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Friday, August 5, 2016

Tesla Note: Dealerships and Inventories

Mike Smitka

One point in my critique of Tesla's flawed business strategy is that by engaging in direct sales it uses up precious cash. First, it does continue to burn through cash, though at a slower pace: cash from operations plus financing in 2016 Q2 came to -$160 million, up from -$480 million in Q1. However, this includes $150 million in deposits for Model 3, so on a recurring basis they went through -$310 million. This was offset by $2 billion in new money, but I would expect financial markets to prove reluctant to keep providing new money at this pace. So Tesla needs to conserve on cash. Yes, they receive cash from leasing, $143 million in the past quarter. This is normal for the industry, particularly for high-end vehicles. However they and not their banks likely bear the residual risk. So this could prove to be very expensive cash if lease-end resale prices are less than those built into the leases. Such unpleasant surprises are far from unknown in the industry. Oh, and Tesla has also run through their subsidies from the State of California, in the form of ZEV credits: last quarter they were $57 million, but this quarter they were negligible. They won't be able to count on this cash and the fat per-vehicle margin it has provided as they move towards the Model 3.

So how can they improve their cash position? In two words: franchised dealerships. Ford Motor Co. had Q1 revenue of $36.9 billion and inventories of $9.8 billion, or 27%. Averaged across a few quarters gives a level of 25%. How about Tesla, with their direct sales model? They have inventory of $1.6 billion on revenue of $1.3 billion, or 125% – 5x the level of Ford.

Can Tesla afford to expand their direct sales network? My answer remains no.

Tesla violates two prime rules of new ventures: preserve cash and preserve management time

To be fair, there is a devil's advocate position. The land and structures of a dealership hold value, where used by Tesla or someone else. In particular, Tesla could lease its stores from existing car dealerships, with the added benefit that they might be able to avoid creating stand-alone service bays. Banks could also provide floorplan, industry jargon for the financing of dealership inventory. These would lessen the drain on cash – but on net they would not generate cash. Back of the envelope calculations – very round numbers – suggest that the cost of a national dealer network would run $5 billion. (I've gone back and forth on this with co-blogger David Ruggles and one other invidiual.) Net of financing, this might require $1 billion in additional cash, spread out across multiple quarters. So it is not out of the question. To my knowledge, however, Tesla has not demonstrated any distinct advantages to its direct sales approach, other than PR, at the expense of significant management time and (I suspect) legal and lobbying costs. In fact, on the Pied Piper dealership satisfaction index, which uses mystery shoppers, Tesla ranks dead last.

On the dealership issue Tesla violates two prime rules of new ventures: preserve cash and preserve management time. So I remain a skeptic.

Footnote: Nikkei just reported that Nissan – joint with Renault a larger electric vehicle manufacturer than Tesla – is selling off its battery making operation. Why? Doing it in-house is more expensive and slower in keeping up with new developments. Why should Tesla be an exception? Source: 日産、車向け電池事業撤退 子会社売却へ 2016/8/5 17:34 日本経済新聞 電子版