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Notes on Tesla China

By: RGF



This was part of some info on Tesla's liquidity.  Admittedly written by a short.  I certainly hope other supposedly US companies don't have similar contracts.

The Implications of the China Agreements

In the wake of the two articles about from me and MaxedOutMama about Tesla’s agreements in China (here and here), some still remain confused about the implications of those agreements.

Here’s a simplified attempt to explain those implications.

(Tesla's CEO with Chinese Premier Li KeQiang, who in January offered him permanent residency. Mark Schiefelbein photo/AFP/Getty Images)

Use Your Imagination...

Imagine that China created a car company and called it Tesla Shanghai. Tesla Shanghai then copied Tesla's vehicle designs, used Tesla's intellectual property, and even slapped on Tesla’s logo so that the Tesla Shanghai cars were indistinguishable from those made in Fremont.

Imagine further that Tesla Shanghai sourced Chinese parts for those cars and, of course, used only Chinese labor. Predictably, China's car company - Tesla Shanghai - would enjoy far lower supplier and labor costs than does Tesla US, and would enjoy as well much lighter environmental and labor law scrutiny. The Chinese company also would have none of the legal fees, lawsuit liabilities, New York State obligations, and other legacy costs that plague the Tesla US operation.

Obviously, the China company would be making in Shanghai the same car that Tesla US is making in Fremont, but at far less cost than Tesla US pays. Consequently, Tesla Shanghai would not only capture all the domestic Chinese demand that Tesla US formerly supplied, but also would begin capturing demand in other geographies now served by Tesla US's Fremont plant.

Well, you say, that’s not at all the case because in reality Tesla US actually owns Tesla Shanghai. Alas, while Tesla US does technically own Tesla Shanghai, Tesla US does not, in many crucial ways, enjoy the benefits we typically think of as belonging to ownership. Because of the restrictions in the Grant Contract and loan agreements, Tesla US will be unable to extract even one nickel from Tesla Shanghai's operations for years to come.

Said another way, Tesla US owns the equity in Tesla Shanghai. That means Tesla US owns the residual claim on Tesla Shanghai's assets, after all creditors and other lienholders have been paid in full (subject to all the vagaries of the rule of law in China).

There are very few ways to extract cash from a subsidiary whose equity you own. You can sell the subsidiary, or cause it to pay dividends to the parent, or cause it to loan money to the parent. Under the agreements Tesla Shanghai signed in China, none of those routes is open to Tesla US.

You also can use transfer pricing - that is, having Tesla Shanghai sell its exported cars to Tesla US for a price that is lower than the price at which Tesla US can resell the cars. We may see such transfer pricing once Tesla Shanghai begins exporting in earnest. However, it seems a solid bet that the Chinese government will keep a tight rein over how generous such transfer pricing is permitted to be. And, in all events, it's demand for the product, in a shrinking market under economic duress, that will most limit any benefit of transfer pricing.

It's Even Worse...

And it’s even worse than all that. Tesla US is being required to pour $711 million into Tesla Shanghai. All that money will likely be contributed before this year ends.

Unable to extract any profits from Tesla Shanghai (if profits there are) other than via transfer pricing, and facing shrinking demand in both the U.S. and Europe, Tesla US's Fremont factory will be badly underutilized, resulting in greater losses. The only likely solution will be to shutter Fremont and move the entire operation to China.

As MaxedOutMama and I clearly and comprehensively laid out, this is the economic reality of Tesla’s agreements in China.

Tesla has never revealed any of this. No analyst has mentioned any of this. No mainstream business publication has written about any of this. Their silence is to their shame. But their silence does not change the facts.

Indeed, the facts get even worse. As its "target production," Tesla Shanghai is required to generate revenues of at least RMB 75 billion by the end of 2023 (a fact which Tesla has never disclosed). At an ASP of $35,000, and using today’s exchange rates, that works out to minimum annual production of 300,000 cars. The target production alone is an obvious constraint on any benefit to be achieved from transfer pricing.

If Tesla Shanghai fails to meet the target production, then Tesla US forfeits the factory (with, we believe, China free to continue using the Tesla intellectual property and brand).

