Tesla’s problems mount in the wake of recent setbacks that include the company’s unexpected cost-cutting move to close its stores to shift sales online, rising cash flow concerns for shareholders and a complaint by the Securities and Exchange Commission that CEO Elon Musk violated his September 2018 settlement with the agency.
Problems for Tesla Inc. (NASDAQ:TSLA) led Barclays’ auto analyst Brian A. Johnson on March 5 to cut his price target on the company’s shares to $192, down from $210, while retaining his “underweight” rating. The downgrade puts the share price at risk for a potential pullback of 32.7 percent, but Johnson also consistently has been one of the least bullish Wall Street analysts who tracks Tesla.
In a research note, Johnson questioned Tesla’s outlook after recent moves that shifted it away from potentially becoming the Apple Inc. (NASDAQ:AAPL) of the automobile industry by driving innovation and turning its Model 3 into the equivalent of an iPhone that consumers want, need and will pay a premium to buy. Instead, Johnson cautioned that Tesla’s “surprise announcement” of a sooner-than-expected introduction of a $35,000 Model 3 pivots away from establishing the vehicle as a premier premium product.
Tesla’s Problems Include Not Becoming the Auto Industry’s Version of Apple Inc.
“Much of the bull narrative has rested on Tesla becoming the next Apple, selling high-volume EVs [electric vehicles] at premium price point and at high gross margins, in part aided by a unique branded retail presence,” Johnson wrote.
The premature rollout of Tesla’s planned low-end Model 3 vehicle undermines the bullish case for the company to follow the example of Apple, particularly with the decision to close all the automaker’s retail stores and sell its vehicles online only, Johnson noted. With reduced profit margins from the sale of the soon-to-be available Model 3, Tesla’s financial results are unlikely to be buoyed by increased sales volume and cost savings, he explained, in justifying a cut to his price target on the stock.
Tesla seems to be changing its “core strategy” and instead is becoming similar to a high-volume Amazon.com (NYSE:AMZN), with the auto maker’s Model 3 turning into a mass market vehicle rather than a highly profitable luxury car, Johnson noted. By moving exclusively to online sales, however, Tesla could be building an “operational moat” to compete with legacy automakers that retain the costs of established dealership networks, he added.
The Model 3 will have a range of 220 miles on one charge and would be delivered within two to four weeks of Tesla receiving the order, according to the company. Musk advised company employees in a recent email that 78 percent of Model 3 orders last year were placed online rather than through its 378 Tesla stores. The change in sales focus is an abrupt departure after the company opened 27 new retail and service centers last quarter.
Tesla’s Problems Include Scrambling to Boost Its Cash Flow
However, Johnson interpreted the revamped strategy as a sign that Tesla is scrambling to boost its cash flow as quickly as possible after paying off $920 million in convertible senior notes on March 1 at a conversion price of $359.87 per share. Since Tesla’s stock has not traded above $359 a share in weeks, the automaker needed to repay its creditors with all cash rather than its previous plan of using its own stock to cover half of the amount.
With Tesla’s year-end 2018 cash and equivalents topping out at $3.69 billion, the company’s $920 million payment to meet its March 1 deadline to cover its convertible debt obligation substantially cuts into its cash position. Tesla also now is expanding its sales and distribution of vehicles to foreign markets, including China, while incurring extra costs to do so that Musk recently indicated will cause it to take a loss in the first quarter of 2019. Its newly exported vehicles into China were delayed upon entry by Chinese authorities this week when the incorrect labels were placed on the Model 3 cars.
Tesla’s Problems Do Not Deter Extreme Bullish Valuation by ARK Invest
Undeterred is Tesla bull Catherine Wood, chief executive officer of ARK Invest, who wrote an open letter to Musk and his board of directors last Aug. 22 that pleaded for him to keep the company public. Wood has aggressive five-year price targets on the company of $700 for its bearish forecast and $4,000 for its bullish case. She reiterated those price targets from last August in an interview this week.
“Exponential growth happens because prices come down,” Wood said. Tesla is riding a “technology cost curve” that traditional, combustion-engine auto companies have not enjoyed in decades, she added.
Analysts who assume Tesla’s price cuts indicate that “demand” for its vehicles is lacking are way off the mark, Wood said. Musk has taken the position that demand exists, but consumers want a reduced price point to improve affordability.
Tesla’s Problems Are Accompanied by a New Round of Job Cuts
The automaker cut 9 percent of its workforce last June, an additional 7 percent in January and Musk has indicated that further job reductions are needed again. He did not specify the size of the latest job trimming.
Wood predicted that Musk’s pricing will fall further as the cost of batteries and other technologies used by the company drop, too.
Musk announced on March 3 that Tesla plans to launch its first sports utility vehicle (SUV) with the introduction of its Model Y, which will cost about 10 percent more than the Model 3 but offer slightly less range with the same battery.
Tesla’s Problems Include New SEC Complaint about Musk’s Tweeting
Musk ended up in the crosshairs of the Securities and Exchange Commission (SEC) again late last month for tweeting without first clearing it with a monitor, in conflict with his prior consent agreement. In that settlement, Musk agreed to give up his chairmanship of Tesla for the next three years and pay a $20 million fine.
