Tesla CEO Elon Musk took to the company’s blog last week to defend Tesla against complaints that the luxury EV maker was behind its Model S production schedule and to explain why it had raised additional capital. Musk had two basic points
1) Tesla raised funds to reduce its risk in the event of supplier problems, which could further delay its production ramp. It’s already had a problem with a supplier having a flood in its factory. Musk wrote that he expects the new capital to go to new vehicle development, not fund Model S production.
2) Production is ramping, now to 100 vehicles a week, and the company will be cash flow positive by the end of November.
So what’s all the fuss about?
Well, with one product, small volumes, and a narrow supplier list, small problems get big in a hurry. So hearing that Tesla was four to five weeks behind schedule can cause worry that production can’t be ramped to meet demand, a rare but real problem. Also, downward revenue guidance quickly sent the stock south about 10 percent.
Also, not all are convinced that the cash Tesla raised was just for risk reduction. Peter Eavis at The New York Times noted that prior to the $193 million cash raising at the end of September and the drawing down of the final $33 million of the DOE loan, Tesla had $67 million of cash on hand. Which isn’t a huge amount of wiggle room for a company going through $120 million a quarter. Eavis is also concerned that Tesla may not achieve its stated 25 percent gross margin, and may report higher margins early on because production is tilted right now toward big ticket, customized Model S sedans.
The bottom line is that Tesla is a high risk venture because it’s a one product company, trying to do something that’s never been done. That means risks like a narrow list of suppliers, a new retail model that has been accused of violating franchise laws, and the biggest risk of all—recalls.
My sense is that when weighing the risk of a slower production ramp versus a potential recall, Tesla will choose to slow production to reduce the chance that any cars may come back. The recall publicity related to the Fisker Karma and the Chevy Volt were detrimental to sales since one of the primary challenges for EVs is establishing trust with the consumer. Tesla is more concerned with its reputation with its customers than making them wait for the Model S.
And now was actually a good time to raise money with the Model S being rolled out, 13,000 reservations on hand, and the share price stable. Tesla would have been stupid not to raise money right now, if it had any concerns about mitigating risk. The time to raise money is definitely not once the problem has occurred and capital gets expensive.
Yes, Eavis has a point that cash was tighter than Musk lets on, but as long as the company hits its delivery targets in a reasonable amount of time, there will be enough cash coming in to cover production costs. There are efficiencies and economies of scale that can be wrung out of even a small volume production. And if Tesla meets or exceeds its 20,000 unit goal in 2013, which I see as very possible as more cars are on the street generating buzz, the company will get to profitability.
The most important metric here is the cancellation rate, which my colleague Katie Fehrenbacher pointed to in her September 25th post. If the delivery delays result in order cancellation, then we have a real cash flow problem. Tesla reported 1,000 order cancellations with 2,600 new reservations in Q3 for a net of 1,600. Tesla should remain diligent about reporting this figure so that investors will know if customers are backing away from an actual purchase.
To my mind, the Model S rollout remains a test run for 2015. That’s when Tesla plans to launch its scaled down Model S to compete with the BMW 3-series, the Audi A4, and Mercedes-Benz C-Class. And Musk says he can do it for around $30,000, extremely price competitive.
The long-term vision at Tesla has always been a mass market EV, and if taking additional capital now eases the road to that day, then Tesla was going to raise more money. It’s money that will allow it to focus on perfecting production of an electric vehicle today so it can do it again in a few years.
This is why Tesla started with the ultra high end Roadster and then moved to the luxury Model S. Those cars have better margins and the company can afford to take a bit of time to get those product rollouts just right. Because as the Nissan Leaf and Chevy Volt sales have shown, when the time comes for a mass market EV, the margin for error will be extremely small.