Or, as seems more likely, if Tesla Shanghai meets the target production, then it's all but certain that Tesla Shanghai will be a major exporter of Tesla vehicles, further starving the Tesla US operation (and, if Tesla goes ahead with a Brandenburg factory, starving that operation as well).

Lack of Segment Reporting Adds Uncertainty to Cash Burn Estimates

As MaxedOutMama and I have pointed out, the lack of detailed segment reporting on Tesla’s Shanghai operations makes it impossible for investors to assess the true state of Tesla finances.

That's true as well for the cash burn estimates in this article. For instance, if more or less of the finished goods inventory is located in China, then less or more of the proceeds from sale of the inventory will be available to mitigate the effects of the cash burn on the Tesla US operation, where it really counts.

Investment Considerations

If the cash burn from the coronavirus shock does not undermine Tesla US's financial footing in 2020, the implications of the deal made with China eventually will. Some day, the market will wake up to these realities. It's simply impossible, however, to say when that day will come.

There's also the geopolitical risk inherent in the rising tensions between China and the West. Consider the spectacle, during the recent conference call, of Tesla’s CEO in one moment praising China’s infrastructure development while, in the next moment, condemning the U.S. governmental shelter-in-place rules as a fascistic deprivation of Constitutional rights. And making that condemnation with a curious amnesia about the radical steps China took in Wuhan (including welding shut the doors of some of its citizens).

Investors would do well to consider all these risks.

For now, the share price of this stock remains positively ludicrous. In the day following publication of the Quarterly Update, Tesla, with its $16 million Q1 result annualized to a $64 million GAAP profit, traded at a P/E multiple of 9,000.

Any retail short position should be small, and carefully hedged. Any retail long position should be taken with the understanding this is by no means a "buy-and-hold, sleep-at-night" stock.

The strongest thesis for the long position is continued evasions and insufficient reporting from Tesla, and continued sleep-walking by the analysts and business press about China.

 

Disclosure: I am/we are short TSLA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am short TSLA via long-dated call spreads. I continue to regard the stock as immune from reality, and strongly discourage shorting in any form by retail investors.

 

