"Tesla. A Much Needed Reality Check (in depth)" - Julian Cox's Expert Analysis Posted

FluxCap said:

I hope Julian won't begrudge me creating a dedicated link to this article. It is the single most comprehensive, and I suspect, accurate analysis of Tesla Motors pre-Q3 2013 that I have read in a very long time. It is worlds more comprehensive and properly researched than all of the recent major investment bank analysis.

Feast your eyes on this, good forum members.

Enjoy, and happy investing.

-Flux

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Can we ask someone here to ask the media to publish this? Kevin? You are deep with San Jose Mercury..?

We need Google searches to pull up articles like this. If you search Tesla Stock, you get nothing but negative headlines, like "Telsa hits speed bump," or "Tesla stock zapped." Nothing about London, new VP hiring, or Julian's analysis.

excellent article- finally someone hit on the unique aspects instead of just a comparison to other auto makers

kenliles said:

excellent article- finally someone hit on the unique aspects instead of just a comparison to other auto makers

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There is much to commend this article, once you get past the highfalutin (and frankly, a bit ridiculous) style of prose.

However, Julian clearly misunderstands the concept of cost of capital, and his objections to the Damodaran model are flawed as a result. To be sure, I also believe Damodaran's model suffers from deeply flawed assumptions. But Cox's suggestion that 0% cost of capital is appropriate is also a gravely mistaken assumption, borne of, apparently, a total misunderstanding of the concept.

Using equity to capitalize a balance sheet carries with it high costs, not zero cost. Further, using convertible debt to capitalize a business carries equity cost, in addition to debt cost. To propose that Tesla's cost of capital is equivalent to the coupon rate of their convertible debt is preposterous. And to further assume the coupon rate of the debt is the only cost of tesla's capital investment in the firm is an even bigger mistake.

God forbid Elon Musk assumed equity carried no attendant cost. We'd be sitting on shares diluted into worthlessness if he did. Fortunately, he does not.

ModelS8794 said:

There is much to commend this article, once you get past the highfalutin (and frankly, a bit ridiculous) style of prose.

However, Julian clearly misunderstands the concept of cost of capital, and his objections to the Damodaran model are flawed as a result. To be sure, I also believe Damodaran's model suffers from deeply flawed assumptions. But Cox's suggestion that 0% cost of capital is appropriate is also a gravely mistaken assumption, borne of, apparently, a total misunderstanding of the concept.

Using equity to capitalize a balance sheet carries with it high costs, not zero cost. Further, using convertible debt to capitalize a business carries equity cost, in addition to debt cost. To propose that Tesla's cost of capital is equivalent to the coupon rate of their convertible debt is preposterous. And to further assume the coupon rate of the debt is the only cost of tesla's capital investment in the firm is an even bigger mistake.

God forbid Elon Musk assumed equity carried no attendant cost. We'd be sitting on shares diluted into worthlessness if he did. Fortunately, he does not.

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So from your analysis what is a fair value for TSLA?

Julian: post it on twitter and use the hashtag $TSLA and #TESLA, then we will all retweet and it will be a "top-tweet" and be on top of the trending list.

ModelS8794 said:

There is much to commend this article, once you get past the highfalutin (and frankly, a bit ridiculous) style of prose.

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I like his style. It makes reading about the numbers far more enjoyable. What I'm having a hard time understanding is why you had to take a cheap shot at his style of prose (making it personal) instead of just discussing the numbers and offering up your own analysis.

Krugerrand said:

I like his style. It makes reading about the numbers far more enjoyable. What I'm having a hard time understanding is why you had to take a cheap shot at his style of prose (making it personal) instead of just discussing the numbers and offering up your own analysis.

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Because how you write matters, when you are trying to reach an audience and convince them of the merit of your ideas. If that style is your cup of tea, more power to the author. It does him no favors, IMO. But, you are right that such matters are inconsequential vs. the meat of it. I will refrain from commenting on it any further.

Between patents and this:

Tesla’s first mover advantage has also allowed it to consolidate supply relationships with a top three of the world’s producers of technically and economically viable cells for automotive (Panasonic, LG, Samsung) and potentially the top four to include BYD. The traditional automotive industry will find itself many years late to the table when it comes to seeking volumes of similar supplies to compete with Tesla. When that time comes the remaining choice may well be between becoming a Tesla drive train customer or negotiating access to Tesla’s suppliers, with Tesla.

