Dear Friends at SC Capital and Others,

Many thanks for reading my note, appreciating it, and for providing feedback. I am publishing my response to your comments in the interest of the broader community on our platform. I have republished your comments in italics while delivering my view after each comment.

I believe the inflection point for Tesla’s valuation will come sometime in the 3^rd/4^th quarter of 2018. If Tesla cannot ramp-up Model 3 to about 3,500/ week at the end of Q2-18, and 4,000/week by end of Q3-18, momentum investors would walkway.

(Warning: this is a long comment)

My response is equally long?

It’s so nice to finally have a Tesla bull with whom to have a healthy debate over Tesla on Smartkarma. Together we can help clients (ourselves) better figure out whether Tesla is a good buy or a good short. We believe Tesla is the next Enron and it’s best to scale into your short henceforth. But let me point out a few questions/doubts we have about some of the statements you made in your excellent report.

ANTYA: Tesla is no Enron. Enron was an aggressive accounting fraud for which executives were sent to Jail including Fastow and Skilling. Enron was a capital intensive power generation, transmission, and trading business that survived via off-balance-sheet entities in the hey-day of deregulation of power markets in the U.S. Tesla is an innovative company whose management believes in its futuristic products; customers love the cars and can’t wait to drive them, and independent bodies such as the NHTSB have given its products top ratings. Multiple reputed automotive magazine reviewers have rated Tesla cars highly for safety and for design aesthetics.

Just like the Apple line-ups earlier in this decade and up until recently, TSLA customers are willing to wait years to get a car and put an advance deposit down, while competitors can’t give their conventional product away including zero financing and incentives, and are rushing into the lowest rung of sub-prime borrowers to keep the treadmill running.

Therefore, in my humble opinion, Tesla is no Enron.

(https://www.nhtsa.gov/vehicle/2017/TESLA/MODEL%252520X%252520P100D/SUV/AWD)

1)You said Tesla has been very “forthcoming” in its disclosures. They’ve actually begun omitting things they used to disclose. Given all of the broken promises from Elon Musk, I would avoid using the term “forthcoming” when referring to Tesla. Here’s just a tidbit of anecdotes that leads us to believe Tesla is not to be trusted:
a)In a February 2017 conference call, Musk said “According to our financial plan, no capital needs to be raised for the Model 3”. Three weeks later, Tesla announced a $1.15bn stock offering.

ANTYA: May 4, 2016 – Tesla First Quarter Update

“Additionally, given the demand for Model 3, we have decided to advance our 500,000 total unit build plan (combined for Model S, Model X, and Model 3) to 2018, two years earlier than previously planned. Increasing production five-fold over the next two years will be challenging and will likely require some additional capital, but this is our goal and we will be working hard to achieve it”.

In my opinion, we all know and believe Tesla will seek more capital going forward, for leasing operations, for capital expenditure funding, etc. More importantly, in my view, that capital will be acquired at higher stock prices than current levels, thus managing dilution expectations of investors. Therefore, capital raises will make the stock less risky – less valuable perhaps – and less volatile for sure.

b) In October 2016, Tesla announced an LA to NY drive on autopilot by the end of 2017. Last February, this was delayed for “three to six months”.

ANTYA: October 26, 2016 – Tesla Third Quarter Update

Last week, we announced that all newly produced Tesla vehicles have the hardware needed for full self-driving capability. This same capability will also be built into every Model 3. Eight surround cameras provide 360-degree visibility around the car at up to 250 meters of range. Twelve enhanced ultrasonic sensors complement this vision, allowing for detection of both hard and soft objects at nearly twice the distance of the prior system, and computing power has been increased by 40-fold over our previous generation hardware. Fleet learning means that all Tesla vehicles with Autopilot will naturally get better over time. Additionally, new safety and convenience features will be rolled out via over-the-air software updates. Tesla vehicles have already been driven over 3 billion miles, including more than 1.3 billion miles logged by vehicles with Autopilot hardware”.

Tesla delivered on the promise of a quasi-autopilot. No one believed they could do what they said, at least no reasonable person thinks that it is possible anytime soon. However, the prospects clearly are endless given the investments in R&D by Nvidia Corp (NVDA US), Waymo, Uber, Tesla Motors Inc (TSLA US) and umpteen others in the fray. An automated car will usher in Nirvana for Lyft, Uber, Waymo, Tesla and others while decimating the traditional car business and livelihood of millions of others. A network of on-demand accessible cars will require fewer overall vehicles anyway; but that is a discussion for another place and time.

So, I agree with your contention that they promised a Frappuccino and delivered an Americano. For some, those are good substitutes. Others can and will wait. Does not make them a fraud? Just overzealous in my view.

