Tesla’s $1.8 Billion Insurance Policy

This note was originally published as an op-ed last week iFortune. Details around Tesla’s debt raise have been updated.  

If only traditional auto and other tech companies were as bold as Tesla. It’s betting itself on the Model 3 moonshot, but de-risking the bet by taking out an insurance policy in the form of selling $1.8 billion in debt at 5.3% yield, greater than the targeted $1.5 billion raise at 5.25%.

It’s important to understand that Tesla does not need the $1.8 billion in debt to ramp Model 3 production. The company can fund the nearly $2 billion manufacturing investment out of its $3 billion cash balance. But Tesla is raising money because it’s critical it has an insurance policy if the Model 3 ramp hits any unexpected issues. Things are going well right now, and raising the money will be much easier than it would be in the future if Tesla faced unexpected issues. If Tesla doesn’t fund for the unexpected, CEO Elon Musk may lose the company.

To illustrate what’s at stake, let’s imagine that Tesla does not raise money today, and a year from now, something unforeseen comes up: a supplier goes under, a recall happens, or there is an earthquake, and the company needs an additional $1 billion to fix the problem. Investors will likely get spooked and pass on the offering at Tesla’s time of need. Then the dominos would begin to fall. Model 3 production would not scale, sales targets would be missed, and the company would likely run out of cash. Tesla’s assets would quickly get scooped up by Apple, Google, or any traditional automakers eager to get their hands on Tesla’s engineers and robotic manufacturing systems. Musk would likely be out, and the army of employees with a shared mission would be leaderless. This measurable risk of default is one of the reasons why Tesla’s bond raise is, by definition, a junk bond.

Debt makes sense and is cheaper. This is Tesla’s first debt deal, which begs the question: Why use debt? Most tech companies use equity, mainly because they don’t have the option to use debt, given their lack of hard assets that debt investors demand. Tesla is a tech company that makes a product through industrial assets that should be financed through debt; doing so optimizes its capital structure. The debt was priced at 5.3%, and is 2.5 times cheaper than equity. Separately, the rank-and-file Tesla employees we talk to believe shares of Tesla are undervalued, and that the company will be much bigger 10 years from now. You can call it a view of the future or blind optimism, but we call it a shared mission.

Coming back for more money. Tesla will need to raise more money in the future. It’s a tech company with industrial assets growing 50% to 100% per year. We expect the company to raise more money to build a new production facility in 2020, as well as Gigafactories 3,4, and 5. Tesla raises money in stages because it needs to grow capital and assets at a consistent, efficient pace. If Tesla grows its capital (cash) base faster than its asset base, it’s not cost efficient. On the other hand, If Tesla grows its asset base faster than its capital base, it risks running out of cash.

Tesla can fund debt service as long as investors believe in the story. Adding the $1.8 billion debt raise at 5.3% to our model, Tesla’s 2018 loss increases to $1.16 billion from $1.06 billion in our pre debt model. While the company doesn’t have the cash flow to service the debt, we expect investors to stand behind the story and service the debt until 2020, when we expect Tesla to start making money.

Don’t confuse the term “junk bond” with the quality of the company and magnitude of the opportunity in front of Tesla. If successful in ramping the Model 3, Tesla’s sales will rise from $7 billion in 2016 to $22 billion in 2018, at which point a middle-income family will be able to afford an electric (and eventually autonomous) vehicle. Revenue from Model 3 will fund Model Y (expected in 2019), Tesla Semi (our best guess is 2022), and, most importantly, the master plan of accelerating the world’s transition to renewable energy.

Disclaimer: We actively write about the themes in which we invest: artificial intelligence, robotics, virtual reality, and augmented reality. From time to time, we will write about companies that are in our portfolio. Content on this site including opinions on specific themes in technology, market estimates, and estimates and commentary regarding publicly traded or private companies is not intended for use in making investment decisions. We hold no obligation to update any of our projections. We express no warranties about any estimates or opinions we make.

