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Tag: Tesla

How Tesla is like a Startup in a Bad Way

TSLAs 2019 Stock Price (YTD) (Source: Yahoo Finance)

The word “startup” is usually associated with innovation and speed. But, from a financial perspective, the thing that most distinguishes a startup from other types of businesses is that startups are dependent on investors for cash to fund growth.

A common misconception here is that startups need investors because they are unprofitable. While many startups are indeed unprofitable (in many cases, rationally so), profitability does not shield a business from the need to invest capital (to build a factory, to build up inventory, to order raw materials for production in advance of sales, etc.) to grow. In the case of a rapidly growing, cash strapped startup, this problem is particularly acute as there are no certain past or future cash flows with which to finance growth and so startups have to turn to pitching investors.

By that definition, electric vehicle maker Tesla is a startup operating on an unprecedented scale. While it may have a valuation (over $40 billion market cap as of this writing) and revenues (over $20 billion in 2018) that look like a “grown up” company, as with virtually all startups, it is completely dependent on investors to finance its growth. Since Tesla went public in 2010, the company has raised over $15 billion of debt and equity (net of paying out dividends and repaying loans), over 2/3 of which has gone into funding the extensive capital expenditures (CAPEX: investments in tooling, equipment, factories, land, etc) they’ve needed to grow.

Note: the numbers / figures presented in this post are based on publicly available data provided by Tesla on its deliveries and financials. As Tesla has a penchant for revising old figures, some of these may be based on slightly outdated figures, but I have tried to use the most recent versions I could find. Tesla does not break out much detail by segment or, for automotive, by car model, and as a result most of the figures here are aggregate level. For revenues and gross profitability, I’ve used GAAP numbers from their automotive segment (inclusive of leasing) but for capital expenditures, operating expenditures, depreciation, and cash flows I’m using the entire entity. This is done both because Tesla does not provide breakouts by segment but also because burdening these costs on Tesla’s automotive business is likely both realistic (due to the fact that Tesla’s automotive segment is responsible for the vast majority of revenue and expenditure both today and in the past) and presents a more favorable view of the business (due to Tesla’s automotive segment consistently being more profitable than the others). Refer to this Google Sheet for additional information.

This has fueled an astonishing 76.4% compounded annual growth in revenue from 2009-2018, which is especially impressive considering that Tesla vehicles sell at a premium relative to the rest of the market.

However, because the company continues to require injections of investor cash (having raised $1.5B in the first two quarters of 2019, after burning $323M of cash in that same time), the key question for any current or prospective investor into Tesla is will all of this cash burn ever pay off?

This is a question that VCs are used to asking with the startups they pour money into, but it’s one that is a lot trickier for Tesla shareholders to answer. A small software startup looking for $10M in venture capital can find many patient sources of capital who are willing to bet that the company either turns profitable (because most of the cost lies in initial development and sales) or gets sold at an attractive valuation.

But, Tesla, with a valuation in the $10’s of billions (pricing out most buyers) and needing to raise $100’s of millions (if not more) each year from investors demanding near-term results (i.e. public market investors, large corporate debt holders and their rating agencies), will likely have to prove that it can generate real profits.

But, that isn’t happening today. While Tesla proudly boasts about record deliveries as a sign of healthy demand, the numbers show this is a direct result of Tesla’s choice to shift away from selling more profitable Model S/X vehicles to selling lower price, less profitable Model 3s. This has exacerbated a multi-year trend of declining per vehicle profitability:

Lower gross profits per vehicle are not the end of the world, provided that Tesla can sell enough Model 3s to make up for the lower unit profit and start covering their other costs. But that also isn’t happening. At a fundamental level, Tesla is just not getting any real operating leverage. While booming sales volumes have boosted Tesla’s gross profits, the company’s operating expenditures (OPEX; or spending on sales, administrative overhead, and research & development) have more than kept pace. Rational watchers can choose to interpret this as either an inability to maintain growth without spending huge amounts on R&D and SG&A or as smart, long-term bets on future technologies, but the data is clear that Tesla has a long way to go before proving it can fund its own growth just by selling more cars.

The chart below shows another way of looking at this — it graphs the number of vehicles Tesla needed to deliver to cover its OPEX in a given year against the number of vehicles Tesla actually delivered that year. What is astonishing is that the number of vehicles needed to cover OPEX has gone up dramatically each year. Only in one year since 2014 did Tesla close that gap — 2018 after two amazing quarters — and from the available data for the first half of 2019, it looks like, barring a dramatic shift in pricing or profitability, Tesla will need to hit its guidance of 360,000-400,000 cars to just breakeven.

