Tesla and Hype

There has been much made recently about Elon Musk going on the offensive (and sometimes being offensive) on Twitter in the last week or so.

Disclaimer: I’m an EV fan, drive a Chevy Volt, and own $TSLA and some Lithium mining stocks.

Drawing the line in the sand

Recently, Elon drew the line in the sand, effectively saying Tesla wont raise another dime from Wall Street (bonds, stock issuance) during the Q1 conference call by cutting off a “boring” question from a Wall Street analyst, and taking a question from a YouTube analyst. He has stated that in Q3 and Q4 of 2018 Tesla will be profitable, and he has pushed his company to start efforts to conserve cash and increase margins.

Good. This is probably something long overdue at Tesla and will help their gross margins on their products and increase profitability (or reduce losses). Tesla right now is roughly 400M a quarter in the hole from a balance sheet perspective (the operating profits from selling cars and other stuff don’t pay for all the overhead of running the company), so they’d need to generate that much to at least break even (not including any increases in debt service coming up in future years).

But the PR and news coverage…

The PR coverage over the last few weeks has been bad for Tesla. Between the Consumer Reports non-recommendation of the Model 3 (which was reversed yesterday after they updated the car’s performance via OTA software updates), and Elon has been going to war with the media and random people on social media, and having his mom defend him on Twitter (was not expecting that). It can be difficult for a non-enthusiast to think Tesla will be able to deliver, or even be a solvent company, by the end of the year.

Timing is everything

I learned something about myself and probably others this weekend about the news and PR and current events. It was announced that ICE had “lost” 1,475 children, and that minor children were being separated from their parents at the border. I drew the conclusion that ICE was taking those kids away and lost them. But that was not the case, in fact they are two separate things – ICE places children with family/extended family/suitable adults and is then no longer legally responsible, but does follow up with the kids occasionally to make sure they’re OK. Following up is good. Separately, ICE separates minor children from their parents at the border. Bad. But I had erroneously linked them in my head until I read a twitter thread about it. And it corrected my thinking on it.

Elon essentially did the same thing – by saying things like if Tesla made the $35,000 version of the car now, they’d bleed money and die, and then turning around and announcing the availability and prices for the AWD and Performance models of the Model 3, he linked those two items in people’s minds. So the media and people are having a collective freak out over the fact that Tesla isn’t going to be able to deliver a $35,000 model at all. Although having done this once before (the 40kWh version of the Model S) doesn’t help Tesla’s case.

While his timing was bad (layoff the twitter, hire more PR people, let them deal with this rough patch), none of the bad press has any material impact on whether or not Tesla will succeed in its goals. It might have an impact on the stock price, or if he has to go back to Wall Street to raise money, but that isn’t in their plans right now. It certainly wont deter the true believers who handed Tesla $1,000 more than two years ago.

Some napkin math

Tesla’s stated goal is that they will have 20% gross margins (profit on each car, minus the costs of the parts, assembling the car, set-asides for warranty work, etc.) on the car. So on a $35,000 car, that is $7,000 of gross margin and $28,000 in parts and assembly. But on a $60,000 AWD car, the gross margin is $12,000 and the parts and assembly cost $48,000. (these aren’t the actual numbers, typically the gross margins on the cheapest car are smaller than the goal while the gross margins on the highest-end cars are more than the stated goal)

The next battle, once Tesla (hopefully) gets to 5,000 cars a week at the end of Q2 is all about gross margins, getting the cost of manufacturing the car (assembly) down enough to make it a cash flow generator for the company. The first option I can think of is to work to trim the hours per car (through automation or otherwise). Right now the plant runs 24/7 – three 8 hour shifts per day everyday of the week. The first step is to reduce that to six days a week, and maybe down to five, and still produce 5,000 cars per week. Then move from 3 to 2 shifts. That trims the hours worked from 168, to 120 for M-F, and then down to 80 hours for two shifts. This is a reduction of 14% for each day they trim, and a total of 55% for 2x8x5, but is probably an even larger impact on labor costs due to overtime, shift premiums, etc. that Tesla is probably incurring with the 24/7 operations. This is easily six months of effort (Q3, Q4), if not longer but the gains are nearly immediate and flow to the bottom line quickly.

Back to the top, if Tesla needs 400M a quarter, at an average selling price of $45,000 and a gross margin of 20% ($9,000) that comes out to needing about 45,000 cars per quarter, or “only” about 3,500 to 4,000 units per week. If they want to be profitable (generate money for the Semi, Roadster 2.0, etc.) anything beyond that they’ll want more cars – like maybe 5,000 a week, 12 weeks a quarter for 60,000 cars.

It seems doable. I’m optimistic about their chances (if I wasn’t I would have sold my stock). Don’t believe the (negative) hype, but you should be skeptical of Tesla’s constantly moving goals, which look more like timelines for software projects that I’ve been a part of, rather than a mass-produced physical product.