Goldman Downgrades Tesla To "Sell" On Cash And Execution Risk

The recent avalanche of bad news for Tesla has refused to stop this morning, when former Tesla cheerleader, Goldman Sachs analyst David Tamberrino, announced he was cutting the company's stock rating to "Sell", slashing his price target to $185, and predicting 28% downside from current prices. TSLA stock was down -2.3% in premarket trading on the Goldman report.

As Tamberrino explains, "we downgrade shares of Tesla to Sell from Neutral with 28% downside to our 6-month price target of $185 (lowered from $190), vs. 8% downside for our coverage. While we believe Tesla currently has a lead relative to OEM peers with respect to vehicle technology adoption, electric vehicle architecture, and (potentially) battery scale, our concerns are more near-term oriented with respect to operational execution on the Model 3 launch, an unproven solar business, and cash needs. Ultimately we see a delayed launch (pushing volume growth out and to the right) and FCF burn rate (necessitating a capital raise before 4Q17) to weigh on TSLA’s shares."

Some additional details why Tamberrino changed his opinion (aside, perhaps, from the immediate lack of more secondary offerings on which Goldman can be lead underwriter):

We downgrade shares of Tesla from Neutral to Sell with 28% downside to our 6-month price target of $185. We expect to see pressure on shares as we progress through the year, as cash burn intensifies and the ramp of Model 3 volumes proves to be slower and flatter than assumed in guidance/consensus. Further, the acquisition of SolarCity – which is undergoing its own business model transition – comes at a time when we believe Tesla should be singularly focused on becoming a mass automobile manufacturer. Lastly, while we see Tesla as a net beneficiary of potential tax reform, we believe the net present value of those benefits would remain effectively unchanged from the current tax system given the increased time it would require to utilize increased NOLs. Our key concerns are as follows:

  • Model 3: Launch curve a concern, operating margin dilutive at current cost, and reservation conversion may be hindered by higher selling prices. We believe the Model 3 will have a more subdued launch curve than the company is targeting as some suppliers have expressed concern around final designs not being locked down. As a result, we expect the company to achieve mass market volumes (i.e., above 100k annualized run-rate) in 4Q18 vs. Tesla’s target of 4Q17.
  • SolarCity business model unproven and acquisition comes at a pivotal point in Automotive product cycle. We believe the recent acquisition of SolarCity increased the risk profile of Tesla amidst a business model transition – from company-owned equipment installation and lease/PPA contracts to customer purchased equipment on cash/loan sales – and provides limited synergies. Ultimately, the acquisition raised the net leverage of Tesla while creating EBITDA and FCF drag that requires incremental non-recourse debt to be raised.
  • Capex ramping significantly, driving incremental capital raise: We forecast a significant increase in near-term capex levels required to bring both the Fremont, CA factory and TSLA’s gigafactory to scale. Overall this drives our forecast for $3bn of automotive capex in 2017 and FCF burn of $2.8bn in 2017. Ultimately we see another equity raise needed before 4Q17. This is further exacerbated by the addition of SolarCity, whose business would continue to be a FCF drag and requires an equal amount of sale of project level debt and tax equity financing to maintain cash balances.
  • Potential tax benefits significant, but would be recognized over a longer period of time – driving net present value lower. While we would expect TSLA to be a net beneficiary of potential US tax changes (i.e., scenario including destination-based tax with border adjustment as well as full capex expensing and elimination of net interest expense) and forecast its NOLs to grow under a potential tax change scenario, based on our model we find that the net present value of these higher NOLs is slightly worse than the status quo given a longer time period to achieve (the company is not currently a cash tax payer and a lower corporate tax rate would push out recognition of NOL benefits).
  • Estimates now include SolarCity; we are well below the Street: We update our 2017 through 2020 estimates following 4Q16 results and further layer on our SolarCity forecast. Overall, our EBITDA estimates fall by an average 12% (SolarCity inclusion, lower Automotive gross margin, pushed out Tesla Energy volume ramp) and are on average approx. 30% below the Street.

Goldman then explains "what would make us more positive?" andnoes the following:

We would become more positive on the stock if the company were able to demonstrate improved manufacturing execution by driving more rapid quarterly production growth in its current vehicle offerings than we model, demonstrate key milestones implying its Model 3 launch remains on track for mass volume in 2H17, drive down the cost of its battery packs faster than expected, demonstrate considerable market demand for the cross-selling between Tesla products and SolarCity products, and deploy capital more efficiently – driving reduced incremental capital requirements.

Unwilling to disappoint the Tesla fanatics, of which Goldman itself was a member until recently, the bank offers the following "quick word to the Tesla bulls"

We continue to view Tesla as a disruptor in the electric vehicle and alternative energy segments – with a clear lead relative to its peers with respect to vehicle technology adoption (increasing advanced driver assist features, revolutionary over-the-air update capabilities, infotainment capabilities, and general consumer-desired features), electric vehicle architecture, and (potentially) battery scale with the build-out  of its gigafactory. However, over time we do not see competitive barriers to entry (other than ease of raising capital and achievement of scale) that traditional OEMs, new entrants into the space, and other battery manufacturers could not duplicate. As a result while we do believe the company has at least one product cycle lead on its competitors, there ultimately could be a Samsung to this Apple (think smartphones), with incremental competition on the horizon as we have detailed in past reports. That being said, this is still an unprofitable Apple at present and pushing growth out and to the right would drive present value down. With that as a backdrop, we see valuation as appropriate at $185, and anticipate downside to shares as we progress through what we believe will be a choppy Model 3 launch that is slower than anticipated.

Some more valuation observations:

  • Share move opens entry point: Since 12/2/16, TSLA shares have risen 42% (vs. S&P500 +8% and Auto coverage average +9%) driven by a mixture of positive news flow (potential beneficiary from tax proposals, gigafactory investor tour, Model 3 pre-production). However, fundamental operations have not exhibited a material improvement and we estimate potential tax benefits are a wash looking at the net present value of NOLs generated.
  • Operational execution still unproven: We see room for shares to de-rate as the Model 3 production launch likely disappoints and as an unproven SolarCity business model likely weighs on the company’s focus/results.
  • Capex ramping, see capital raise in 3Q17: We forecast $3bn of automotive capex in 2017 and FCF burn of $2.8bn, necessitating a $1.7bn equity raise.
  • Valuation: Our 6-month price target becomes $185 (from $190), now adding SolarCity ($9) to Tesla Energy ($31 from $34 on slower ramp) and probability-weighted automotive segment ($145 from $156 on lower margins) valuations.
  • Key risks: Stronger Model S/Model X demand and/or production, positive free cash flow generation, and incremental new product announcements

Finally, and perhaps most amusing, is Goldman's rendition of what the bank calls Tesla's "hype cycle"

Trading the TSLA hype cycle: TSLA shares have mostly traded in a $180 to $280 range over the past couple years (Exhibit 1), and we again see room for downside toward the bottom of this band. Historically, (1) the stock takes an average 3 months to move significantly higher driven by “hype” around incremental product launches, new business lines, and delivery growth is priced in; (2) post these runs, TSLA takes approx. 7 months to de-rate as launches are pushed out, deliveries miss expectations, and gross margin percentage disappoints. This has occurred three times over the past three years. And as laid out above, we believe the drivers behind the most recent stock surge (beneficiary of potential tax changes, Model 3 launch/delivery timing, and gigafactory investor tour) are baking in benefits that will take longer to materialize and we expect the stock to de-rate as a result.