The SEC late last month asked a federal judge to find Musk in contempt of court for allegedly violating his agreement to ensure his tweets were reviewed and approved before he sends them. Tesla’s response to the complaint is expected next week.
The court has not scheduled any further proceedings at the current time. Musk’s settlement of the previous SEC complaint was announced on Saturday, Sept. 29, and the stock rallied in the following days as investors appeared to view the resolution as positive news after the SEC sued him on Thursday, Sept. 27, for “false and misleading” tweets about having “funding secured” to take the company private.
The SEC initially sought to bar the 47-year-old Musk permanently from serving as an officer of any public company, but Wall Street analysts warned the regulators that the fallout for Tesla could be huge if Musk, a company co-founder, was forced out as CEO, too.
Musk’s settlement with the SEC also required Tesla to pay a $20 million fine, to provide supervision of Musk’s Twitter account and to add two independent board members. He ran afoul of the SEC for a series of Aug. 7 tweets about taking the company private in a multi-billion transaction at $420 a share for a “substantial premium” of more than 20 percent above the company’s then-current share price.
A price of $419 a share would have been 20 percent above the stock’s Aug. 7 price, but Musk told SEC investigators he rounded it up to $420 a share, since the number 420 is associated with April 20, known in some circles as national “Weed Day.” Musk added he thought his girlfriend would find the number “funny,” even though he acknowledged it is “not a great reason” to choose a buyout price.
Tesla’s Problems Raise Questions about Its Valuation
“While many have questioned Tesla’s recent strategic decisions, as well as CEO Elon Musk’s personal judgment, the company and the stock have always been the subject of naysayers, haters and most importantly, short sellers,” said Jim Woods, editor of Successful Investing and Intelligence Report. “For the past several months, the shorts have been in control. However, investors with a longer-term horizon will likely look back on this period as a time to get in on TSLA at a discount.”
A less optimistic view comes from Bob Carlson, who heads the Retirement Watch advisory service.
“Tesla has consistently over promised and underperformed,” Carlson said. ”The price reductions that were recently announced will make it harder for the company to generate profits on a regular basis. If the electric vehicles prove to be popular, other manufacturers will enter the market and make life harder for Tesla. The company’s stock has benefited from a ‘halo effect’ and a lot of hype. After recent declines the [share] price still is too high.”
Chart Courtesy of stockcharts.com.
Tesla’s Problems and Responses Could Be a Sign of Getting a ‘Little Desperate’
“Leaping from niche luxury brand to the mass market was supposed to be a triumph for Tesla,” said Hilary Kramer, a Wall Street professional who leads the Value Authority, GameChangers, Turbo Trader and Inner Circle advisory services for individual investors. “Instead, the math looks a little desperate. After all, if you’re selling a product at a loss, cutting the price to boost your volume is a guaranteed way to burn more cash before you can claim any meaningful efficiencies of scale. Wall Street was looking for a $120 million profit in the current quarter. The company now tells us that thanks to the Model 3 and its highly affordable price point, we’re going to see a loss. They may take in $2 billion a month. It’s not enough.
“It’s a 180-degree turn from six months ago, when Tesla was able to turn $4 billion in quarterly sales into a $500 million profit and Elon Musk vowed that the cash would keep flowing for the foreseeable future. Laying off 7 percent of the work force and now closing the Tesla retail network hasn’t made that happen. That’s a big miscalculation. I’m not convinced the direct sales model works up here at a $35,000 price point. People want to test the driving experience. They want to go home with the car they test.
“And I’m not convinced closing the store network is all about cutting the price point. If Musk wanted to start the Model 3 at $35,000, he could’ve waited until the math made sense before he rolled it out. An extra $2,000 in sticker shock isn’t going to move the needle much either way — either mass market drivers want an electric car, or they don’t. Instead, it looks like an effort to slow the bleeding. That’s not a strong look, especially when you’ve established a reputation for erratic behavior online and on conference calls. Elon, if you want to convince us that everything’s great inside Tesla, show us the math. Otherwise we can’t take you at your word as easily as we once did.”
Musk once again has a growing number of people to convince that he can succeed with his innovative yet financially struggling automobile company. The latest set of problems could prove to be his undoing or his next chance to disprove his critics and thwart the short sellers.
Paul Dykewicz, www.pauldykewicz.com, is an accomplished, award-winning journalist who has written for Dow Jones, the Wall Street Journal, Investor’s Business Daily, USA Today, the Journal of Commerce, Seeking Alpha, GuruFocus and other publications and websites. Paul is the editor of StockInvestor.com and DividendInvestor.com, a writer for both websites and a columnist. He further is the editorial director of Eagle Financial Publications in Washington, D.C., where he edits monthly investment newsletters, time-sensitive trading alerts, free e-letters and other investment reports. Paul previously served as business editor of Baltimore’s Daily Record newspaper. Paul also is the author of an inspirational book, “Holy Smokes! Golden Guidance from Notre Dame’s Championship Chaplain,” with a foreword by former national championship-winning football coach Lou Holtz. Follow Paul on Twitter @PaulDykewicz.