Tesla’s Exciting Q3 Numbers… And Chronic Flaw

by Jean-Louis Gassée

It happened: Tesla has delivered consistent financial and industrial performance for five quarters. The company is now well-positioned to produce millions of electric vehicles in a not-too-distant future. Why, then, does it continue to tout as Full Self Driving something that isn’t so?

Two weeks ago, in a Monday Note titled Musk’s Exaggerations Will Catch Up With Him. Or Not., I posited that in spite of his long history of verbal excesses, Tesla CEO Elon Musk would continue to move forward unscathed. It’s an easy prediction. But for a slap on the hand from the SEC after he imprudently tweeted that he was considering taking Tesla private and had secured funding at $420 per share, Musk has suffered little punishment for his outrageous claims. (At the time of the audacious tweet, August 2018, Tesla shares traded at the $60 level. Ironically,TSLA closed at $420 last week, split accounted for…):

What I failed to emphasize is that Musk’s impudence is forgiven because he manages to deliver. He’s often a bit — or a lot — late, but he delivers, nonetheless. In his own words: “I always deliver what I say, just maybe not in the time frame that I say it”. And deliver is precisely what Tesla did in this year’s third quarter.

As the company’s press release points out, deliveries reached 139K cars in Q3, bringing total deliveries in the first nine months of the year to about 319K cars. To reach the often discussed goal of 500K cars for 2020,Tesla will need to deliver a very ambitious 181K cars in the final quarter. Output from the recently opened Shanghai factory, whose yearly production capacity is pegged at 250K vehicles, will certainly help.

Whether or not Tesla ships half a million electric vehicles this year, Musk now has the largest EV production machine in the world. And he also manages to make money: The company has shown a profit for the past five quarters. Furthermore, Tesla has generated cash in the process, as detailed in the Financial Summary of the company’s Q3 Update:

Some critics (correctly) argue that Tesla’s profits are artificial, they’re not intrinsic to the company’s pure automotive operations. Indeed, looking at the second line in the chart, we see revenue labeled as “…of which regulatory credits”. Environmental regulations award brownie points to companies that cause less pollution, and allow the more virtuous companies to sell these bonus points to businesses that are eager to avoid regulatory fines for exceeding their allowable pollution levels. Auto industry lore insists that the only reason Fiat Chrysler built and sold the tiny electric Fiat 500 was to obtain regulatory credits that it used to mitigate the immoderation of its “thirsty muscle cars”.

In Q1 2020, Tesla received $354M in regularity credits and posted Generally Accepted Accounting Principles (GAAP) income of $16M. Without the credits, Tesla would have lost money that quarter. For the past five quarters, GAAP net income totaled $699M and regulatory credits totaled $1.446B. In other words, on a GAAP basis, Tesla lost money.

But if we look at the non-GAAP line that uses more flexible accounting rules, Tesla’s five quarters of Net Income reach $2.28B, handily exceeding the regulatory credits for the same period. We can see why Tesla publishes both sets of numbers.

(If GAAP vs. non-GAAP numbers intrigue you, Investopedia offers a helpful article on the topic. Proponents of non-GAAP numbers insist they allow for a more realistic set of numbers. Opponents insist it opens the door to excesses.)

As long-time readers know, I’m fond of the “Cash is a Fact, Profit is an Opinion” proverb. From that perspective, Tesla’s situation looks really good: For the past five quarters the company’s Free Cash Flow amounts to $4.1B. Let’s compare this to the $1.446B of regulatory credits. Why? Because these credits are pure cash, no production costs, only pen and paper. No GAAP or non-GAAP argument either: Even without regulatory credits, Tesla would have generated $2.657B of life-giving Free Cash Flow in the past five quarters,

In total, Tesla’s cash position now exceeds $14B. This gives Musk the means to continue investing in the company’s production capacity, a topic addressed in the following chart from the Q3 Update:

In addition to the Fremont operation, Tesla has 250K units-per-year Model 3 capacity in Shanghai. The company is also pouring money into Shanghai’s Model Y capacity, it has a factory in Berlin for the Model 3 and Model Y, it’s creating a Texas production unit, and is developing projects in the US for its Tesla Semi and the long awaited Roadster.

These projects might very well require more than Tesla’s current $14B cash position, but that shouldn’t be viewed as an insurmountable problem. At $420/share, Tesla stock provides ample opportunity to raise cash. With more than 900M shares outstanding, selling 10M share would raise about $4B while inflecting modest dilution, probably around 1%, upon current shareholders.

This estimate is a vast oversimplification used for order of magnitude purposes and to illustrate how comfortable Tesla’s situation is, how it can support its CEO’s ambitious plans. When the factories it’s currently developing come to full capacity in a not-too-distant future, Tesla will have the means to produce several million vehicles per year. So, yes, as discussed two weeks ago, Musk can keep telling tall stories without fear of consequences.

There might be a cloud, however, in this sunny picture. Specifically, I can’t understand why Musk continues to flog what he blithely calls a “Full Self Driving” (FSD) vehicle.

It’s commonly acknowledged — by everyone except Musk, apparently — that a fully autonomous vehicle is one that can drive itself from point A to point B without any human intervention. This is what car geeks call Level 5 automation, but that’s not what Tesla offers under the “Full Self Driving” designation. In today’s Tesla vehicles, an attentive driver is always required, and the company has no credible path to eliminating the human at the wheel.

One can’t help wonder when — not if — the NHTSA (National Highway Transportation Safety Authority) will intervene. Without a doubt, Tesla offers sophisticated driver assistance technology…but why not call it just that: Driving Assistance, or some hyperbolic but still truthful variation? It’s one thing to exaggerate a little or a lot about delivery schedules, it’s another to promise Full Self Driving that isn’t. Tesla’s brilliant performance doesn’t need that excess.

— JLG@mondaynote.com