• Tesla Roadster launch was 9 months delayed; Model S was 6 months late; Model X was 2 years late. And we all know about the Model 3.

ANTYA: Dreamliner was years late and over budget. That was Boeing with 100 years of experience building aircraft & spacecraft and with the full support of the U.S. government’s technology infrastructure, and every Boeing supplier out there. However, once the Dreamliner stabilized Boeing stock has gone through the roof. The best time to buy Boeing was during its Dreamliner troubles. I think even now it’s a good stock to own, but similar returns won’t be forthcoming.

Ford built something called Edsel that flopped out of the gate. If you are pushing the envelope, it is bound to be challenging. Those are not missed promises by Tesla, but delays. I drove Ford’s electric prototype built in Norway in 2001/02. It was a disaster that put me off Electric vehicles until Tesla debuted. The important part is that after delays, each and every one of these vehicles has turned out to be winner and not a dud like the Edsel. If even one of those was dud, Tesla would be in receivership by now.

In my book, product delays are par for the course. Yes, that could cause capital constraints as you rightly point out, but those are likely short-lived and volatile times to trade the stock and create a position in it for buyers and book profits for shorts.

2) Don’t trust the Model 3 weekly production rate of 2K units/week during the last week of March. This involved calling all idle workers from the Model S & X lines to come and help. Stripping out that 2,020 units they pushed out in the last week of March, Tesla’s Q1 weekly production rate of the Model 3 was only 704 units, below the 1,000 units/week Q4’17 exit rate.

ANTYA: Of course, your math is correct. But the positive side is that if idle workers can help that is great. Therefore, I deduce that either Tesla is understaffed on Model 3 or overstaffed on Model S/X. Either way, it appears that a production ramp can be achieved. However, the fact that excluding the last week of Q1-18, production averaged less than the exit rate of Q4-17 is worrisome, but not significant. In my view, it will take six months to nine months for the production line to stabilize. In 2013, the first full year of Model S Tesla averaged a bit more than 2,000/month. Given that Tesla is in the 5^th year as a car company and produced 100,000 vehicles in 2017, I am assuming that they can average 2,500/week on Model 3 for the entire year because now they are an established car/technology company and are no longer an upstart.

Going back to the earlier “forthcoming”, the following is from Tesla’s 2017-10K.

This limited, and in many cases single source, supply chain exposes us to multiple potential sources of delivery failure or component shortages for the production of our products, such as those which we experienced in 2012 and 2016 in connection with our slower-than-planned Model S and Model X ramps”.

To refresh everyone’s memory, Model S and Model X ramped up slower than anticipated as well and had battery pack-related issues, just like the Model 3.

3) Your forecasts of 100K units of Models S & X appear to be in line with Tesla’s forecasts. As we noted in our note on Tesla yesterday Tesla Q1 Deliveries Undershoot & Model 3 Output Lags, Q1 Model S & X combined only came to  21.8K units, and from Q3, Tesla will be facing competition from Jaguar’s I-Pace, which is lower-priced, faster and gets a longer range on one charge (see this note on the subject Tesla to Face Stiff Competition From Jaguar’s New EV). Also, keep in mind that the Model S is now over 5 years old. In the auto world, this is like buying Christmas cake after the New Year. 

ANTYA: I believe market participants understand and agree that competition in the category is bound to heat up. The question is can it heat up in the Model 3 segment before Tesla can stabilize its operations. If it heats up in the top-end of the market, Tesla can handle that and has already planned for it. Competitors will come higher and move down. Therefore, in my view, it is not surprising that Tesla is focused on Model 3, because before competitors enter that segment, Tesla would have established a vital beachhead. The fact that I-Pace must lower its price – if we can say that because it’s neither comparable to model S or X or Model 3 – implies Jaguar must leave money on the table to compete. I said that as much in my previous note Tesla Inc. – Headed Higher, Will Defy Skeptics. I-Pace begins at approximately $70,000 whereas Model 3 starts at $35,000, not that Tesla is selling any Model 3’s at that price currently.

Model S being “5-year old” reminds me of an old debate between BlackBerry and Apple Inc. Once Apple changed the paradigm to a flat, touch-enabled screen, then software became the benchmark, and BlackBerry was left in the dust, and so was everyone else thinking of designing the next cool phone. So, all Tesla needs to do is change the grill, a contour here or there, redesign seats etc. and voila! I know I am being simplistic, but an upgraded or newer Model S is not the real challenge because that production line is running.

