Tesla Model 3 Pre-order Financing Creates A Bubble
Pre-order Count Falls Short of One Billion Dollars
On April 3rd, Elon Musk tweeted the pre-orders had hit 276 thousand for Tesla's Model 3. This was an improvement to the March 31st launch, but contrary to faulty headlines, sales were still under one billion dollars. Why then was there mention of over $7 billion in sales? The answer is important to company stock investors and anyone in hunt for a tech bubble to burst.
Each customer was required to pay $1,000 up front for the right to be first purchaser in their region. Sound confusing? It requires further explaining, but to be clear, the $1k was in no way a purchase order. Further, the base model cost of $35k was not exchanged. This means fiscal year 2016 will immediately reflect $1k multiplied by +276 orders, granting Tesla millions of sales revenue not billions.
The $1k exchanged was for a contract agreement that Tesla calls a "Reservation." It contains ambiguous terminology, bilateral cancellation (optional refund) and no set price of sale.
Three aspects under review in this article:
- Fulfillment of pre-orders
- Base model pricing
- Tesla's income sheet (can they afford a refund?)
Test Ride A Model 3; Now Wait 1.5 Years
Model 3 Not Available Until 2017-2018
According to Tesla's blog, the Model 3 will begin production in "late 2017." West Coast receives fulfillment priority, thus we can expect the first batch to be made in the home region. If sales were to be overwhelming, which there are hints this is the case, we might expect supplemental factories elsewhere. Perhaps Tesla will join the Cuba revival and setup shop overseas.
Seeing how the first production isn't until late 2017, it will be 2018 that fulfillment or deliveries hit their stride. However, if production capacity isn't improved upon, the rate of fulfillment could require several more years for completion. For the sake of argument, the earliest delivery is one and a half years away.
According to the terms of the Reservation, a purchase order for the full price isn't set until the car is ready and customer is at the front of the queue. This allows for $1k to be tied up for about 1.5 years before offering $35k (2016 base value quote).
The first concern governing the Reservation is supply and demand over a lengthy 1.5 years. For example, suppose April Reservations are comprised of $35k base value customers. When Q3 (third quarter) 2016 hits and pre-orders are doubled; how could a company honor the budget shoppers? They would most likely need to provide priority to those of elevated trim packages and add-ons.
Secondly, a $35k base value is an early quote. By the time Tesla figures out matching production to the demand, it would be reasonable to expect the base value to elevate.
Tesla Model 3 Fulfillment Schedule
Tesla Reservation Contract Sets Vague Terms of Pricing
In section three of the Reservation contract: "Order Process" states the purchase agreement will be made at a later date. Only then will the price be set, but it will include unknown "duties, transport and delivery charges and any other applicable fees." With the unknown costs and time lapse, base model price is likely to be higher than $35k.
This begs the question, will the initial Reservists be able to afford the finalized price of the Model 3? I think the price will inflate and push people to think of the $1k refund. Before showing sign of an adjusted price, Reservists could be required to add funds to keep their place in the queue. This would allow for Tesla to realize more revenue in 2016, assist with production costs and keep Reservists committed.
Alas, the contract allows for cancellation. This may sound like an accommodating refund if the customer were to change their mind. The language is not exclusive and would imply that Tesla may also cancel the Reservation. A refund of one thousand dollars would be manageable, but if a 1.5 year wait and price inflation would cause 50% cancellation; the refund would be difficult to honor.
Terms of the Quasi Purchase Order for Model 3
The Model 3 Reservation Refund
In 2015, Tesla Motors, Inc. (NASDAQ: TSLA) income sheet showed approximately $4 billion in sales. That would be an impressive figure except the cost of making those sales left them with less than a quarter for gross profit. Of the $923 million in gross profit, $718 million was spent on research and development. Return on Research Capital (RORC) was low compared to competitors. Total expenditures wiped out all profit and then some.
Per the terms of Reservation agreement, fees of $1k are not placed into escrow. The money is likely in flow with normal Tesla operations. After the end of 2016, should Tesla's income and margins follow custom, the money will have been spent. It's difficult to pay refunds when after paying employees and financing R&D the company is already in the red.
The Cult Following of Elon Musk Has Created a Bubble
Seeing how the pre-orders have not created realized sales for 2016, the excitement and false headlines are unreliable. Based on Tesla's estimations, it will take several years to complete these orders. Financial statements from previous years show that the company does not maintain positive net income. Expenditures are at high margins in respect to revenue and in the event of a catastrophic refund demand, production delays or failure to produce, net loss will grow.
The odds are stacked against Tesla Motors, Inc. and Elon Musk. Great branding and business leaders can certainly outperform, but this time the elevated projections are a bubble waiting to burst. If stock price responds too generously to the rhetoric and continues to perpetuate the false accounting it could be a harsh reality in the years to come. The car would remain a great ride and loved by the niche consumer, but from an investor point of view the outcome could be much different.
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© 2016 t aaron brown