Posted in Tesla  • 

Mcity Expert Weighs In On Autonomous Driving

“People tend to overestimate the amount of change that can happen in the near-term, and understate it in the long-term.” Huei Peng, Director of Mcity

Last week we made a trip to Ann Arbor, Michigan to hear more about Mcity. Mcity is a public-private partnership that focuses on the research, development, and deployment of connected and automated vehicles.  It runs the Mcity Test Facility, a 32-acre proving ground for advanced mobility vehicles and technologies, which opened in 2015 at the University of Michigan.  The Mcity Test Facility has eight connected intersections, a traffic control center, cameras, radars, and a small fleet of its own fully-automated driverless vehicles. The public-private partnership is comprised of more than 65 industry members including: BMW, Ford, GM, Honda, Toyota, Intel, Qualcomm, and State Farm.  It also leverages many government funded projects, from the U.S. Department of Transportation, and the U.S. Department of Energy.

Mock city approach. While there are other paved test facilities used for connected and autonomous vehicle testing, Mcity is the first purpose-built mock city in the United States designed specifically for autonomous driving research.  We see this mock city approach as an important avenue to advance autonomy. It’s important to note that WayMo and Uber’s projects in Phoenix and Pittsburgh are testing largely on public roads.  Testing in a controlled environment such as the Mcity Test Facility has many benefits: the tests are safer, cheaper, faster, and repeatable.

Importance of DSRC. One focus at Mcity is dedicated short-range communications, or DSRC. DSRC is designed specifically for automotive safety applications, and enables vehicle-to-vehicle or vehicle-to-infrastructure communications with an effective range of 1000 feet.  DSRC, like other wireless communications, does not need line-of-sight visibility to detect potential safety threats, such as an unseen vehicle ahead stopping suddenly in a snowstorm. DSRC can essentially serve as another sensor, providing useful vehicle and traffic information to support autonomous driving. We’re surprised to hear that many traditional auto manufactures believe DSRC makes cars safer, but WayMo and Tesla are not taking advantage of its benefits.

When will we have self-driving cars? Heading into our visit, we wanted to get a read for when consumers will be able to purchase a fully autonomous vehicle in the United States. Peng cautioned that while autonomous vehicles are ready for some niche and limited applications, anytime, anywhere driverless vehicles may take longer than we think, commenting that “developing a car that is 90% safe is relatively easy, 99% safe is harder, and the remaining 1% will take a very long time.” While Peng stopped short of predicting a roll out year, our sense is that 2025 will be the year when some autonomous vehicles are on par with, or better than, average human drivers in most driving conditions. It is clear that a lot needs to happen between now and the time we reach full autonomy. Peng illustrated this in an analogy that today self-driving cars are in the relatively early stages of development, much like planes before the airline industry invested a tremendous amount of time testing new technologies as it moved to fully automated planes like the fly-by-wire Boeing 777.   Getting to that level of readiness is necessary for autonomous driving to reach mainstream use, and will require much more evaluation and testing.

We took our findings from Mcity and applied it timing of Tesla autonomy, AI and auto, and quality of miles driven data. It’s important to note that the insights below are attributed to Loup Ventures.

We’re believers in Tesla, despite the fact we think they’ll miss their autonomy launch target. We expect Tesla to miss their 2019 autonomy launch target, and see 2022 as more realistic roll out year. Elon Musk has been clear that he expects each Tesla made today to be autonomous in 2019. What’s not clear about the 2019 target is what level of autonomy will be reached. At the recent Model 3 hand-off event, Musk made a reference to sleeping in your vehicle as an acceptable activity in autonomy, suggesting their 2019 goal is to reach the Level 4 or Level 5. Getting to Level 5 is a light year leap from Level 4. Level 4 autonomy is where no driver is needed, but the vehicle’s speed, range, and weather conditions (snow is a material problem) are limited. Level 2 autonomy is available today in some production cars as advanced driver assistance. It’s important to note, Tesla’s approach is evolutionary, moving Autopilot to Advanced Autopilot, and finally to self-driving. This is different than WayMo’s revolutionary approach of entering the market with a Level 4 or 5 autonomous vehicle.

