“I think it probably makes sense to raise capital to reduce risk.” That’s what Tesla (NASDAQ:TSLA) CEO Elon Musk said on the latest conference call. On past occasions, even shortly before previous funding rounds, Mr. Musk always has avoided to answer questions about a possible capital raise, so this was an unexpected and somehow blunt move.
And his change in strategy has worked. Since then there has been little speculation about Tesla’s actual cash needs. The company will continue to invest and it will get the money it needs as soon as necessary. That’s the general consensus.
But how much money does Tesla actually need?
Cash needs for investments
Let’s start with the easy part: the guidance on capex which Tesla provided in their latest shareholder letter:
We expect to invest between $2 billion and $2.5 billion in capital expenditures ahead of the start of Model 3 production. We continue to focus on capital efficiency while also investing in battery cell, pack and energy storage production at Gigafactory 1.
Earlier in the letter Tesla had stated:
Our Model 3 program is on track to start limited vehicle production in July and to steadily ramp production to exceed 5,000 vehicles per week at some point in the fourth quarter and 10,000 vehicles per week at some point in 2018.
Production starts in July. Invest $2 to $2.5 billion ahead of the start of production. It led most analysts to conclude that Tesla is to spend $2 to $2.5 billion in the first half of the year.
Let’s be careful though. As is always the case with Tesla, there might be some wording games at play here.
In the first sentence of the first quote Tesla seems to indicate the $2 to $2.5 billion is related to Model 3 production. In the second sentence they say (bold is mine) “We continue to focus on capital efficiency while also investing in battery cell, pack and energy storage production at Gigafactory 1.” Could this mean that further investments in the Gigafactory come on top of the $2 to $2.5 billion for Model 3? If so, the total estimate for 2017 should be higher than the given range.
But the real issue with the capex guidance is the timing. Let’s look for Tesla’s 10-K between the recent filings of executives selling their shares. On page 14 the 10-K says:
Our production plan for Model 3 is based on many key assumptions, including that we will be able to build and equip a new dedicated final assembly line for high volume production of Model 3 at the Tesla Factory without exceeding our projected costs and on our projected timeline.
This at least means Tesla has not yet finished building the assembly line for Model 3. On the conference call CEO Elon Musk said:
We don’t know exactly where the trouble points (64:53) are going to be. We tried to model it out as carefully as possible, but there’ll be things that aren’t captured in the model.
At that point Mr. Musk is explaining that the capex guidance is for building a production line with a capacity of 5,000 cars per week. After that, Tesla will increase its capacity to 10,000 cars a week, which he assumes will only cost 70% of the current capex guidance.
The general picture here is that Tesla will build an assembly line for 5,000 cars a week this year (to be finished in the fourth quarter, according to the second quote given earlier) and then build a second line with the same capacity next year.
So the $2 billion to $2.5 billion capex guidance is not just for the first half of the year. It’s the money needed for the first assembly line and other tooling, which Tesla expects to finish in the fourth quarter. This conclusion is in line with Morgan Stanley’s latest note on Tesla where Adam Jonas expects no more than 2,000 Model 3 cars to be delivered this year.
Therefore we assume Tesla needs $2.5 billion for capex in 2017. We take the upper side of the range based on our previous remark in regards to possible additional Gigafactory capex. Capex for a second line won’t be relevant until 2018.
Cash needs in operations
Our conclusion with regard to capex has some consequences for Tesla’s cash needs in operations. Tesla’s second master plan said the company planned to make money on high end models first before starting to work on Model 3.
Again there might be some issues with wording here because in contrast with Mr. Musk’s claims in the plan, Tesla is not yet making any money. They do have revenue or course, but the bottom line, what “making money” normally refers to, is still negative. Very negative, in fact, because during the fourth quarter Tesla had an operational deficit of $448 million.
This number gets even worse when considering the “accounts payable” and “accrued liabilities” lines on the balance sheet. Both liabilities combined went from $2.3 billion at the end of the third quarter to over $3 billion at the end of the fourth quarter. In other words, even with burning nearly half a billion in cash, Tesla ran further behind than ever on paying its bills.
One of the reasons for Tesla’s ugly jump in negative operational cash flow in Q4 is that the company eased on spending in Q3. For the whole year Tesla’s operational cash burn came in at $124 million. That’s a more reasonable figure of course, but then again we have to add the increase in accounts payable because Tesla won’t be able to postpone paying its bills forever. The increase in “accounts payable” and “accrued liabilities” during 2016 was a whopping $1.7 billion.
Adding this $1.7 billion and the $124 million as an estimate for the 2017 operational cash burn results in $1.8 billion.
As a matter of fact, extrapolating the Q4 cash burn into 2017 also would come at $1.8 billion.
Therefore we expect Tesla’s cash deficit in operations to be $1.8 billion. We’re assuming then that Tesla’s operational business this year will be more or less comparable to last year. That’s once again in line with Adam Jonas’ projections of Model 3 volume being neglectable for 2017. We also assume here that Tesla won’t be able to increase its accounts payable much further.
Cash needs for purchase obligations
With $2.5 billion in capex and a cash deficit of $1.8 billion in opex, we’re already at $4.3 billion.
