Question

Questopn: Earlier this week, Elon Musk proposed that Tesla may go private. What would this mean for the company's cash flows?

Article:

Tesla Doubles Loss, but Burns Less Cash Than Expected

Electric-car maker finished the second quarter with $2.2 billion in cash

By Tim Higgins

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Tesla Inc. TSLA -4.83%▲ reassured investors it would achieve a profit later this year, as a rush of Model 3 sales in the second quarter helped the electric-car maker burn less cash than expected.

The results, which sent Tesla’s shares soaring in after-hours trading Wednesday, should give Chief Executive Elon Musk some wiggle room to prove that a continued production rate of more than 5,000 Model 3s a week during the third quarter can make the auto maker cash-flow positive and profitable. He made that promise earlier this year and reiterated it Wednesday in a letter to shareholders, though many analysts doubt it can be kept.

Tesla more than doubled its loss from last year’s second quarter to $717.5 million, its seventh consecutive quarterly loss during an period intensely focused on ramping up production of the Model 3. Tesla reached the long-delayed goal of making 5,000 Model 3 sedans in a single week during the final days of June. Now the test is whether it can sustain that production to generate necessary cash and eventually prove it is no longer a niche luxury brand but one capable of building millions of cars a year.

“It took 15 years to execute on our initial goal to produce an affordable, long-range electric vehicle that can also be highly profitable,” Mr. Musk wrote in Wednesday’s shareholder letter. “In the second half of 2018, we expect, for the first time in our history, to become both sustainably profitable and cash flow positive.”

Later on a call with analysts, Mr. Musk said he expects Tesla will record a profit in all subsequent quarters—except perhaps if the economy collapses or the company pays back a big loan, he said.

If Mr. Musk begins to fulfill that promise, he could calm investors and analysts concerned by Tesla’s dwindling cash pile. Mr. Musk has bristled at the idea of raising more cash, and on Wednesday told analysts he doesn’t plan to issue new equity.

Instead, Mr. Musk said he plans to focus on paying down the company’s debt—not refinancing it. He expects a new factory proposed for Shanghai will cost $2 billion and will be financed with debt in China.

“Are we running low on money? The answer is no,” Mr. Musk said on the call. His tone of the call differed greatly from the prior quarter when he sparred with analysts, sending shares plummeting. Mr. Musk apologized to those analysts on the call Wednesday and generally sounded upbeat—if tired.

Tesla finished the second quarter with $2.2 billion of cash. Its negative free cash flow of about $740 million was lower than what a consensus of analysts expected. The company previously said it needed to keep a minimum cash balance of $1 billion, and several analysts had said Tesla would need to raise more money.

The quarterly report, and Mr. Musk’s subsequent comments, sent Tesla’s shares up nearly 9% to $327.70 in after-hours trading on Wednesday. The shares were down more than 3% this year ahead of Tesla’s quarterly report.

“I was expecting more cash burn, possibly even a severe one because there were a lot of production costs at the end of the quarter to meet the 5,000/week target but many of those vehicles likely were not delivered until Q3,” David Whiston, an analyst for Morningstar Research Services, wrote.

Mr. Musk remains optimistic that Tesla can make 1 million vehicles in 2020, though he expressed new caution saying it “seems pretty likely” the company will make 700,000 to 800,000 that year. He said Tesla’s Fremont, Calif., assembly plant and Nevada battery factory should be able to produce about 600,000 a year plus 100,000 to 200,000 at the new Shanghai facility, which is supposed to begin production that year.

The company had previously said it would begin China production in 2020 while in Tesla’s shareholder letter the company said the first cars would roll off the line in about three years, which would put it at 2021.

Tesla reiterated it expects to produce 6,000 Model 3s sedans in a week by late August. The company said it plans to build 50,000 to 55,000 of the sedans during the third quarter and that it remains on target to make a total of 100,000 Model S sedans and Model X sport-utility vehicles for the year.

Mr. Musk has sought to cut costs in the pursuit of profitability. The company slashed 9% of its workforce in June, and Mr. Musk promised a management reorganization after his engineering chief stepped aside.

The company on Wednesday cut back further on planned capital expenditures as part of a strategy to focus building out its existing infrastructure for making the Model 3. It now plans to spend less than $2.5 billion this year, lower than a $3 billion projection in May, which itself was down from the $3.4 billion previously announced and spent last year.

Revenue during the second quarter rose 44% to $4 billion. Tesla said last month that total vehicle deliveries reached 40,740, a dramatic increase from more than 22,000 vehicles a year earlier thanks to increased production of the Model 3 sedan. Tesla sold about 18,440 Model 3s during the period.

Earlier in the day, Mr. Musk had a little fun with a prominent short seller. David Einhorn, the president of hedge fund Greenlight Capital, criticized Tesla and its CEO in a letter to investors Tuesday and wrote that he “is happy that his Model S lease ended” and was “happy to switch to an electric Jaguar.”

Mr. Musk wrote on Twitter: “Tragic. Will send Einhorn a box of short shorts to comfort him through this difficult time.”

Answer 1

The company’s decision to go private will put a further strain on the company’s cash flow situation. The proposal announced by Elon Musk says that the amount for buyback will be $420 per share and this puts a valuation of $71 billion on the company.

We know that the company already has negative cash flows. The financing of the buyback will be done through debt and this will put a further strain on the already negative cash flow situation of the company. Besides the buyback the company will need cash for its significant expansion plans. Positive cash flows provide lenders with a reasonable reassurance of repayment. The fact that Tesla is a money-losing car company and has not recorded an annual profit since its IPO in the year 2010 will mean that the cash flow situation for the company will further deteriorate. This is because the company will need substantial cash to service its debt by having to pay annual interest amounts to lenders and this will mean that the cash flow from operations and free cash flow of the company will further worsen and remain in the negative territory till the debt is paid off.