AI’s fit. When we think about AI being better than humans, we think of cases where machines have defeated humans, like in chess or video games. These examples are in a world with a finite number of choices. On the other hand, driving in the real world has an infinite number of choices. WayMo, Uber, and Tesla are at an advantage when it comes to tackling these infinite choices, given that they’ve already logged significant miles to feed their respective self-driving neural networks. We believe the miles driven gap will be hard for new self-driving players to close. Because the problem is so complex, the neural network will need to learn from hundreds of billions of miles (today we are sub 2 billion miles). Also, consider that a car can only drive on roads that its trained on, so a U.S. autonomous car can’t drive in China.

Quality of data. While it’s true AI with more miles is better than fewer miles, it’s important to understand the distinctions between data captured by each player. We believe Waymo’s 3 million miles have saved most if not all of the critical data, and we have questions regarding how much data is stored and shared back from Tesla’s owners. Most Tesla data is discarded, since a Wi-Fi connection once a week doesn’t have enough bandwidth to share all of the data.

We left our visit to Mcity with a better sense of how traditional auto and tech companies are approaching autonomy. In addition, we reached a few new insights about the timing question, including the fact that the timing question is less relevant. We think back to Peng’s flight analogy, and believe we’re underestimating the significance of change autonomous vehicles will bring to the world.

Disclaimer: We actively write about the themes in which we invest: artificial intelligence, robotics, virtual reality, and augmented reality. From time to time, we will write about companies that are in our portfolio. Content on this site including opinions on specific themes in technology, market estimates, and estimates and commentary regarding publicly traded or private companies is not intended for use in making investment decisions. We hold no obligation to update any of our projections. We express no warranties about any estimates or opinions we make.

Tesla: Short Term vs. Long Term

People tend to overestimate what happens in short-term, and underestimate what happens in the long-term. We believe that notion will define the Tesla story over the next six years. We caution that it will take time for the Tesla story to unfold, and that there will be disappointments along the way, but Tesla’s Jun-17 quarter results and outlook around production and demand suggest the company is on a track to be a significant beneficiary in the global paradigm shift to EV and autonomy, all while producing affordable vehicles. Traditional auto is in a tight spot, dogged by legacy engineering (both on vehicles and manufacturing), and high labor costs. Tesla’s biggest challenge is ramping production, and, to a lesser extent, the threat of other tech companies (WayMo, Baidu, Apple).

Key Takeaways From The Quarter. Tesla maintained its outlook around key expectations including Model 3 production ramp, cap ex spend and profitability. The company also achieved slightly higher gross margins in Jun-17 than expected. In addition, there was commentary that in the past 5 days, they have not seen cannibalization of Models S and Model X from Model 3.  Instead, there has been an increase in both Model S and Model X orders, plus an uptick in Model 3 reservations to an average of 1,800 per day. Tesla clarified that there are 455k net reservations for Model 3, and that the “greater than 500k” reservations comment Musk made last Friday was 518k gross reservations.

3 Additional Gigafactories Are Coming. On the call, Musk mentioned that there are plans for Gigafactories 3, 4 and 5. One of these will likely be in the US, one in Europe, and one in China. We believe it will take 3-6 years to build these additional factories. This is significant for Tesla, as other automakers need to build factories at a similar scale and have yet to even break ground on their version of a Gigafactory. This underscores the structural lead Tesla is slowly building over traditional auto manufacturers as it relates to EV battery production.