*Multiplied 2019 H1 vehicles deliveries & deliveries to break-even by 2 to compare directly with data from past years

If Tesla is not clearly demonstrating improving profitability, then for the startup investment story to work, it needs to at least demonstrate improved capital efficiency (how effectively it spends investor cash on production). While one can point to Tesla’s more moderate CAPEX spend since 2017 as evidence for this, it is more relevant to understand how Tesla is progressing in its ability to turn CAPEX investments into profit.

While its difficult to calculate precise figures around capital efficiency in the absence of specific data on the cost to build a factory and how the factories are utilized, a ratio of Tesla’s annual automotive gross profits (adjusted to remove depreciation) to its annual depreciation (a way of measuring how current and past capital expenditures are utilized in a given year, albeit one which also factors in CAPEX from Tesla’s non-automotive businesses because Tesla does not break those out separately) can be instructive. The chart below shows that, where Tesla once generated nearly $5 in profit per $1 of depreciation in 2015, it generated only $2.69 in the first half of 2019 (over 40% less). In other words, if Tesla is improving its capital efficiency and utilization as it ramps production and learns from its past mistakes, its not apparent in the numbers.

Adj. Automotive Gross Profits are GAAP Automotive Gross Profits, Less Total TSLA Depreciation

All of this is not to say that Tesla is doomed — the company’s sales, despite missteps (happy one year anniversary of “funding secured”), continues to grow, and the company has clearly captured the American public’s imagination and mind-share as it pertains to electric vehicles, and equity/debt investors continue to extend Tesla more capital even at its current valuation and debt load.

But, in terms of capital requirements, Tesla is running the largest startup experiment of all time. Earlier this year, Bird raised $300M to invest in (what are currently) money-losing electric scooters. In a sense, Tesla is doing the same thing with the Model 3 but at a far greater scale, all the while trying to develop autonomous driving technology and financing the massive liabilities of its SolarCity business. As a result, Tesla needs to continue to sell the dream both to the public and to investors, and to continue to maintain the vision of future profitability and capital efficiency as a misstep here could cause things to rapidly unravel.

Special thanks Andrew Garvin and Derek Yang for reading an earlier version of this and sharing helpful comments!

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Henry Ford

This weekend, I paid a visit to The Henry Ford. Its a combination of multiple venues — a museum, an outdoor “innovation village”, a Ford Motors factory tour — which collectively celebrate America’s rich history of innovation and manufacturing and, in particular, the legacy of Henry Ford and the Ford Motors company he built.

While ambitious super-CEOs like Larry Page (Google), Elon Musk (Tesla), and Jeff Bezos (Amazon) with their tentacles in everything sometimes seem like a modern phenomena, The Henry Ford shows that they are just a modern-day reincarnations of the super-CEOs of yesteryear. Except, instead of pioneering software at scale, electric vehicles, and AI assistants, Ford was instrumental in the creation of assembly line mass production, the automotive industry (Ford developed the first car that the middle class could actually afford), the aerospace industry (Ford helped develop some of America’s first successful passenger planes), the forty hour workweek, and even the charcoal briquet (part of a drive to figure out what to do with the lumber waste that came from procuring the wood needed to build Model T’s).

In the same way that the tech giants of today pursue “moonshots” like drone delivery and self-driving cars, Ford pushed the frontier with its own moonshots: creating cars out of bioplastic, developing biofuels, and even an early collaboration with Thomas Edison to build an electric car.

It was a striking parallel, and also an instructional one for any company that believes they can stay on top forever: despite the moonshots and the technology advantages, new technologies, market forces, and global shifts come one after the other and yesterday’s Ford (eventually) gets supplanted by tomorrow’s Tesla.

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Tesla in Energy Market

One of the most fascinating things about the technology industry is how the lines between markets and competitors can shift all of a sudden. One day, Nokia is mainly thinking about competing with phone makers like RIM and Motorola on getting influence with carriers and upselling text messaging services / ring tones and, the next, they need to deal with players like Apple and Google, fostering a strong app ecosystem, creating intuitive user experiences, and building a brand that resonates with users.

One interesting case that has emerged in the past couple of days is the electric car company Tesla entering the Home and Industrial energy market. In much the same way that software let Apple and Google build operating systems that could double up as phones, the manufacturing prowess and battery technology which let Tesla take on the electric car market also gives them the ability to offer energy storage solutions for the utility market.

When I was a VC looking at energy storage opportunities, there was a fair amount of discussion in the industry about the future potential for electric cars connected to the grid to themselves to operate as energy storage / load balancing. I never expected this to amount to much for at least a decade — when the penetration of electric vehicles would be high enough to make sense for utilities to invest in this capability. Never would I have imagined the path to anything even remotely like this would be through an electric car company directly making and offering electric batteries to supply the market. While history will judge whether or not Tesla is successful at this (a lot of unanswered questions around the durability of their Li-ion batteries for utility purposes and how they will be serviced / maintained), you can’t fault Tesla for lack of boldness!