But I do agree; they need to do something soon. More importantly, if acceleration, ease of use, etc. are the criterion for customers, then they are already leading edge in all Tesla models. So your concern with an outdated model is a macro issue for the entire industry because what will a souped-up car be going forward? How and why will anyone upgrade if they don’t gain more speed, more autonomy, more comfort or more mileage? In mileage, Tesla already leads. The specs of the next roadster sound too good to be true.

4) When you refer to the Model 3 bottleneck being linked to Panasonic at the Gigafactory, I hope you’re not saying that it was Panasonic’s line that caused the bottleneck. Panasonic has been ready to supply 5K units of Model 3 per week since last autumn. The bottleneck was caused due to Tesla’s battery pack not properly fitting Panasonic’s LiBs.

ANTYA: From 2017 Tesla Inc. 10K

Although Panasonic has a long track record of producing high-quality cells at significant volume at its factories in Japan, it has never before started and ramped cell production at a factory in the U.S. like at Gigafactory 1. In addition, we have started producing several components for Model 3, such as battery modules incorporating the lithium-ion cells produced by Panasonic, at Gigafactory 1. Some of the manufacturing lines for such components have taken longer than anticipated to ramp to their full capacity. We expect that we will continue to experience challenges as we move through the ramp, and we will continue to fine-tune our manufacturing lines to address them. While we currently believe that we will reach our production targets, if we are unable to resolve ramping challenges and expand Gigafactory 1 production in a timely manner and at reasonable prices, and if we or Panasonic are unable to attract, hire and retain a substantial number of highly skilled personnel, our ability to supply battery packs or other components for Model 3 and our other products could be negatively impacted.”

It appears to me that management is transparent in saying that this will be no cake-walk. Your team highlights all the challenges that exist very eloquently as well. But the problem is operational and not scientific. It is interesting that you say the issue is one of “fit” because that is a design/ physical challenge that can be overcome. If not in a month then in six months, but it can be done.

5) Your point about Tesla having the Supercharger advantage is very salient, and we totally agree: Tesla owners have better access to quicker charging stations than non-Tesla owners. However, given that Tesla is most likely structurally bankrupt, at $250K per Supercharging station, how many more can they build, given all their other financial needs?

Also, did you hear that the VW Group (including Porsche, which will launch its “Model S killer”, the Mission E, in 2019) is planning to spend $500m on their own charging stations just in the US? Also, as Daniel Hellberg questioned, “what portion of current Tesla owners regularly travel outside the battery range of their vehicles?

And finally, on this point, the lack of Superchargers for non-Tesla EV owners hasn’t stopped Chevy Bolt and Nissan Leaf sales to reach a combined 7K units in Q1 versus the combined Models S & X 9.7K unit sales. Keep in mind that Nissan is just ramping up production of its new Leaf and GM has slowed down Bolt production by 2/3 in order to add capacity.

ANTYA: That competitors will have to spend significantly more than Tesla to make a dent in the marketplace is clear, because either everyone will adopt a standard charging interface making charging locations friendly for the car when away from home, or, build duplicative infrastructure. More importantly, are people buying the new generation of EVs because they are “Green”, or because they are “Better”. The Green agenda can be accomplished with a Nissan Leaf hybrid or some other hybrid car, whereas a Better agenda can only be achieved via a better car.

Battery life, charging locations, charging time, the life of the battery over the years of ownership, etc., etc. are all uncertain, and even more so for the unproven new entrants. So your contention about capital intensity for superchargers while correct, makes them more important and not less. Metcalf law would state that the value of a network is square the number of nodes in a network. ( https://en.wikipedia.org/wiki/Metcalfe%27s_law ) and with an ever-expanding network, no wonder competitors have to replicate it before they can launch. With Model 3 customers paying to use the superchargers, who is to say that the supercharger network cannot become self-funded over time?

6) You mentioned that Tesla owners could use the “Wallpack” from Tesla’s Energy Division to supercharge their Tesla’s at home. I assume you’re referring to the Tesla “Powerwall”, which is a system that has a home charging station that draws energy from solar panels you buy from Tesla’s Energy Division (formerly, the nearly bankrupt SolarCity which Tesla duped investors into agreeing to absorb in 2016) and put on your roof. The reason this hasn’t taken off yet (and why Tesla’s Energy Division continues to lose money) is because it costs roughly $71,500 to install such a system in one’s home.

So, you are saying it costs as much as the Tesla. Next time my mortgage can include the car, the roof and the car charger, all amortized over 25 years. ?