But it doesn’t stop there.
The 10-K says Tesla has purchase obligations for 2017 totaling $2.76 billion (page 51).
It’s a tough call to further dissect that number. The $2.76 million obviously includes the purchase of batteries which will be used in Model S and Model X production. So in our calculation, that money already has been accounted for in the operational cash needs. The number is not necessarily related to production estimates either. Most of the money is in fact a number Tesla and Panasonic agreed upon to make sure the latter would get a decent return on its investment in Nevada.
So let’s just make a rough estimate of how much money we’ve already accounted for in opex. If Tesla plans to build 100,000 of its existing models in 2017 with 85 kWh batteries per car and $150/kWh, that would correspond with $1.275 billion. That leaves $1.5 billion in other purchase obligations to be added to our calculation.
With $2.5 billion in capex, a $1.8 billion deficit in opex and $1.5 billion in other purchase obligations, Tesla’s total cash deficit for 2017 comes in at $5.8 billion.
With Tesla’s plans to ramp up production one would also have to make a provision for extra working capital. But as we expect this ramp to take place in 2018, we will ignore this extra cash need for now.
One other mystery factor here is cash flows from SolarCity. Whether Tesla will experience a deficit or surplus here is hard to predict as the number depends on the agreements with financing partners in the joint ventures who own the leased panels. These agreements have not been disclosed. Based on SolarCity’s cash burn in the past we think it’s not overly pessimistic to assume the net cash flow from SolarCity to be zero.
Credit lines run dry
A $5.8 billion cash deficit is not too bad, one might think, as Tesla had already 3.4 billion in cash on its balance sheet at the end of 2016.
But there is a problem.
To show that impressive cash balance Tesla had to draw nearly all the money it could get from its two credit lines. The 10-K says:
In addition, we have established a senior secured asset based revolving credit agreement (the “Credit Agreement”) that allows us to borrow, under certain circumstances, up to $1.2 billion. As of December 31, 2016, we had $969 million in borrowings under the credit facility pursuant to the Credit Agreement. We are also party to a warehouse credit facility with lender commitments of $600 million (the “Warehouse Facility”), of which we had borrowed $390 million as of December 31, 2016.
In other words, Tesla had only $400 million left to borrow from these credit lines at the end of last year.
Also, the existing cash balance has to be seen in the total amount of current assets and liabilities. Tesla’s working capital (current assets minus current liabilities) at the end of 2016 was only $400 million. That means the $3.4 billion in cash was already largely offset by accounts payable and other liabilities. Tesla could maybe let their working capital slide to zero, but then they would soon get in conflicts with the convenants of their credit facilities.
That means Tesla has only 2 times $400 million left to play with, and with a projected cash deficit of $5.8 billion, Tesla will need at least $5 billion in new funding during 2017.
Comparing 2016 and 2017
If you think that number is hard to believe, let’s compare to last year. In 2016 the cash deficit was $1.5 billion ($2.2 billion increase in cash position minus $3.7 billion cash flow from investing activities). Capex is supposed to rise from $1.4 billion in 2016 to $2.5 billion this year, meaning an increase with $1.1 billion. The operational deficit is to rise from $0.1 billion to $1.8 billion. Remember Tesla managed to keep its operational deficit low last year by postponing $1.7 billion in payments, which showed up on the balance sheet as current liabilities. Tesla can’t keep adding to this number without their working capital number to become negative. Thirdly we have the $1.5 billion in other purchase obligations.
Adding it all up gives $1.5 billion (2016 deficit) + $1.1 billion (increase in capex) + $1.7 billion (increase in operational deficit) + $1.5 billion (purchase obligations) = $5.8 billon (2017 deficit).
Another capital raise
So let’s return to Mr. Musk’s announcement that Tesla will probably do another capital raise.
Will he be bold enough to raise the $5 billion at once? That would be quite a shock to the investment community which has somehow ignored the company’s cash needs so far.
Will Tesla try to get part of the $5 billion from new debt deals? At least they’ll have a lot of new equipment to offer as collateral, so there might be an opportunity to use that. The same is true for the purchase obligations, which will show up as inventory, meaning it’s collateral that can be used when borrowing extra money.
The unavoidable question of course is whether Tesla investors will be prepared to once again put that amount of money in the company, being it by offering new debt or through buying new shares. Talking about a billion here and a billion there, one tends to forget how much money $5 billion actually is. If Tesla would rely on retail investors buying 100 shares each, the company would need to convince another 200,000 people to put $25,000 of their savings in the company. Even when looking at larger investors like Ron Baron, a guy who knows a few things about electricity what made him invest $300 million in the company, Tesla would need to find another 17 such investors. That’s no easy task.
We’re only looking at 2017 by the way. Mr. Musk has already indicated that Model 3 will be largely unprofitable during the ramp up. With this ramp up to be expected in 2018 we will be in for even more operational cash burn then, on top of debt repayments which will come due and the plan to build a second assembly line for Model 3. I honestly don’t see how Tesla on its own will succeed in keeping this business going.
Disclosure:I am/we are short TSLA, OWNING PUT OPTIONS.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.