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I find a compelling argument for a much higher share price.

Tesla’s first mover advantage has also allowed it to consolidate supply relationships with a top three of the world’s producers of technically and economically viable cells for automotive (Panasonic, LG, Samsung) and potentially the top four to include BYD. The traditional automotive industry will find itself many years late to the table when it comes to seeking volumes of similar supplies to compete with Tesla. When that time comes the remaining choice may well be between becoming a Tesla drive train customer or negotiating access to Tesla’s suppliers, with Tesla.

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I doubt Tesla has any control as a gatekeeper on a commodity cell that is universally used in laptops and can be supplied by numerous companies. If other car companies want the same type of cells and will commit to certain volumes, Panasonic and the others will scale up accordingly.

Tesla does appear to have a superior design for the total battery pack in terms of battery management system and heat management. Nissan clearly has an inferior design based on the complaints from Leaf owners related to rapid loss in range. That is clearly a win for Tesla technology.

Toyota and Mercedes clearly felt it was worthwhile to buy from Tesla instead of building their own. If this stuff was easy, they would have done it in-house.

i thoroughly enjoyed reading julian's article as well. like models8794, i thought the part about cost of capital was a weak point of the article; another (imho) is the discussion of tesla's cash conversion cycle. while tesla doesn't have to build "inventory" like a traditional auto manufacturer, it isn't correct to say that tesla receives 100% of the cash required to build the car before the car is built. the deposit is received up front, and the balance is received upon delivery of the finished car to the customer.

so while i would agree that the amount of time that tesla has to float the cost of the car is shorter than traditional automakers, it isn't factual to say that tesla receives 100% of the cash before setting out to build the car. perhaps i'm missing something in his argument, but i thought that this was another "weak" area of an otherwise extremely articulate and well thought out article.

just my $0.02,
surfside

surfside said:

i thoroughly enjoyed reading julian's article as well. like models8794, i thought the part about cost of capital was a weak point of the article; another (imho) is the discussion of tesla's cash conversion cycle. while tesla doesn't have to build "inventory" like a traditional auto manufacturer, it isn't correct to say that tesla receives 100% of the cash required to build the car before the car is built. the deposit is received up front, and the balance is received upon delivery of the finished car to the customer.

so while i would agree that the amount of time that tesla has to float the cost of the car is shorter than traditional automakers, it isn't factual to say that tesla receives 100% of the cash before setting out to build the car. perhaps i'm missing something in his argument, but i thought that this was another "weak" area of an otherwise extremely articulate and well thought out article.

just my $0.02,
surfside

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I think the reality is somewhere in between, and Julian alluded to this, but I'm not sure if his point was clearly expressed. At the risk of putting words in Julian's mouth, I'll elaborate.

A $40k, $5k, (or now, $2.5k) deposit is enough to get production started, so part of the car is already paid for. Production to delivery time is now on the order of 4-6 weeks for domestic customers, and 8-12 weeks for Europe. Tesla then receives 100% of full purchase price upon delivery.

If we assume that Tesla enjoys standard credit terms with suppliers (60-90 days net terms), that means that they are in fact getting paid 100% of the material cost of the car, plus profit, before the bill comes due on materials that went into building said car.

Now, we all know that this isn't entirely factual. Some suppliers probably don't allow for extended dating terms; and they need to have a minimum amount of components and raw materials already in inventory to keep production running smoothly without delays. However, I would hope that by now they have a pretty good handle on the supply chain and can gauge component inventory to be on par with production rates. This speaks to Elon's comments during the Q2 conf call, when he said that they are still learning to not 'be stupid' about how to build cars. This is how they are going to get to >25% GM by Q4, and why no other car company is able to achieve such a high margin.

Assuming they are now 'less stupid', than yes, they can essentially book the revenue for the car before they need to pay for the materials required to build it. One more reason that traditional auto industry valuation methods are worthless when looking at TSLA.

rdalcanto said:

We need Google searches to pull up articles like this. If you search Tesla Stock, you get nothing but negative headlines, like "Telsa hits speed bump," or "Tesla stock zapped." Nothing about London, new VP hiring, or Julian's analysis.

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Agreed, it's great to see a comprehensive piece like this that lays out the TSLA case in some detail (beyond the bite-size snipes we often see in the press).