Last point here, and sorry for rambling on for so long, but I think it’s worth it. Tesla’s lofty valuations were built on the following three premises in our opinion, none of which has anything to do with being able to mass-produce cars at a profit, which Tesla has yet to prove:

1. Superior battery technology–> Tesla has had the lead in terms of cost/kWh, which are now said to be below $120/kWh and falling. VW just announced in early March that they have finalized contracts with their suppliers for $120 kWh by 2020 and GM has a similar deal with LG Chem. But keep in mind that both of these rivals have immense economies of scale, so the walls are closing in on this “investment pillar” of Tesla.

ANTYA: That’s right, and I agree with you that they will all catch up to Tesla in technology. It is equally possible that Tesla will catch up to them in car manufacturing. I remember the diesel cheating scandal from VW, the airbags from Takata, and the breaking issues of Toyota. All corporations are prone to dishonesty and hyperbole. And so is Tesla by the way! They cannot be cut from a different cloth, but at least their fabric is transparent and has less legacy and moving parts.

I’m not sure that the competitors can catch up by 2020.

2) Autonomous driving superiority–> Don’t know if you’ve been following the news of last month’s Uber and Tesla Model X accidents. But it caused Uber, NVIDIA, and Toyota Motor to halt their autonomous driving tests. Tesla hasn’t stopped selling its Autopilot options on its cars despite this, which we think is very risky and opens up the doors to potential lawsuits (in fact, some believe that Tesla’s false Autopilot claims have led to pending lawsuits that prevent it from doing any public equity financing). Waymo, the superior company in the autonomous driving field, is plowing ahead with its experiments and will continue to have a pilot run of autonomous taxis starting from late this year in Phoenix, AZ. Tesla has no edge in autonomous driving, we believe.

ANTYA: In my opinion, fully functional autonomous driving is more of an issue for fleet sales in the future, than an individual or consumer sale issue. At the end of the day, individuals do like to be in control of their cars and want the driving experience. However, if someone else has better autonomous driving tech and Tesla doesn’t match up, how that affects the market remains to be seen. Is autonomous driving the most important selling feature, or is it nice to have? It is not free! Can Tesla’s growth be stunted by a lack of fleet sales? I don’t know. All I know is that fleet sales are considered loss leaders by some in the conventional auto industry.

3) Lower costs due to selling directly & never advertising–> This should add 150bps to whatever Tesla earns on car production, which unfortunately is negative at the moment. However, the selling directly to the customers and saving dealer margins, as well as not having to advertise, is only good until Tesla has competition to deal with.

Up to now, they’ve had no competition. And this is where the end begins for Tesla: there are 120 new EVs hitting the market in both the mid to high-range segments, and we frankly don’t see what will keep Tesla as coveted of a brand once the likes of Jaguar, Audi, Porsche, Hyundai, Nissan, VW, Benz, etc. come to market with models that are cheaper and better. And they’ll all be properly beta-tested, unlike Tesla’s Model 3.

ANTYA: I agree with you that competition will cause clutter. I don’t know how this will impact Tesla. It is of utmost importance for them to reach 500,000 units next year, i.e. 2019 and higher thereafter. The first hurdle is to get close to 5,000/ week sometimes in 2018.

In fact, the reason we don’t see Tesla reaching 5K/week in unit output this year is that they have so many glitches at the moment that it will require line re-toolments (FYI the center iPad-type screen on the Model 3 is causing huge problems. Watch out if this is recalled). If you’ve read this far, thanks for your patience. If you find any of the above debatable, we’d appreciate your views.

Please see attached car review for whatever it is worth. There are many others out there. I have neither driven a Tesla Model 3 nor seen one yet in Toronto.

http://www.thedrive.com/new-cars/17280/tesla-model-3-the-first-serious-review

How many miles/km do current owners of Tesla drive?

I think this question attempts to highlight that people can charge overnight and be off in the morning. While true, this approach defeats the purpose of mobility and freedom. As an owner/driver of a car, the car has to work in all conditions at all times. Life, travel, outings cannot be planned on the basis of the charge in the car. Grand design or assumption defeats mobility, whereas unplanned detours are the norm on a road-trip. Highway conditions, accidents, weather changes, scenic country roads, etc., etc. All of that is possible because there will always be gas in the tank, or it is readily available everywhere with 100 years of human ingenuity invested in that process.

As far as charging for EVs is concerned with enough capital, everything is possible for everyone. However, none of Tesla’s competitors are growth stocks, and no-one on this platform considers them as such. Those stocks are not investments to be held but traded for 5% or 10% gain here or there. And if the market gets wind of the fact that one or some of them are going all out to compete in this segment, then we know for sure that Tesla’s multiple expands and the rest will contract.

With Tesla, one could make a fortune, or Musk could lose one.

I hope this is helpful to all those interested in Tesla Inc.