@Montana Skeptic , "Tesla, with its $16 million Q1 result annualized to a $64 million GAAP profit, traded at a P/E multiple of 9,000."$64M/185M shares is ~$0.35 EPS. $880/$0.35 is PE* ~2,500 . But now it's a bargain at only ~ PE* 2,100*highly questionable "earnings" after very aggressive accounting
04 May 2020, 01:35 PM Reply 0 Like
"Badger is surprised Tesla did not draw down the full amount under its ABL."@Montana Skeptic Maybe Tesla can't. It's determined by the borrowing base, which we are not privy to. Inventory increased by almost $1 billion, so it possibly should have increased. However, how much of the increase was in China rather than Tesla -rest of world and not eligible for inclusion? To answer questions like this, it's critical to see the Tesla-China numbers separately, or at least the Tesla ABL borrowing base. The critical items in the loan agreement, including the borrowing base cert. are items that are "xxx"'d out in Tesla's SEC confidentiality agreements.
04 May 2020, 01:31 PM Reply 1 Like
Thanks for this through analysis. Tesla itself is a great idea, but was made to a Ponzi scheme by greedy Robinhood investors and Internet fanboys. A little exaggeration from my side, I know - but you know what I mean. The company metrics and the market value do not match, not even if growth targets of 50% and plus can kept up for a while.
04 May 2020, 01:27 PM Reply 2 Like
Excellent analysis. But I wonder if the “Useful Liquidity” $amount estimated by Badger should be increased: Amazon’s recent comments on the increased cost of operations under pandemic conditions were a grim reminder that businesses with large numbers of employees will see their operating expenses soar. In short, it seems that companies may try to take even more liquidity into a Chapter 11 filing in order to have the best shot at successfully restructuring.
04 May 2020, 01:27 PM Reply 0 Like
Perhaps it’s simpler to say that -if Amazon’s estimates of expense are accurate- Badger’s $2 Billion estimate for a successful restructuring should be higher.
04 May 2020, 01:36 PM Reply 0 Like
@Montana Skeptic Great Article and analysis- I agree. I think they will raise more capital, but I guess that's the point. Typically that would be seen as a negative, but TSLA has continually raised capital via debt or stock without any difficulties, even when they are clearly burning though it and not generating any ROIC- so its hard to see the liquidity crunch at $700 a share. Its almost self-fulfilling or reflexivity, the higher share price begets easier capital raise, begets higher share price. Investors in this name are buying based on some premise of electric auto-driving or maybe just plain old momentum. So many shorts have been burned, they aren't coming back either. We need to see the share price drop much more meaningfully before the liquidity problem phase begins.
04 May 2020, 01:24 PM Reply 0 Like
"Imagine that China created a car company and called it Tesla Shanghai. Tesla Shanghai then copied Tesla's vehicle designs, used Tesla's intellectual property, and even slapped on Tesla’s logo so that the Tesla Shanghai cars were indistinguishable from those made in Fremont."Because I know so don't think this possible.. China has literally done exactly this with other car makers such as BMW (well they didn't copy the BMW badge). When BMW sued, the Chinese government said the two cars were nothing alike and through it out.
04 May 2020, 01:20 PM Reply 0 Like
@Montana Skeptic This whole subject is highly complex and, as you pointed out Tesla leaves out key data. It's bit like playing "Wheel of Fortune, but you can't even "buy a vowel" (i.e. get an answer to a straightforward question.). I plan to post a number of comments on some of the subtleties regarding the issues you raise. In some respects, the situation may be worse than you realize; in others, I don't see a reason for concern. Unfortunately, because SA's default is to post the last comment first, this will the the last comment most SA readers see.
04 May 2020, 01:15 PM Reply 5 Like
Good stuff Montana !
You put a lot of details around what we all know is the Elon Musk now Elon Musk Chicom shell game !
At top of my list is how the breakthrough required to make EV's mass market (a dry electrolyte, thin film style batter that is lighter and recharges fast) would in essence obsolete much of the Telsa empire. Without this breakthrough then schlepping along the EV enthusiast curve willing to use a dangerous liquid electrolyte battery and severely adjust use of vehicle to Tesla recharge profile.Why working capital which gives Tesla time to wait out this US shutdown and what is real ownership of Tesla Shanghai really matters !I can assure everyone with current Chicom sentiment in US there is no freaking way Tesla's made in China will ever be legal to use / sell in US ? I guess what Musk probably has in mind is selling them in Europe but my guess Western democracies in Europe are also wide awake to the Chicom fraud for past decades !This brings all back to working capital for survival and reinvestment and your article some great detailed insight !thanks
04 May 2020, 01:11 PM Reply 2 Like
Please MS. Get a life. This has gone on for what? Six years?Six years of being totally, absolutely and completely wrong. It would be comical if it weren't so sad. Six years while tesla has grown from a shoestring operation to an international goliath ready to eat Ford and GM and even mighty Toyota. Six years while Elon Musk has been proved right over and over and over while Montana Sceptic has been proved wrong literally hundreds of times and right never.Whatever masochistic reason you are doing this, it is really time to stop. Tesla is no longer some hyped earth lovers dream. It is as real as can be with many models and many more coming and the love of its customers not abating. Have you ever even driven one? To know what it is all about. Ten minutes and that old -tech foul smelling, noisy piece of garbage you are driving, even it is made by Porsche or Daimler or Lamborghini, will seem like something Hannibal dragged over the alps with his elephants when he was attacking Rome.
04 May 2020, 01:10 PM Reply 0 Like
If you don't like his articles don't read them?
04 May 2020, 01:21 PM Reply 2 Like
