Are Investors Underestimating Tesla's Cash Burn Rate?

  • Barclays has sounded the alarm on Tesla saying that investors could be underestimating just how much cash the company needs to spend in its quest to become a bigger manufacturer.
  • Tesla is cash flow negative, and often resorts to borrowing or issuing new shares to raise cash to finance its operations.
  • A deeper look at Tesla's current cash flow reveals that it's not as bad as reported.
  • Ultimately the money Tesla is spending to expand is money well spent and will begin paying off in the not-too-distant future.

For most unprofitable companies, there is always a danger of burning through too much cash and facing a severe cash crunch especially if spending is not kept under tight control. Tesla (NASDAQ:TSLA) is a company that is solidly in the red--the company sports a profit margin of -24.54%. But there is an even bigger problem for Tesla. Not only is the company not free cash flow positive (cash flow after capital expenditure) but does not generate any cash from ongoing operations either.

Now Barclays has sounded the alarm on Tesla saying the company’s cash burn problem will not go away, and will in fact get worse as the years roll on.

‘‘Tesla  will continue to burn through lots of cash in its quest to become a bigger car maker, and Wall Street may be underestimating how much spending remains ahead, according to analysts at Barclays. TSLA does not boast a strong track record in spending efficiently, and its business strategy will keep it a capital intensive company.’’

Barclays estimates that Tesla will burn through $11 billion over the next five years, which is ~20% of what Tesla is likely to realize as revenue over the period. The analyst then went on to point to something that is rarely discussed about Tesla:

‘‘If TSLA does not become more efficient in making its planned Model 3 mass market car, the company runs the risk of running out of money to invest in software, which is essentially what truly differentiates the company from other EV manufactures.’’

The comments by Barclays probably did not surprise anyone, considering that the analyst is one of Tesla’s biggest skeptics. Barclays has a Sell rating on Tesla stock, with a price target of $180, about 17% below Tesla’s current price.

Just how bad is Tesla’s cash burn rate?

A cursory glance at Tesla’s quarterly reports can often lead to the wrong conclusions about the company’s cash position. Tesla reported a hefty cash flow of negative $203 million during the last quarter while its capital expenditure clocked in at $392 million, mainly related to building its Nevada Gigafactory and retooling its production plants for Model X.

But a look at Tesla’s shareholder letter reveals that the company’s real cash position is not anywhere nearly as bad as its first looks after making several key adjustments. Tesla says this in Page 4 of its Q3 Shareholder Letter:

Our GAAP cash outflow from operations during the quarter was $203 million, but this does not include $163 million in cash inflows from vehicle sales to our bank leasing partners. Furthermore, $31 million of cash was consumed by our direct leasing business funded by Tesla, and is included in cash flow from operations.

Adjusting for the impact of our leasing and financing business, our core business was almost breakeven on cash generated in Q3 prior to capital expenditures

So after making the adjustment for cash inflows from leasing its vehicles, Tesla’s cash flow looks a lot better--cash flow falls to negative $9 million from negative $203 million. Still, that does not detract from the fact that Tesla’s cash flow remains in the red, which is never a good thing because it usually leads to one or both of the following options for a company:

  • Borrowing to finance its operations.
  • Making a secondary share offering in a bid to raise cash.

Tesla usually resorts to both options to raise cash, though it leans much more heavily to borrowing through issuing convertible notes than issuing new shares. Tesla ended 2014 with convertible notes worth about $1.86 billion. Long-term debt can be less punishing to investors than issuing new shares when interest rates are as low as they are right now. Convertible notes can of course be converted to shares, but analysts estimate that Tesla’s share price would have to hit roughly $360 for the owners of those notes to convert them profitably to shares. With Tesla’s share price remaining depressed lately, this might not happen over the next two years.

Tesla recently announced a secondary offering of 2.1 million shares of common stock. With 130 million outstanding shares, the resulting share dilution will be less than 2% so that is not likely to affect Tesla’s earnings per share or its share price for that matter. Tesla has made three secondary share sales during its 5-year public life, none of which has resulted in share dilution of more than 5%.

Tesla will quite likely continue issuing convertible notes to raise cash for its capital-intensive projects. Current indications are that interest rates are likely to remain quite low, so Tesla’s mounting debts are not likely to spiral out of hand.

Looking at the bigger picture

Tesla’s high cash burn rate and mounting debts is not anything new, and is in fact one of the major reasons investors have lately begun souring on Tesla stock. But as Morgan Stanley aptly pointed out, Tesla’s cash burn rate is significantly outweighed by its long-term ambitions.

Most of the development costs that Tesla will incur over the next five years will be in relation to the production of Model 3, the first model that the company has slated for mass production. And mass production is a good thing for Tesla since it will take the company closer to the scale necessary to become profitable. Tesla aims to produce Model 3 cheaply enough to enable it to sell the vehicle at just $35k, though Morgan Stanley has warned that production difficulties could push that price closer to $60k. The analysts have also warned that Tesla might not be able to meet its production target during the fourth quarter and 2016 due to production difficulties.

But even assuming Morgan Stanley’s predictions turn out to be quite accurate, Tesla will not be in any real danger of facing a cash crunch. Tesla is burning through a lot of cash, but it’s ultimately money well spent.

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