I used to think traveling the world to visit auto plants was exhausting, but traveling the world seeking new asset management clients is truly tiring. There is, however, a weird symmetry with my destinations and Tesla’s travails.
Last summer I happened to be in Thailand attempting to grow my Asian client base when Elon Musk made his ill-advised “pedo guy” comments about Thailand-resident cave explorer Vernon Unsworth. This week I am pitching potential clients in South Africa, the place of Musk’s birth, while watching Tesla’s slow death.
Tesla shares fell more than 10 percent in last week’s trading, a decrement of nearly $5 billion in market capitalization. While the goalposts are always moving for Tesla investors, Friday’s 7% plunge was caused by two “old-time” Tesla problems:
- Musk sent an email to all Tesla employees begging for belt-tightening.
- Reports indicated that Autopilot was engaged when a Tesla, this time a Model 3, was involved in a fatal crash.
We have seen this movie before.
Autopilot’s functionality is anything but what is implied by its name. Tesla’s camera-based system clearly has a problem recognizing metallic objects with a higher profile than its vehicle’s driver. This crash is the second time a Tesla on Autopilot drove under a semi-truck’s trailer, shearing off the roof in the process.
In my opinion, a 3D-ranging system such as LIDAR would help prevent such accidents, but Musk has made his opposition to LIDAR quite apparent. During the company’s Autonomy Day presentation in April, Musk referred to LIDAR as “a fool’s errand.”
Whatever the science, another person is dead. Shouldn’t he have had has hands on the wheel, as the NTSB’s report indicated he did not for eight seconds before the crash? Of course, but that’s the problem–and the huge liability for Tesla.
Autopilot is the most misleadingly-named consumer product I have ever seen. German regulators would not let Tesla use that name for the advanced driver assistance system (ADAS). Clearly it has given some drivers a false sense of security. Whether that is ultimately Tesla’s liability will be decided in the courts. From a financial perspective, Tesla simply cannot afford the elevated G&A costs associated with product liability litigation, but those lawsuits will only increase after Friday’s news.
So, as Musk brags about Tesla’s ability to put a million robotaxis in the road by 2020, fatal crashes belie the safety of that effort. What Musk is describing as robotaxis would be cars operating in a Level 5 system on the Society of Automotive Engineers scale. Not a single person among my many auto industry contacts believes full autonomy can be achieved without LIDAR, but Musk has always danced to his own tune. Today’s Autopilot–still classified as a Level 2 system by the SAE–is once again implicated in fatal crash.
So that’s what is killing Tesla: liabilities. Musk’s email hinted at Tesla’s inability to finance current liabilities. He noted the company’s net proceeds from its equity/convertible debt offering of two weeks ago would only cover 10 months’ worth of cash burn at the rate Tesla experienced in the first quarter. I noted that in my Forbes column last Wednesday, and I hope Elon read that piece.
Long-term liabilities, those due in more than one year, are much easier for equity markets to ignore. I heard investors repeating that school of thought as recently as last week: If Tesla can raise $2.4 billion and pay its bills, then it’s all gravy until Elon gets his robotaxis on the road.
By virtue of its cash burn Tesla is increasing its long-term liabilities every quarter, not decreasing them. By virtue of producing more cars, Tesla is increasing its potential future liabilities, not decreasing them.
While I don’t want to engage in speculation, I have followed the auto sector for 27 years and learned a thing or two about contingent liabilities in that time. How could Volkswagen survive the dirty insider dealing that preceded the diesel scandal? The company reserved for it. How could GM survive the ignition scandal, Toyota thrive after the sudden-acceleration scare and Ford survive the rollover problems of the Explorer? The companies reserved for it.
So, that’s why auto companies are given such low multiples by the equity markets. It may have looked like VW was trading at 6-7x EPS pre-diesel scandal, but when the vast majority of those purported earnings were ultimately wiped away by retroactive charges, the Wolfsburg giant’s real-world P/E was actually much higher It is also why Tesla’s inflated multiple has always been so befuddling to me.
The profits made from selling a car are only the the beginning. The after-sales costs can be much more than replacing a faulty fan belt. So, car companies are now, and always will be, massively overcapitalized at the latter end of auto cycles. Cash cushions are built to offset potential future liabilities, not just to prepare for massive macroeconomic slowdowns.
But Tesla is, by any measure, massively undercapitalized. I have published math showing that in many Forbes columns, but if you don’t believe me, just read Musk’s email again.
Tesla doesn’t have the balance sheet flexibility to withstand any sort of shock. That balance sheet should be being bolstered by profits on increasing sales of the Model 3, but as I noted in this Forbes column, that model is just not selling well.
So, that’s why I am writing about Tesla’s death while sitting a few miles from the place of Elon Musk’s birth. The stock market is finally beginning to price in a heightened risk of default for Tesla–the bond market figured that out a year ago–but there is so much more downside from here. I have to tip my hat to a sharp-eyed reader who noted my contention in my last Forbes column that the downside for Tesla shares was “limitless” was overdone. Yes, Tesla shares can only go to zero.
But the journey from Friday’s close of $211.03 to $0.00 would be an incredibly painful one, impacting bondholders, commercial partners–including major supplier Panasonic–Tesla’s employees and its legion of loyal “fanboys” who rushed to buy its cars.
I have lost count of how many times I have written “cash flow never lies” in regards to Tesla. As the stock market belatedly realizes that truism, the world is witnessing to the death of Musk’s dream. It will get much uglier from here.