On the conference call they declined to respond to their thinking re new board seats and mentioned they had spoken with institutional investors and had received assent about going whole hog with long term expansion. That is not a quote but my recollection. It caused me to suspect the next raise may be a private placement. I suspect if that is the case, part of the deal will again (like in 2018 I think it was) greatly reduce the available cash by requiring Tesla to buy a large number of puts, which Tesla will claim is to 'reduce potential dilution' from the (presumably) converts they will be issuing. Speaking of dilution, I have not seen any commentary on the new diluted shares outstanding number being 199m. Dilution is certainly continuing apace. But a private placement may boost the liquidity without the necessary price discovery of trying to sell it in this market.
04 May 2020, 01:10 PM Reply 0 Like
@Scotsman66 "It caused me to suspect the next raise may be a private placement. I suspect if that is the case, part of the deal will again (like in 2018 I think it was) greatly reduce the available cash by requiring Tesla to buy a large number of puts"I assume you mean the convertible issue where they used some of proceeds to sell a CALL spread to move the dilution strike price up. Still if I Tesla I would raise both equity and debt and, sure, why not more converts.
04 May 2020, 01:18 PM Reply 0 Like
Do you really think TSLA voluntarily spent over 120m to move the dilution strike price up? I expect their next raise will make OXY's debt raise from Buffet look cheap, when factoring the net cash and constructive interest rate; or the potential dilution will be large at prices not much (if any) higher than currently.
04 May 2020, 01:35 PM Reply 0 Like
"I believe Tesla will raise capital this quarter."1. Musk frees up some personal liquidity.
2. Q1 results knock it out of the park, well Tesla-style.
3. Going to bleed cash.
4. EVERY company that can raising money.
5. Stock hits $860 intra-day.
6. Musk goes "bearish" on TSLA.
7. Gets the stock down below $700 intra-day.
8. Morgan Stanley upgrades.Putting two and two together I would concur...
04 May 2020, 01:02 PM Reply 0 Like
Montana, do you believe that Tesla can raise billions in this environment if they need to? If yes, your article is just FUD.
04 May 2020, 01:02 PM Reply 0 Like
@Montana Skeptic @Bill Cunningham @MaxedOutMama @Andreas Hopf @watchingfromabove @cparmerlee
Tesla is hiring developers from Magic Leap to help build games that interact with reality and help train FSD. The intermediate goal is to control the car using electronic gloves. Eventually this will become part of a subscription model for taking over the car remotely in hedge cases where FSD is lacking capabilities.
04 May 2020, 01:02 PM Reply 0 Like
sounds like a scoop. Will be interesting to watch when and how this plays out, and catches the attention of analysts and press. --> kudos to Montana Skeptic and Badger for this fine and illuminating work !
04 May 2020, 01:00 PM Reply 2 Like
"Badger enjoyed a long and successful career in high-yield finance that included participating in workouts (including the 2009 GM and Chrysler bankruptcies) of companies that were bankrupt or highly distressed."Wow! Just wow! Amazing to be in the company of such accomplished and talented TSLAQers.
04 May 2020, 12:43 PM Reply 1 Like
@Montana Skeptic The point is well made that Tesla Shanghai is effectively a competitor to not an asset of the Tesla company in which shareholders are invested.
04 May 2020, 12:41 PM Reply 5 Like
I completely agree. This whole setup benefits the Chinese. It’s a huge huge risk for Tesla. Only stratospheric success will benefit Tesla shareholders in the long run.
04 May 2020, 01:27 PM Reply 0 Like
Tesla--smoke and mirrors--
04 May 2020, 12:39 PM Reply 1 Like
While I have to accept Badger's expertise in such matters, I was struck by the fact that he only estimates that Tesla will have paid only $900 mil in April against $4 bil in accts payable. It's a pretty forgiving bunch of trade creditors that are allowing Tesla that much slack. Especially when Badger only forecasts $500 mil in A/P drawdown for May. That would still leave more than $2.5 bil in unpaid A/P that are at least 60days old. Either Tesla's suppliers are somehow over a barrel and will put up with that kind of treatment or the amount of A/P burn is underestimated.
04 May 2020, 12:34 PM Reply 7 Like
Author’s reply »
@hawkeyec: "I was struck by the fact that he only estimates that Tesla will have paid only $900 mil in April against $4 bil in accts payable..."Keep in mind that we don't know how much of the A/P are in China.
04 May 2020, 01:36 PM Reply 0 Like
Assumption: Tesla will increase sales by 50% per year for 5+ years into the future, and auto margins will increase as more of the car becomes software, costs of manufacturing drop, and costs of the battery drop. Bulls assume this, and if this happens the stock is cheap.
04 May 2020, 12:32 PM Reply 1 Like
If Tesla's "earnings" increase enough, then the stock is cheap. Got it.
04 May 2020, 12:36 PM Reply 9 Like
randykirk: "Assumption: Tesla will increase sales by 50% per year for 5+ years into the future, and auto margins will increase as more of the car becomes software, costs of manufacturing drop, and costs of the battery drop. Bulls assume this, and if this happens the stock is cheap."There's always a risk when assuming, but even in the rosiest scenario, Tesla is overpriced right now. Ridiculously so.
04 May 2020, 01:28 PM Reply 3 Like
@Montana Skeptic Here is an honest question.
You've been writing articles negative to Tesla, such as this one, for close to five years.
Ostensibly, especially by weight of sheer number, they allude to Tesla's downfall.
Yet Tesla has not fallen but, since you began your series of articles, has been quite successful.
With their likely avenues of disruption, including soon bringing the upfront cost of their vehicles to at or below ICEV cost-parity, Tesla will soon do much better than merely thrive.
With that lengthy preamble, has it never come to your mind that you've been wrong about Tesla?
That Tesla will become one of the most successful companies in history?
Think about it.
04 May 2020, 12:31 PM Reply 11 Like
@Zwalderon Here is (another) honest question. Why does your commentary and question not address the contents of the article?
04 May 2020, 12:46 PM Reply 12 Like

