One of Tesla's (NASDAQ:TSLA) biggest fans just cut his earnings estimates for the electric carmaker -- and unlike most Wall Street analyst notes, this one is a big deal.

In a note issued on May 15, Morgan Stanley analyst Adam Jonas, long one of the most ardent Tesla bulls on Wall Street, cut his price target for Tesla's shares from $376 to $291 and slashed his earnings estimates for the next three years.

If you've followed Tesla closely (or even not so closely), you know that Jonas has long been, shall we say, enthusiastic about Tesla's prospects. (Your humble author admits to having made light of Jonas' enthusiasm from time to time.)

But while he has been very optimistic about the potential for Tesla's technologies, Jonas is a smart analyst who knows the auto business well. If he's concerned about Tesla, then it's time for investors to be concerned. Here's what he said.

The big question: Will Tesla need more cash?

Here's the background: In its first-quarter letter to shareholders, Tesla said that it expects ongoing production problems with the Model 3 to be solved by midyear, getting production of the compact electric sedan to a sustainable pace of 5,000 per week. Once that happens, the company said, profits should follow:

If we execute according to our plans, we will at least achieve positive net income excluding non-cash stock based compensation in Q3 and Q4 and we expect to also achieve full GAAP profitability in each of these quarters. This is primarily based on our ability to reach Model 3 production volume of 5,000 units per week and to grow Model 3 gross margin from slightly negative in Q1 2018 to close to breakeven in Q2 and then to highly positive in Q3 and Q4.



CEO Elon Musk said that Tesla will be able to get to that milestone without having to raise additional cash. That assertion has been received with considerable skepticism: Quite a few analysts think that Tesla will have to raise at least $2 billion later this year to get the Model 3 to a sustainable high rate of production -- and to cover debt payments that will begin to come due later this year.

How Jonas sees the question

In his note today, Jonas framed his concerns around that debate:

The number one issue at the heart of the Tesla investment debate is whether the company is currently operating at a low level of utilization of a very large industrial complex, where incremental revenue can bring large incremental gross margins and improvement of cash consumption, or the next 50-100% of growth in revenue brings forth other calls on cash and does not materially move the company in the direction of a fully self-funding existence.

In a nutshell, here's the real question, as Jonas and his team (and many others) see it: Is Tesla finally about to kick its longtime addiction to outside cash, or not?

Jonas thinks not. He believes that Tesla will have to raise $3 billion in the third quarter of 2018, and that half of that will be used to pay down Tesla's debt. But he thinks there's a larger issue: He now believes that the long, trouble-plagued ramp-up of Model 3 production, and the changes Tesla has had to make to overcome manufacturing problems, will have the effect of lowering Tesla's margins on the Model 3, which were already likely to come under pressure from rising commodity costs and unfavorable foreign-exchange movements. Jonas writes (emphasis added):

It is our view that the challenges in ramping up Model 3 production reflect fundamental issues of vehicle design, manufacturing process, and automation levels that can weigh against the profitability of the vehicle. The company has acknowledged that it, to some extent, over-automated the Model 3 production process and is now reengineering accordingly. Movements in raw material prices and FX add further headwinds vs. our prior expectations. Tesla management believes the Model 3's margin performance below its 25% target level will be temporary, whereas we believe this headwind is more structural.

Simply put, the changes that Tesla has had to make to the Model 3 itself, and to its production line, have been expensive. Those costs, when amortized over the life cycle of the Model 3, will have the effect of squeezing Tesla's margins.

That will hit profits in the near term, Jonas forecasts. He had previously expected Tesla to get to profitability in 2019. He now sees Tesla posting full-year losses through 2020.

Metric 2018 2019 2020 Earnings (loss) per share, current forecast ($9.89) ($4.69) ($0.12) Earnings (loss) per share, prior forecast ($6.81) $1.31 $2.76

Data source: Morgan Stanley estimates.

Forecast: Tesla's margin will look ordinary

Tesla has long argued that it will -- eventually -- be able to earn fatter margins than its "legacy" rivals. That argument has rested on several assumptions around integration and automated manufacturing.

But as Jonas notes, the experience of the Model 3 production ramp, as well as rising commodity costs and foreign-exchange movements, has called those assumptions into question. His long-term forecast for Tesla's operating margin is now 9.8%, down from 14.3% previously. And in the not-quite-long term, the prediction is even more conservative: Jonas sees Tesla generating an operating margin of just 8.2% in 2025, on sales of just over 1.1 million vehicles.

For context, here are the operating margins and sales totals posted by several legacy automakers in 2017.

Automaker 2017 Operating Margin 2017 Vehicles Sold Market Cap BMW AG 10% 2,464,000 $71.1 billion Daimler AG 8.9% 3,274,000 $85.4 billion General Motors 6.9% 9,600,000 $51.8 billion Ford Motor Company 6.4% 6,607,000 $44.6 billion

Data sources: The automakers and Bloomberg. Results are for the year ended Dec. 31, 2017. Operating margins are earnings before interest and tax (EBIT) divided by revenue. Vehicle sales totals include trucks, but not motorcycles, and are rounded to the nearest thousand. Market cap is as of May 15, 2018.

Simply put, Jonas has lowered his expectation for Tesla's long-term profitability from "best in class" to "similar to BMW and Mercedes-Benz." (And, incidentally, similar to what GM and Ford have recently earned in North America.)

What does all this mean?

It's another sign that expectations for Tesla, which have been so lofty for so long, are starting to come back to Earth. Jonas' current expectation that Tesla will sell 1.1 million vehicles at an 8.2% operating margin in 2025, seven years from now, doesn't seem unreasonable (assuming that it gets through the Model 3 debacle, of course).

But it does raise big questions about Tesla's lofty valuation. If BMW, which sold almost 2.5 million vehicles at a 10% margin in 2017, is worth about $71.1 billion today, then what will Tesla be worth in 2025, with a lower margin and less than half the sales? And more to the point, what is it really worth today?

Jonas set his price target conservatively at $291. But it's hard to see an answer that isn't quite a bit lower.