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The Marketing Glory of NVIDIA’s Codenames

This is an old tidbit, but nevertheless a good one that has (somehow) never made it to my blog. I’ve mentioned before the private equity consulting world’s penchant for silly project names, but while code names are not rare in the corporate world, more often than not, the names tend to be unimaginative. NVIDIA’s code names, however, are pure marketing glory.

Take NVIDIA’s high performance computing product roadmap (below) – these are products that use the graphics processing capabilities of NVIDIA’s high-end GPUs and turn them into smaller, cheaper, and more power-efficient supercomputing engines which scientists and researchers can use to crunch numbers (check out entries from the Bench Press blog for an idea of what researchers have been able to do with them). How does NVIDIA describe its future roadmap? It uses the names of famous scientists to describe its technology roadmap: Tesla (the great American electrical engineer who helped bring us AC power), Fermi (“the father of the Atomic Bomb”), Kepler (one of the first astronomers to apply physics to astronomy), and Maxwell (the physicist who helped show that electrical, magnetic, and optical phenomena were all linked).

cudagpuroadmap

Who wouldn’t want to do some “high power” research (pun intended) with Maxwell? 🙂

But, what really takes the cake for me are the codenames NVIDIA uses for its smartphone/tablet chips: its Tegra line of products. Instead of scientists, he uses, well, comic book characters (now you know why I love them, right?) :-). For release at the end of this year? Kal-El, or for the uninitiated, that’s the alien name for Superman. After that? Wayne, as in the alter ego for Batman. Then, Logan, as in the name for the X-men Wolverine. And then Stark, as in the alter ego for Iron Man.

Tegra_MWC_Update1

Everybody wants a little Iron Man in their tablet :-).

And, now I know what I’ll name my future secret projects!

(Image credit – CUDA GPU Roadmap) (Image credit – Tegra Roadmap)

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The Goal is Not Profitability

I’ve blogged before about how the economics of the venture industry affect how venture capitalists evaluate potential investments, the main conclusion of which is that VCs are really only interested in companies that could potentially IPO or sell for at least several hundred million dollars.

One variation on that line of logic which I think startups/entrepreneurs oftentimes fail to grasp is that profitability is not the number one goal.

Now, don’t get me wrong. The reason for any business to exist is to ultimately make profit. And, all things being equal, investors certainly prefer more profitable companies to less/unprofitable ones. But, the truth of the matter is that things are rarely all equal and, at the end of the day, your venture capital investors aren’t necessarily looking for profit, they are looking for a large outcome.

businessgrowthBefore I get accused of being supportive of bubble companies (I’m not), let me explain what this seemingly crazy concept means in practice. First of all, short-term profitability can conflict with rapid growth. This will sound counter-intuitive, but its the very premise for venture capital investment. Think about it: Facebook could’ve tried much harder to make a profit in its early years by cutting salaries and not investing in R&D, but that would’ve killed Facebook’s ability to grow quickly. Instead, they raised venture capital and ignored short-term profitability to build out the product and aggressively market. This might seem simplistic, but I oftentimes receive pitches/plans from entrepreneurs who boast that they can achieve profitability quickly or that they don’t need to raise another round of investment because they will be making a profit soon, never giving any thought to what might happen with their growth rate if they ignored profitability for another quarter or year.

initial_public_offering

Secondly, the promise of growth and future profitability can drive large outcomes. Pandora, Groupon, Enphase, Tesla, A123, and Solazyme are among some of the hottest venture-backed IPOs in recent memory and do you know what they all also happen to share? They are very unprofitable and, to the best of my knowledge, have not yet had a single profitable year. However, the investment community has strong faith in the ability of these businesses to continue to grow rapidly and, eventually, deliver profitability. Whether or not that faith is well-placed is another question (and I have my doubts on some of the companies on that list), but as these examples illustrate, you don’t necessarily need to be profitable to be able to get a large venture-sized outcome.

Of course, it’d be a mistake to take this logic and assume that you never need to achieve or think about profitability. After all, a company that is bleeding cash unnecessarily is not a good company by any definition, regardless of whether or not the person evaluating it is in venture capital. Furthermore, while the public market may forgive Pandora and Groupon’s money-losing, there’s also no guarantee that they will be so forgiving of another company’s or even of Pandora/Groupons a few months from now.

But what I am saying is that entrepreneurs need to be more thoughtful when approaching a venture investor with a plan to achieve profitability/stop raising money more quickly, because the goal of that investor is not necessarily short-term profits.

(Image credit) (Image credit)

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