Tesla's change of direction could put it on a bumpy road

Elon Musk. Photo / AP

It took Elon Musk only 60 characters to radically change the direction of Tesla.

His tweet on Tuesday that he was considering taking the company private, and had secured funding to do so at US$420 ($630) a share, sent the stock surging, as investors salivated over the potential US$72 billion deal.

Big questions remain unanswered by Musk or Tesla. Who will fund a buyout? How would the new structure work?

The billionaire has at least been clear about his resentment of life on the public market.

Musk has fought running battles with speculators who have made Tesla America's most shorted company. About a quarter of Tesla shares are on loan to traders who will profit if the share price falls.

Musk referred to this in a blog issued after his initial tweet, referring to "distracting, wild swings" in the share price and "perverse incentives for people to try to harm what we're all trying to achieve".

Tesla has faced what Musk called "production hell" as it tried to increase the rate at which it built Model 3 cars.

The affordable vehicle is intended to bring battery-powered motoring to the masses, but mass production has proved more difficult than Tesla anticipated, as it failed to hit self-imposed targets. The celebrations of short sellers as he fell short have riled Musk.

Even some of those investors who believe in Tesla's mission are viewed as a problem by its co-founder.

Providing them with quarterly reports places "enormous pressure on Tesla to make decisions that may be right for a given quarter, but not necessarily right for the long-term", Musk complained.

Some sympathise. Ross Gerber, a vocal investor in Tesla, raised concerns that "last quarter Tesla went to extreme lengths to hit their numbers, losing money flying equipment in from Germany".

"I am sure Elon was sitting there thinking, 'Why am I doing this to make Wall Street happy? I could of hit the numbers a month later and no one would care'."

Musk is evangelical about electric cars and a more sustainable future powered by solar energy. Such ambitious and distant goals are rare in a public company for good reason.

Musk's critics have been quick to claim that the real reason to go private is that it simply cannot fund itself much longer by tapping Wall Street shareholders and bond markets.

Tesla said it burned through US$700 million in its most recent quarter. This was less than US$900m last time round, but the company has gone through US$8b in four years and racked up debt approaching US$10b.

It is yet to make an annual profit.

Critics say Tesla can't maintain such spending and will need to raise new funds. That could prove difficult on public markets given the state of its balance sheet.

At current rates, Tesla could be out of cash next year.

Jefferies analyst Philippe Houchois said: "While the quarterly earnings de-stressed the short-term outlook, Tesla did not reassure that profitability can support organic funding of investments in future products and manufacturing capacity."

"Tesla will need additional capital to fund these or risk being caught with a narrow and ageing product range within two years."

The Tesla range is small compared with traditional car makers. It only offers the low-cost Model 3, the saloon Model S, and SUV Model X. A new sports car is coming, along with a truck. By industry standards Tesla is tiny. It is the world's biggest-selling electric car marque, but that achievement has been registered by selling fewer than a quarter of a million cars in total.

By comparison, Volkswagen Group, the world's largest carmaker, sold more than 10 million vehicles last year across all its brands.

Core sales at BMW, with which Tesla competes more directly at the more expensive end of the market, were 2.09 million in 2017.

Tesla needs to make a wider range of cars and more of them if it is to survive, according to most seasoned industry observers. It will need dealerships too, and more charging stations.

Estimates put the overall cost at US$30b over the next decade. Competition is increasing too. Tesla has pioneered the electric car market but now the big names are moving in on its territory fast, accelerated by the dieselgate scandal and pressure from governments.

Major carmakers are bringing decades of experience in mass production to electric vehicles, while Tesla continues to struggle with tales of panel gaps, wonky trim and other quality failures.

More competition could also put pressure on Musk's plans for profitability. At 25 per cent, Tesla makes a much higher gross margin on its cars than most traditional manufacturers thanks to the willingness of early adopters to pay a premium for new technology. Volkswagen, BMW and Daimler all make less than 10 per cent.

Evercore ISS analyst George Galliers suggested faster production might help Tesla, however.

He said: "This [current high] is despite Tesla being subscale and unable to secure the sort of contracts the giants can.

"We'll have to see what the margins are when it can get a better deal."

Anyone backing Musk's buyout plan will need to believe in Tesla's lofty valuation of almost US$70b. It compares with Ford at US$40b, BMW at US$64b and VW Group at US$88b. Tesla requires faith in the future.

Malcolm Polley, president of US investor Stewart Capital Advisors, said: "Tesla is trading at greater than 100 times next year's earnings, assuming they're profitable and they don't burn through their cash. In whose imagination is that not assigning value to innovation?"

Some observers have suggested Tesla might be better off seeking a safe haven by merging with an established car maker. Piggybacking off another company's experience could increase production faster than any cash investment.

Yet for Musk, it seems independence is more valuable than anything.

This story first appeared in the Daily Telegraph and was reproduced with their permission