@RedFalcon Because his only point is to try to discredit the author like the other shills here. Tesla survives every year with a capital raise, thus Montana Skeptic was never wrong. It can survive going forward with recurring capital raises or go bankrupt any year without that.
04 May 2020, 12:53 PM Reply 3 Like
@RedFalcon "Why does your commentary and question not address the contents of the article?"It has.
It addresses the contents of all his articles.
04 May 2020, 12:53 PM Reply 1 Like
Montana Skeptic, please keep writing. I have hold TESLA for five years. Thank you.
04 May 2020, 12:56 PM Reply 0 Like
@Zwalderon
"It addresses the contents of all his articles."Not really, beyond one bull case, all it really does is point at the stock price and imply MS is wrong because the stock price has so far, held up.I assume you're long the stock?
04 May 2020, 12:57 PM Reply 0 Like
@Wez "Not really"Yes really.
My question addresses all his articles exactly as I intended.
04 May 2020, 01:13 PM Reply 0 Like
hi @Zwalderon , I think you raise the wrong question. Even if you are surounded by people that doubt gravity for years, you are right calling it out - even if you cannot change their opinion. Eventually all that goes up will come down. and the same is more than true for Tesla as you could briefly see in March (fell like a rock). Regards
04 May 2020, 01:29 PM Reply 0 Like
1) "...Badger is surprised Tesla did not draw down the full amount under its ABL..."Did the 10Q state the anything new about the DB ABL ? Because, I would speculate (based on experience) that after getting the Jan 20th borrowing base cert, the ABL relationship guys got pistol whipped by their credit committee, and forced Zach to raise $2 billion asap. which Zach dutifully did. I would then speculate (based on experience) that the ABL line isn't exactly fully available for Zach to draw on. Thats why.2) $8 billion cash ? You forgot to correct for 'cash equalviliants'
04 May 2020, 12:22 PM Reply 2 Like
vooch....good point on ABL availability. It answers MS's query on where the other $200 million went. It's simply not available under the borrowing base calculation. The notional amount of the facility is irrelevant. It could be $6 trillion, but you can still only borrow what your borrowing base supports.
04 May 2020, 12:51 PM Reply 2 Like
"For now, the share price of this stock remains positively ludicrous. In the day following publication of the Quarterly Update, Tesla, with its $16 million Q1 result annualized to a $64 million GAAP profit, traded at a P/E multiple of 9,000."Quoted for emphasis...
04 May 2020, 12:17 PM Reply 5 Like
New paradigm.Complete idiocy.
04 May 2020, 12:39 PM Reply 2 Like
Question, do you think Panasonic will produce as many battery cells as possible for example to deliver to Shanghai, for energy storage products or just for inventory, even if Fremont stays closed until June? Does anyone know if Gigafactory 1 is already operational or not?
(edited)
04 May 2020, 12:14 PM Reply 0 Like
Montana said “Tesla isn’t leading anyone in anything”!
Shows you how far he’ll go to deceive people to drive the stock down.
He knows Tesla is THE leader in EV’s!
04 May 2020, 12:48 PM Reply 2 Like
Tesla is not leader in battery tech, neither autonomous driving and EV sales. Don't worry, it will become clear in the next months.
04 May 2020, 01:12 PM Reply 3 Like

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