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Sure, Tesla burns rubber – but it also burns cash

A Tesla Motors Inc. Model X P90D electric sport utility vehicle (SUV) stands on display at a Tesla Motors Inc. showroom in London, U.K., on Tuesday, Jan. 10, 2017.

Chris Ratcliffe/Bloomberg

A Tesla Model S sedan can accelerate from 0 to 100 kilometres an hour in just over three seconds – almost as fast as the fastest Ferrari. Of course, Tesla owners who are also Tesla shareholders – and many are – are used to pleasingly outrageous performance. Fast cars, fast shares.

The company's shares have climbed from about $180 (U.S.) in early December to $252, a gain of 40 per cent in less than three months. With a market value of $41-billion, this niche car maker is worth only $8-billion less than the mighty Ford Motor Co. and three times more than Fiat Chrysler Automobiles (FCA).

How to explain Tesla's share price surge?

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While the so-called Trump rally can take some credit, a lot must go to Elon Musk, Tesla's chairman and CEO, who strides the technology world like an invincible Roman god. He builds products that could transform entire industries. The mad genius launches rockets, installs glass solar shingles on rooftops, builds battery packs that power houses and produces sleek, silent all-electric cars that make combustion-engine vehicles look like museum pieces. Shareholders treat him as if he were a genetic meld of Steve Jobs and Henry Ford – the ultimate disruptor, who promises endless growth and maybe a ticket to Mars.

As a punt on a tech fantasy, one that could come true, Tesla shares are compelling. But as a purchase based on fundamental investing principles, they have a lot to be desired. The company does not make money, burns cash at an alarming rate, requires endless torrents of equity capital to stay alive, sometimes falls short of delivery forecasts and will soon face potentially vicious competition from the auto makers that it humbled. As FCA's Italian-Canadian boss Sergio Marchionne said in 2015: "There is nothing that Elon does that we cannot do."

That's not entirely accurate. Mr. Musk, unlike Mr. Marchionne, seems able to attract rich, price-is-no-object investors in the same way that Formula 1 events attract diehard racing fans. But for how much longer? Maybe years, maybe not.

The fourth-quarter results for Tesla (formerly Tesla Motors) served as a handy reality check.

The company – which now includes SolarCity, the U.S. solar-panel company where Mr. Musk was chairman – lost money. No surprise there. The deficit, under GAAP – generally accepted accounting principles – was $121.3-million. The non-GAAP figures were more flattering.

Tesla shareholders are used to losses. Since joining the stock market in 2010, the company has reported a quarterly profit only twice on a GAAP basis, and the losses have been generally greater than analysts' estimates. It did make a $22-million profit in the third quarter, but it appears most of the bump came from selling pollution credits to other auto makers (revenue from selling credits fell 86 per cent in the fourth quarter).

If the losses, while never pleasant, did not come as a surprise, the cash flow numbers did. In the fourth quarter, Tesla burned through $970-million in cash as it geared up to produce the mass-market Model 3 sedan, which will be priced at $35,000 – about half to a third the price of a luxury Model S. In the same quarter, the capital expenditures (capex) came to $500-million.

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Both the cash burn and the capex figures were at their highest quarterly levels since Tesla went public. So are both set to come down? Forget it. Telsa has announced it expects to invest as much as $2.5-billion between now and the start of the Model 3's commercial production in the summer. Assuming it reaches that level, the first-half capex would be more than the total capex in the last six quarters.

Given the monstrous capex spending and the expected cash burn to come, it should come as no surprise that Tesla will almost certainly tap investors once again. On this week's conference call with analysts, Mr. Musk said it "probably makes sense" to issue more equity. "How close to the edge do we want to go?" he asked. "According to our financial plan, no capital needs to be raised for the Model 3, but we get very close to the edge."

The gravity-defying performance of the shares means Mr. Musk would be foolish not to raise equity. The question is whether investors will keep funding the company with their historic alacrity if the Model 3 doesn't meet production and sales expectations, and we all know that the company has a habit of missing guidance for deliveries. Mr. Musk said Model 3 production will exceed 5,000 cars a week "at some point" in the fourth quarter of 2017 and 10,000 a week some time next year.

The total car production goal is 500,000 next year and one million by 2020. Since Telsa made only 84,000 cars in 2016, that's an ambitious leap that will require more factories, capex and equity offerings, which will translate into more shareholder dilution. The make-or-break Model 3 (which will come, incidentally, with lower profit margins than the far more expensive Model S) may not reach 500,000 deliveries in 2018, all the more so since the competition is about to come on strong. All the top auto companies are pushing into electric cars, and the highly rated Chevrolet Bolt, which just hit the road, is aimed right at Model 3 territory.

A lot has to go right for Tesla in the next couple of years to justify the lofty share price, and a lot could go wrong, given the ambitious roll-out program at Tesla's car and solar divisions. As long as investors are buying into Mr. Musk's promise of revolution, the shares may remain intact. But if the cash burn continues at horrific rates, watch out.

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About the Author
European Columnist

Eric Reguly is the European columnist for The Globe and Mail and is based in Rome. Since 2007, when he moved to Europe, he has primarily covered economic and financial stories, ranging from the euro zone crisis and the bank bailouts to the rise and fall of Russia's oligarchs and the merger of Fiat and Chrysler. More

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