Tesla Inc. (TSLA, Financial) has been on a tear since reporting fourth quarter earnings on Jan. 29. CEO Elon Musk painted a rosy outlook, claiming that the electric car company had finally turned the corner and would henceforth be a profitable enterprise. During the earnings conference call, Musk told analysts that Tesla, long reliant on external capital injections to keep the lights on, neither needed, nor intended, to raise fresh capital anytime soon:
“We are still generating positive cash. In light of that, it doesn’t make sense to raise money because we expect to generate cash despite this growth level.”
Yet, a mere two weeks later Tesla announced that it is once again tapping capital markets, this time for a $2 billion equity sale.
Tesla appears to be embracing an opportunity to raise some quick cash while its stock price remains phenomenally elevated. Given the sorry state of its first quarter so far, it may be the last chance the company has to raise at such high price levels.
Timing is key
The capital raise comes as no surprise to those who have been paying close attention to Tesla’s finances. While Musk told analysts that no raise was needed or expected, it was hard to see how he could pass up the opportunity to raise off the back of the recent incredible stock spike.
The timing is key. Tesla managed to squeeze out a profit in the fourth quarter thanks to continued cost cutting, recognition of deferred revenue and demand pull-forward in the Netherlands thanks to a changing EV tax credit law in that country.
So far in 2020, things have been far less impressive. In fact, the first quarter is shaping up to be extremely nasty for Tesla. Demand for Tesla vehicles has collapsed in the Netherlands since the start of the year, and it has been extremely sluggish in Norway, traditionally the upstart EV company’s second largest market. Meanwhile, Tesla’s Shanghai plant has faced temporary shutdowns due to the coronavirus outbreak, while Chinese demand will likely suffer due to widespread fear and government quarantines.
Looking down the barrel of a bad quarter, raising a few billion dollars on the back of irrational exuberance is a prudent strategic move on Tesla's part.
Digging deeper
According to Tesla, the cash raised in this latest funding round will be used to shore up its balance sheet, as well as to fund “general corporate purposes.” That explanation is far from satisfactory for investors.
If one digs below the surface of the company's financial statements, a more credible reason for raising at this time becomes clear. While Tesla claimed profits in both the third and fourth quarters of 2019, this was only possible thanks to hard non-repeatable, financially unsustainable moves. The most glaring one is Tesla’s ongoing cutting of capital expenditure to the bone. During the past few quarters, capex has actually been net-negative, after factoring in depreciation and amortization. That is obviously unsustainable for a supposed growth company, especially one that is building new facilities and manufacturing capacity in foreign markets (and not to mention developing a host of new products).
In other words, Tesla has managed to push back recognition, or execution, of a number of big expenses, including billions of dollars in capex for its Shanghai plant. Now, as Tesla begins to clear forests in Germany for a European plant, it will need to spend billions of dollars more.
Not enough cash
Tesla has neither the cash on hand, nor the cash generating power, to meet a range of critical financial obligations. It is important to remember that Tesla has never made a full-year profit. On a GAAP basis, Tesla still lost close to $1 billion in 2019. The company managed to squeeze out a $105 million GAAP profit in the fourth quarter, but that is a drop in the bucket when compared to Tesla’s medium-term and long-term contractual obligations.
Tesla has about $12.5 billion in long-term debt, which is certainly a millstone around its neck. Much of it is convertible and, at least at the moment, most of the convertible debt is in the money. However, that can swiftly change, especially if the second half of the first quarter proves as disappointing as the first.
Worse still, Tesla must also contend with its $33.5 billion in contractual obligations, including a whopping $16.3 billion in purchasing obligations through 2024, principally with battery provider Panasonic. The millstone of purchasing obligations appears set to grow ever heavier for Tesla over the next few years since, as Panasonic is not producing batteries for Tesla's Shanghai vehicles, expanding international production will not help to absorb the extant obligations.
Verdict
Tesla does not have anything like the cash flow necessary to meet its various capex pledges and purchasing obligations. Moreover, it is far from clear that Tesla can even continue to break even on an ongoing operating basis. This doubt can only mount in the months ahead as the effects of slowing European sales, California market saturation and mounting legal threats become more readily apparent to the public. Sure, the stock has taken on a life of its own to be sure, but the underlying financials cannot be ignored.
A bad first quarter seems inevitable at this point. Investors might be best served by following Tesla’s lead and selling stock now.
Disclosure: Author is short Tesla.
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