Brace for Future Disappointments. As we’ve mentioned, this will take longer and be bigger than most people think. Our belief that it will take longer implies that there will be disappointments along the way. Here’s our best guess at the top 6 disappointments over the next two years: 1) Tesla may need to raise more money. 2) Tesla may miss on production targets by a quarter or two. 3) Full autonomy may come as late as 2021, not in 2019. 4) There may be a need for another factory to grow annual production above ~600k vehicles. 5) Demand may be negatively impacted when US tax incentives are reduced in 2019. 6) We’ll continue to see competitive announcements from other auto manufacturers and tech companies. While these disappointments will fuel controversy around the story, we believe they do not change the long-term potential of Tesla.

Tesla’s stealth advantage. Not captured in the quarterly results is something much bigger: Tesla stakeholders are on a shared mission to change the world. Tesla’s stakeholders include employees (all of which are shareholders, from the management team to the custodians), Tesla owners, shareholders, and suppliers.

Changes to our Model:

2017 Unit Shipments Adjustments

  • Vehicle delivery estimates increased from 101K to 105K.
  • Adjustment is due to higher Model S and X unit delivery assumptions based on positive comments on the call.

2018 Unit Shipments Adjustments

  • Vehicle delivery estimates increased 308K to 316K.
  • Adjustment is due to higher Model S and X unit delivery assumptions based on positive comments on the call.
  • Previously modeling 4% Y/Y decline in Model S and X unit growth, but changed to flat growth.

2017 Revenues, Margins, EPS Adjustments

  • Revenues increased from $11.2B to $11.8B; driven by higher model S and X unit deliveries.
  • Gross margins decreased from 23.4% to 22.7% due to lack of scale efficiencies related to Model 3 ramp.
  • EPS lowered from ($6.77) to ($7.06) due to lower gross margins.

2018 Revenues, Margins and EPS Adjustments

  • Revenues increased from $20.4B to $21.4B, driven by higher model S and X unit shipments.
  • Gross margins increased from 23.3% to 23.6% due to faster than expected scale efficiencies with model 3 ramp. We believe they can hit 25% gross margins in 4Q18, although it could be earlier.
  • EPS goes up from ($6.76) to ($5.93) due to slightly better gross margins.

Disclaimer: We actively write about the themes in which we invest: artificial intelligence, robotics, virtual reality, and augmented reality. From time to time, we will write about companies that are in our portfolio. Content on this site including opinions on specific themes in technology, market estimates, and estimates and commentary regarding publicly traded or private companies is not intended for use in making investment decisions. We hold no obligation to update any of our projections. We express no warranties about any estimates or opinions we make.

Tesla’s Stealth Advantage: Shared Mission

There’s been a lot written about the Model 3 and little more I can add about the car, but I’d like to share something I noticed at my first Tesla event last week: the incredible power of a shared mission.

Tesla’s Fremont factory is one of the world’s largest buildings, so it was no surprise that the Model 3 hand-off event was a 5 minute shuttle ride from where the guests first assembled. Twelve people rode in my shuttle, of which four earned their ticket to the event through their participation in the Tesla Referral Program, where Tesla owners receive credit towards their next Tesla purchase by referring a customer. In case you’re wondering, the other seven people were suppliers. The shuttle worked its way around the back of the factory past what seemed like an endless line of people wrapping around the building. My group wondered aloud where all the people had come from. We got dropped off on a black carpet next to a staging area for a ride in a Model S on the test track.

At 7:30PM, an hour-and-a-half before Elon Musk would take the stage, I took two Model S test rides with Spyglass Capital fund manager Jim Robillard, and talked to a wide range of Palo Alto-based Tesla employees. I started each conversation by asking, “What’s on your mind?” Each employee lit up, detailing their contribution to the Model 3, and why they believe it will change the world. Investors I spoke to were not concerned about the central bear case on the Tesla story, that the company will never make money and run out of cash. Instead, they talked about the importance of EV, Tesla’s head start in battery production, and Tesla’s mission to accelerate the world’s transition to sustainable energy.

