Tesla is leading not only the electric vehicle evolution but also the battery storage technology. In Tesla flagship products such as the Model S and Model X, the sophisticated powertrain produces the fastest electric cars in the world. Furthermore, Tesla has developed the most advance battery technology to power all its electric vehicles. The Model S and Model X are having the longest battery range in the world.
It may look like that Tesla is going to become the next Apple or Google. As such, it seems like a no-brainer to buy Tesla stock when the company is still young. However, there are still significant amount of risk associated with investing in Tesla stocks. The following paragraphs list out several risks of investing in Tesla stocks.
Risk 1: Tesla has not been consistently profitable
One of the major setbacks in Tesla is the fact that the company has not been profitable consistently since its initial public offering (IPO) in 2010. According to the 2018 annual report, the accumulated loss incurred by the company as of December 31, 2018 was $5.32 billion. The net loss in year 2017 alone made up as much as $1.96 billion, which was the largest, as the company is ramping the Model 3 production.
Moreover, Tesla has been burning large amount of cash on manufacturing of electric vehicles, construction of solar energy system and capital expenditure as seen from this article: Tesla cash burn rate. The amount of cash spent was way more than the cash generated from its business operation. Over the years, Tesla has been resorting to stock issuance and debt borrowing to fund its business operation. Without doing these, Tesla will run into liquidity problem in no time.
The following chart shows Tesla quarterly operating income for the past 5 years from 2015 to 2019. As seen from the chart below, out of the 18 quarters shown, only 3 quarters were having positive operating income. Some of the quarters were losing as much as $500 million. The operating profit chart shows that Tesla core business of selling electric cars and building solar energy system as well as installing solar panels have not been able to generate meaningful profit over the years.
Do I get any dividends from Tesla stocks?
Because of the fact that Tesla has been consistently unprofitable over the years, it has not been and will not be paying any dividends in the foreseeable future.
Furthermore, with all the debts that the company is carrying, there are certain restrictions bounded by these debt covenants as to how the company is allowed to distribute its profit (if Tesla ever makes one) such as in the form of a dividend.
Not until the company is able to consistently make a profit and generate substantial amount of free cash flow, existing investor can only hope that the share price of Tesla stock will appreciate in the future.
Risk 2: Tesla is counting on only one product for growth
Tesla is targeting to achieve a production and delivery numbers of between 360,000 and 400,000 vehicles per year in 2019 according to its quarterly update letter. As of Q2 2019, Tesla has only managed to deliver 159,000 vehicles year to date as shown in the following graph.
Out of the 159,000 vehicles delivered in the first half of 2019, the Model 3 delivery made up roughly 80% of the number at 129,000 units, making it the most important product for Tesla to achieve growth.
As shown in the graph below, Tesla automotive revenue is closely correlated with total vehicle delivery numbers. The rise and fall of automotive revenue is directly trending in the same direction as the plot of vehicle delivery numbers. Since Model 3 delivery makes up as much as 80% of total delivery, Tesla revenue growth is directly tied to the growth of Model 3.
Notice that the decline in vehicle delivery in 1Q 2019 from 90K to 60K units has caused a significant drop in automotive revenue in the same quarter.
This makes the growth of Tesla extremely vulnerable to Model 3. The graph above shows that Tesla is basically counting on only one product which is the Model 3 for growth. The risk here is that any mishap of Model 3 would definitely spell big losses for investors.
The following chart shows Tesla Model 3 delivery numbers.
As seen from the graphs above, Tesla may not always be able to meet the expected delivery target. For example, there was a significant decline in Model 3 delivery at only 51,000 units in 1Q 2019 which was a far cry from the delivery target of 70,000 units. As a result of the decline in Model 3 demand, the total vehicle delivery was also affected and had reached only 63,000 units, a short of roughly 20,000 units from the delivery target of 90,000.
In short, Model 3 may make or break Tesla. It’s Tesla’s lifeline for its future survival. Tesla is banking on Model 3 for now, which is offered at lower price point and produced at significantly higher volumes than Model S and Model X combined, to make a profit.
Risk 3: Continuous stockholders equity dilution
Another risk of investing in Tesla stock is the risk of stockholders facing the continuous dilution of equity ownership in the company. The equity dilution can be due to multiple reasons. Some major reasons of equity dilution are the conversion of convertible debts to equity and stock issuance for raising capital.
The following chart shows Tesla share outstanding over the 5-year period from 2015 to 2019.
As seen from the chart above, Tesla common stock outstanding has increased significantly over the 5 year period. In 1Q15, the share outstanding was only 126 million but the share count has increased to 180 million in 2Q19. The increment is roughly 43% over the 5-year period.
Conversion of convertible debts to equity
As mentioned, one of the reasons of equity dilution is the conversion of debts to equity. As of the 2Q 2019 quarterly filing, Tesla has about $6.7 billion of convertible debts. The lenders of these convertible debts have the options to convert them to common stocks under certain terms and conditions when Tesla stock prices hit certain thresholds.
Here is an except from the 2Q 2019 quarterly filing regarding the dilution of Tesla stocks due to convertible long-term debts:
“Transactions relating to our convertible notes may dilute the ownership interest of existing stockholders, or may otherwise depress the price of our common stock.”
The conversion of some or all of the Tesla Convertible Notes or the Subsidiary Convertible Notes would dilute the ownership interests of existing stockholders to the extent we deliver shares upon conversion of any of such notes.
Our Subsidiary Convertible Notes have been historically, and the other Tesla Convertible Notes may become in the future, convertible at the option of their holders prior to their scheduled terms under certain circumstances.
If holders elect to convert their convertible notes, we could be required to deliver to them a significant number of shares of our common stock.
As quoted above, if these bond holders decide to elect to convert their convertible debts, Tesla is required to issue a significant number of shares of common stocks. This will certainly lead to stock ownership dilution and further depress the price of its common stocks upon the conversion of such debts.
In addition, Tesla may prefer to issue common stocks to settle these convertible debts when they come due instead of paying off with cash since the company is already running thin on cash.
The following snapshot shows the total amount of unpaid principal balance for the convertible long-term debt in the 2Q 2019 quarterly filing.
Stock issuance for capital raise
Another reason of share dilution is the common stock issuance for capital raise. The following graph shows the major stock issuance that has occurred in the past quarters.
You may notice from the chart above that certain quarters were having exceptionally high increment of share outstanding. For example, in 2Q19, share outstanding has increase by 3% from the prior quarter. The reason for the increment is due to the issuance of 3.5 million common stocks for $847 million of capital. Furthermore, in the same quarter, Tesla has also issued about 0.9 million common stocks for acquisition purpose.
In short, as long as Tesla is losing money, the company stockholders equity dilution will continue to get worse.
The authors wrote this article themselves, and it expresses their own opinions. The authors are not receiving compensation for writing the article. The authors have no business relationship with any company whose stocks are mentioned in this article.
1. All images and financial figures were obtained from Tesla Quarterly and Annual Financials.
2. Featured images are obtained from Maurizio Pesce.
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