by Jean-Louis Gassée

With Tesla’s Model 3, Elon Musk seems to have succeeded in making a killer Battery Electric Vehicle (BEV) and yet Wall Street visionary sheep keep braying.

Right after Tesla reported a $408 million loss for the quarter ending last June (Q2), its shares dropped by more than 13%, thus wiping out $6B of Tesla’s market capitalization, which now stands at $40.6B.

This is a puzzling reaction by investors speculators, and doesn’t shed the best of lights on the visionary sheep who make a living peddling guesses about a company’s next quarterly numbers.

First, the steep drop in Tesla Shares doesn’t seem to come from worsening losses — the $408M is much less than the $702M drop in the previous quarter — but from merely missing the numbers that the Wall Street touts were trading on. (Purists will object that both numbers are “everything included”, which means they incorporate “non-recurring” losses that, supposedly, don’t belong in the normal course of business… but there’s always something non-recurring at Tesla.)

Second and perhaps more importantly in the Street’s view, Q2 average revenue per vehicle decreased to $56.6K versus $58.7K in Q1. This was made more significant by a sharp (51%) increase in vehicle deliveries, from 63K cars in Q1 to more than 95K in Q2. Correspondingly, Tesla’s “Automotive Gross Margin” (as the company calls it) dropped from 20.3% to 18.9% on revenue that grew 46%, from $3.7B in Q1 to $5.4B in Q2. (All this from the company’s Q1 and Q2 SEC filings, always more reliable than Elon Musk’s Twitter feed.)

What the critics don’t seem to see is that the lower revenue per vehicle is good news.

At its unveiling in March 2016, the Model 3 was unequivocally presented as a lower cost vehicle aimed at reaching a much larger market segment than the expensive, $100K+ Models S and X. After the highly electric launch and thereafter during the painful process of debugging Model 3 manufacturing, Tesla was repeatedly criticized for selling its new “People’s EV” at a significantly higher price than the original $35K target, often way above $50K for a realistic configuration. This is no longer completely the case as the entry level model can now be had for $39K (“before savings”, Elon, please spare us the cheap car dealer BS…) and the more muscular version for $48K. It appears that the Model 3 is doing its job of attracting new/more customers.

How can that be bad if Tesla is someday to become not the exception it still is but a mainstream automaker?

“Yes, but…”, they say, “Because of cannibalization by the more popular Model 3, demand for the higher price S and X models is softening! Lease prices for Model S are sharply lower than they were three years ago, by about 30%!” (This is true, as a just concluded transaction for a family member attests.)

Such softening demand and discreet price moderation alarm the carnival barkers. One such barker even predicted that Tesla’s stock price will soon drop to $45/share — from this week’s $228! In that author’s opinion, Tesla is valued, wrongly, as a tech company while it actually is a car company with the attendant miseries of cyclicality and high capital expenditures.

What the 45$/share seer misses is that Tesla actually is a tech company. As discussed in a recent Monday Note, Tesla is software driven, pursuing a very Silicon Valley strategy of owning all the layers of the “stack”, from processors to driver-assistance code, giving it a strong medium term advantage over legacy automakers.

But our barker is right about one thing: Tesla’s Gross Margin is in automaker territory. At less than 19%, Tesla is “already there”, meaning the number is similar to GM’s 19%, Ford’s 13%, and Fiat Chrysler’s 13.5%. (These are numbers that make one wonder why Apple keeps hiring Tesla execs, but I digress.)

Contrary to what the pessimists say, Tesla’s survival is not at stake. Musk knows what every surviving entrepreneur knows: Cash is a fact, profit is an opinion. As long as you have cash to pay the bills you cannot avoid paying, you stay alive, you can make progress, create new products, get new customers, build more production capacity.

Profit (or loss) is a very elusive notion, less tangible than cash. In a given period of time, you make a profit when your net assets (what you own minus what you owe) increase. There are exquisitely delicate rules to measure the value of the things you own (how do you measure intellectual property?), how inventories age, how to prudently discount your debtors… You can be profitable because you sell gizmos at a very nice margin and yet go bankrupt because your customers don’t pay what they owe you. As you run short of cash, your creditors — and Uncle Sam — may have a way to force you to disgorge what you owe them and ultimately kill your business.

Let’s recall the early days of Amazon (without comparing Jeff Bezos to Musk) when there was much pearl clutching each time the company announced larger and larger losses at each reporting period. The company is dying! But no, its sales were growing fast; buyers paid right away while Amazon paid its suppliers on its own good time. The timing difference amounted to large amounts of cash that Amazon used to keep the company growing despite the accounting losses generated by its investments in its business.

Back to Tesla, it has about $5B in cash (minus approximately $500M or so for a note due next November). How this can be construed as bad news is a mystery to this former entrepreneur. Musk can keep growing the company and, perhaps soon, become self-funding, that is generate enough cash on a continuing basis, no longer needing to sell shares or raise debt.

But will the legacy automakers stand still as Tesla grows? In the all-important US market, I don’t see much room for competition, particularly from US automakers. It’s not that Ford, GM, or Fiat Chrysler are complete idiots and have no idea how to make a BEV, it’s that they don’t see a way to make money doing so. They look at Tesla’s cumulated losses, then they look at their own numbers and fear reactions from their shareholders.

Today, in the US at least, trucks keep automakers solvent. GM couldn’t sell trucks in Europe and, as a result, pawned off its European subsidiaries (Vauxhall and Opel) to Peugeot-Citroën. Ford drastically reduced its production of sedans, relying on its best-selling F-series of trucks (America’s best selling vehicle for the 42nd year!), and Fiat Chrysler makes no mystery of its need for an alliance.

European makers, German ones actually, are closer to competing with Tesla but they also don’t seem to see a way to make money with BEVs. (And, oddly, they keep losing CEOs — Mercedes, BMW and, earlier, Volkswagen.) They make announcements of expensive low-range vehicles but they can’t touch the Model 3, a car that Tesla claims is outselling all of its gas-powered equivalents combined in the US:

Same result in Europe where the Model 3 also dominates the mid-premium segment.

Still, Tesla’s situation isn’t entirely good news.

To start, one wonders which of Musk’s ambitious projects will experience the type of delay we’ve come to expect from Tesla. Will it be the opening of the Shanghai factory slated for the end of the year? Or its new battery factory, utilizing technology from its Maxwell acquisition, scheduled to open sometime next year? Or breaking ground for a factory in Europe, a region that’s much less friendly to manufacturers than is Silicon Valley?

Then there’s Musk himself with his hyperbolic announcements and prophesies. Musk keeps getting away with predictions of Full Self Driving (FSD) capabilities sometimes next year (my spouse didn’t buy that $6K option), with a vision of a resulting fleet of 1 million robot taxis by the end of 2020!

But what do you expect from a gifted entrepreneur who also launches rockets and wants to die on Mars “but not on impact”, sells solar energy devices, bores tunnels under congested city locations, and wants to wire our brains?

It’s a wonderful time to be alive and watch Elon Musk.

— JLG@mondaynote.com