At 8:45PM, the event kicked off with Project Loveday finalists, named after Bria Loveday, the 11-year-old who suggested to Musk that Tesla should host a user-generated commercial competition. The quality of the commercials was impressive, requiring a ton of effort given the modest grand prize of an on-stage introduction at a future Tesla event.

At 9:00PM, Musk took the stage in front of 6,000 vocal fans – all employees. The long lines my shuttle bus had passed on the way to the event was Tesla’s manufacturing muscle waiting to get into the event. The crowd’s energy suggested the rank and file share the same passion about Tesla as the optimistic Palo Alto-based employees I had talked to earlier in the evening. The main screen briefly switched to a live feed from Gigafactory 1 in Sparks, NV. Same thing: a huge crowd of hand waving employees.

During my trip home from the event I realized that I had gone to meet a car; instead, I met a group of Tesla stakeholders on a shared mission to change the world.

As an analyst, I’ve always evaluated companies based on unit forecasts, product road maps, competition, profitability, and management teams. As a venture capitalist, I’ve added to that list culture and the level of shared mission. During my trip home from the event I realized that I had gone to meet a car; instead, I met a group of Tesla stakeholders on a shared mission to change the world. Tesla’s stakeholders include employees (all of which are shareholders from the management team to the custodians), Tesla owners, shareholders, Project Loveday participants, suppliers, and even an 11-year-old fan from Michigan.

I was reminded of the famous anecdote about President John F. Kennedy. During a visit to the NASA space center in 1962, President Kennedy noticed a custodian at work. He walked over to the man and said, “Hi, I’m Jack Kennedy. What are you doing?” “Well, Mr. President,” the custodian responded, “I’m helping put a man on the moon.”

Tesla has this same stealth advantage: a shared mission at a scale greater than I’ve seen in my 20 years in tech.

Disclaimer: We actively write about the themes in which we invest: artificial intelligence, robotics, virtual reality, and augmented reality. From time to time, we will write about companies that are in our portfolio. Content on this site including opinions on specific themes in technology, market estimates, and estimates and commentary regarding publicly traded or private companies is not intended for use in making investment decisions. We hold no obligation to update any of our projections. We express no warranties about any estimates or opinions we make.

Model 3 Hand-Off Event: Our Top 10 Questions Answered

We continue to believe the Model 3 will be the most important catalyst to the world’s adoption of EV and autonomous driving. And we expect it to play a big role in commercializing and consumerizing AI and robotics technologies. Heading into the Model 3 hand-off event, we had 10 key questions, of which 5 were answered as expected, 4 were favorable to our expectations, and 1 was a disappointment. Here they are, along with our take, listed in terms of importance:

Preorders: As expected. Demand for Model 3 is strong despite under selling. On Friday, Tesla announced there are over 500k preorders for the Model 3, up from 373,000 reservations placed six weeks after the vehicle’s preview in March of 2016. Over 500k preorders is in line with our expectations (see our note dated 7/5/17). While in line with expectations, the number is impressive given that there has been little to no Model 3 advertising. In addition, Tesla has been “anti-selling” the Model 3, and hasn’t even had vehicles available to test drive until Friday night.

Production Ramp: As expected. The production ramp will take longer than most people think. We are expecting about 6k Model 3 deliveries in 2017. Musk made it clear that it will be difficult to ramp production commenting, “we will be in production hell for at least 6 months, maybe longer”. Musk cited the Model 3’s 10k unique parts from around the world. Tesla may have difficulties keeping these parts flowing into the production line. We believe the assembly line itself is another obvious manufacturing hurdle. Based on observations at the hand-off event, we think it will be November before the Model 3 assembly line is even in place, and it will take several months after that for the kinks to be worked out.

Our Delivery Assumptions: As expected. It’s going to take longer to ramp deliveries, but this story will be bigger than most think. Our delivery estimates are unchanged. We’re expecting about 6k Model 3 deliveries in Dec-17, 308k in 2018, 373k in 2020. Our breakout year for the company is 2023 when we have deliveries of 1.6m, up from 980k in 2020.