Stylistic issues aside (that's a matter of preference), Julian Cox has been a great influence on my own decision to invest in TSLA. If you like his work, or find it even mildly helpful, he actually wrote a very comprehensive piece in Seeking Alpha prior to this one - a ways back, but, it's also a great read:
Tesla Motors Inc (TSLA): On Elon Musk And Tesla Motors: The Art Of Modern Warfare In A Noble Cause - Seeking Alpha

Thank you for the many kind comments. I trust my use of British English can be pardoned.

It looks like it is worth clarifying that I am not suggesting that external capital raised by Tesla would come at zero cost.

It's not the forward looking cost of capital that is zero if a fund raiser is required, the zero multiplier is the amount of external capital required = none, nada.

The thing that I have laboured to clarify is the fact that Tesla really does have a cash-flow-positive core business. Elon is not lying when states that he Tesla can and almost certainly get ready for production of 200,000 Gen III in 2017 on $1 Billion of internally generated cash.

This is what is mind blowing about this company, if they had not already proven out a business model that could grow on internally generated cash, in the auto industry of all things, nobody would believe it. It has certainly never been done before hence the failure of every modelling exercise by analogy to existing manufacturing metrics. Q3 the market will get unquestionable proof. Remember that they had circa $750 million in the bank when last seen. Check how little that number has diminished when the numbers come out. There is a fair chance the bank account has actually grown despite rapid expansion into Europe and Asia.

Prior to Tesla it would have been almost impossible to imagine a publicly listed company not going on a fundraiser selling its expansion plans in Europe and Asia to investors for more cash, especially with a stock up at $190 within months of establishing its business model in the US. Two reasons it has not done that - Elon must remain in control by voting rights not just charisma, Tesla does not need to sell more shares to execute its expansion roadmap from here on in.

You can see the incentive for not raising external capital in the numbers - a jump in value of existing shares from $67 to $200. On top of that, it cost Elon $150 million of debt to GS to maintain his >25% holding in TSLA voting stock last time they did a fundraiser (so he can veto the worst stupidities that can happen like selling the company at a fraction of its future worth). Post startup phase, this company is very dilution averse, and that is a very good thing for the holders of what could easily be the last shares to be issued for a very long time.

I have taken up Norse's suggestion and Tweet'ed a link to this piece: https://twitter.com/Julian_A_Cox/statuses/394083493245755392

Julian, you are conflating the concepts of cost of capital with required reinvestment rate and ROIC; your conclusions are hopelessly illogical as a result. I would suggest refreshing yourself on the basic concepts of the components of a discounted cash flow model if you intend to hold yourself out as an analyst with something to contribute to this debate. A highly educated Englishman should certainly have no trouble with O-level Business Studies coursework.

ModelS8794 said:

Julian, you are conflating the concepts of cost of capital with required reinvestment rate and ROIC; your conclusions are hopelessly illogical as a result. I would suggest refreshing yourself on the basic concepts of the components of a discounted cash flow model if you intend to hold yourself out as an analyst with something to contribute to this debate. A highly educated Englishman should certainly have no trouble with O-level Business Studies coursework.

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And all forum members should certainly have no problem with polite discourse. You've could have made your point without putting down another forum member. Please reign in the snark factor. There is no need.

bonnie said:

And all forum members should certainly have no problem with polite discourse. Please reign in the snark factor. There is no need.

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These forums are rife with gushing praise of mr. Cox's expertise, and more than a handful of forum members are clearly taken enough with his analytic prowess that they are committing real dollars to his conclusions. This is a shame.

i will endeavor to point out the basic flaws in his analysis with more empathy in the future.

ModelS8794. I am not persuaded that your remarks are useful. I believe you are confusing the cost of capital from an investor's perspective with the cost of capital as seen from the business. From the business side we were looking at dilution and the cost of servicing debt. This is the function of cost of capital used in Damodoran's spreadsheet and precisely the one I have chosen to correct. I do not believe Tesla needs to sell equity or purchase debt in 2014 through 2018. I believe the businesses Tesla is often compared with for the purposes of modelling would do, hence the difference in value. I do not believe the distinction is sufficiently well appreciated and much effort has been put into obscuring that difference out of either ignorance or the desire to profit from the ignorance of others.