupon of 2%, are due 5/15/2024 and are indicated to carry 27.5% "up," or conversion premium, if you are keeping score at home.
Musk's admission that Tesla's key product is not going to reach its profitability goal was the key takeaway from Tesla's call. It is also the key reason why I believe the shares are still massively overvalued at $243. I never believed Musk's 25% automotive gross margin target was sustainable anyway. Given the first quarter's massive delivery shortfall and clear margin pressures, though, I am now deriving a much lower fair value for Tesla shares of about $125 - contact me via Real Money and I will be happy to provide my full methodology.
Yes, that's 50% downside from here.
So, be careful. Ignore the Musk-mania in the media and focus on the numbers with Tesla. They are not good.