Our ASP Assumptions: Favorable. While we believe there will be higher ASP’s, our delivery expectations remain unchanged. We’re raising our ASP assumption until the end of 2018 to $50,000, up from $44,000, because we believe there will be greater interest in the long-range model (+$9,000) and Enhanced Autopilot (+$5,000).

Cannibalization: Favorable.  The Model 3 is the best car in the world for its money, but it’s no Model S. After test driving both the Model 3 and the Model S, it’s clear these are very different cars. Similarly, we view the target consumer for the Model S as a different consumer than the Model 3. However, our TSLA model still assumes dramatic cannibalization of Model S from Model 3, with Model S deliveries going from 49k in 2018 to 27k in 2023. We’re leaving the model unchanged to be conservative.

Cost of Enhanced Autopilot: Disappointment. We did not expect Enhanced Autopilot to be a $5,000 feature, which causes us to speculate about whether or not there will be an up charge in a few years for full autonomy. Every Model 3 will have the hardware (8 cameras, 1 radar sensor, 12 ultrasonic sensors, 10 teraflops of computing power from Nvidia’s Drive PX2 platform) for Enhanced Autopilot today and will enable full autonomy, likely in 2-3 years. We were surprised the company is charging $5,000 to activate the Enhanced Autopilot feature today. This begs the question: Will the company charge to unlock full autonomy? Enhanced Autopilot features include traffic speed matching, changing lanes, merging on and off highways, and parking. The summon feature will be extended to more complex environments, like a busy parking lot. According to TechCrunch, the self-driving feature will cost consumers an extra $3k.

Full Autonomy: As expected. Every Tesla made today has the hardware to be upgraded to fully autonomous driving, which will likely be available in a few years. Unfortunately, lawmakers, not technology, will be the hold-up. The message from Tesla is clear: Autonomy will be here sooner than you think. Musk’s comments at the hand-off event where consistent with past comments, “Cars will be increasingly autonomous. You won’t need to look at an instrument panel all that often . . . You will be able to watch a movie, go to sleep. Every Tesla being produced now has all of the hardware necessary for full autonomy. . . it’s got 8 cameras, 12 ultrasonic sonars, it’s got the forward radar and it’s got over 10 teraflops of computing power.” It’s worth noting that a time frame for autonomy was not given. In the past, the company has suggested it would be achievable with a software upgrade sometime in 2019 or 2020.

Range: Favorable. Long range battery version breaks the 300-mile barrier. Standard battery is $35,000 and has a range of 220 miles; 0 to 60 mph: 5.6 seconds. Long range battery is $44,000 and has a range of 310 miles; 0 to 60 mph: 5.1 seconds.

Design & Performance: Favorable & As Expected. Consumers are going to love the design and the interior of the Model 3: a minimalist interior, single panel landscape display, glass roof, no grill with all smooth surfaces. As for the ride, our short test ride was more of a teaser than an actual test ride. There is a gap in ride performance between the Model 3 and the Model S, which should be expected given Model 3 will cost about 40-60% less than a typical Model S. That being said, car buyers in the $30-50k range will be more than pleased with the Model 3 ride. Elon Musk tweeted following the event that their will be a performance version of the Model 3 in the middle of 2018.

Safety: As expected. Expected to have 5-star rating. Video at event illustrated Model 3 is safer than 5-star rated Volvo S60.

Disclaimer: We actively write about the themes in which we invest: artificial intelligence, robotics, virtual reality, and augmented reality. From time to time, we will write about companies that are in our portfolio. Content on this site including opinions on specific themes in technology, market estimates, and estimates and commentary regarding publicly traded or private companies is not intended for use in making investment decisions. We hold no obligation to update any of our projections. We express no warranties about any estimates or opinions we make.