Tesla Model 3 Lease Analysis

Tesla recently announced leases on the Model 3. My initial take on it was that it made no sense at all. After having a chance to talk it through in detail with @KlendathuCap, I can now see how they make some sense. Not a lot, but more than none.

Background Info

ABL Financing

Tesla’s Asset Backed Loan (ABL) has total available financing is $2.425B. This is a credit line administered by Deutsche Bank, but several banks have lent a slice of the total. Tesla gets to draw cash from the ABL in order to fund its operations.

The ABL is a secured loan, meaning that the outstanding amounts use specific Tesla assets as collateral. It Tesla defaults on the loan, the ABL lenders get paid by liquidating the assets backing the loan. The proceeds generated this way go to the ABL lenders first, before any bond holders.

If Telsa’s cash balance drops below 50% of the amount borrowed under the ABL, there are some nasty contingencies if they try to draw down the last 10% of the ABL total. For practical purposes, let’s call the ABL capacity $2.2B.

When Tesla builds a car and adds it to inventory, they get borrow cash from the ABL equal to 85% of the Net Orderly Liquidation Value (NOLV) of the car. I don’t know exactly what the NOLV is for a Model 3 (M3).

Tesla probably has quite a bit of leeway in setting that number, as long as DB signs off on it. Let’s assume it’s $50,000 for an M3—the ASP I calculated for March. That means they get to borrow $42,500 for each M3.

Cash Costs

As Mark B. Spiegel pointed out after the M3 SR announcement, Tesla announced a $1500 “cash profit” on the $35k car. That would mean a cash cost of $33,500 on the M3 SR.

Given that, we can scale up the average cash cost to $40,000 on our “average” M3 that retails for $50,000.

Double Financing

When Tesla builds a car, they buy the parts and materials on credit, increasing their Accounts Payable (AP) by the cash cost of the car.

That same car, though, can be used as collateral for ABL. (This works for steps along the way, like parts inventory and Work-In-Progress (WIP) inventory, since parts and materials are paid for using AP and eligible for the ABL—but let’s focus on completed cars because they’re worth the most).

This means that when Tesla first builds a car, they get to double finance it. The $40,000 cash cost gets put on AP to be paid later, and Tesla can borrow another $42,500 from the ABL (assuming they have the capacity).

Lease Terms

Looking at Tesla’s leasing calculator, leasing a $50,000 M3 with 15,000 miles / year for 3 years would have a monthly payment of $736 ($8,832 / year, $26,496 total). Let’s forget about residual values, and the fact that the lessee can’t buy the car, etc. right now.

If Tesla needs cash immediately, they can turn around sell the lease off in the form of an auto-lease bond, like they did with S/X leases back in December of 2018.

How much is $26,496 over 3 year worth?

The actual value will depend on a variety of factors, including the credit worthiness of the borrowers. But using a 10% discount rate, it’s worth $22,809.

Let’s call it $23,000. Add to that the $4,000 up front, and we can see Tesla earns $27,000 in cash when leasing a $50,000 M3.

Of cours, Tesla owns the car at the end of the term—but that doesn’t help them when they’re running out of cash today.

Cash Impact of the Lease

Tesla’s M3 leases ask for $3,000 - $4,700 upfront. Let’s call it $4,000—this is 10% the cash cost of the car. How can Tesla benefit from letting go of a car for only 10% of the amount spent to build it, when they’re already critically low on cash?

There are 2 scenarios to consider:

When the ABL has excess capacity When the ABL is maxed out

1. When the ABL has Excess Capacity

Let’s assume that Tesla has Net 90 terms on its AP (meaning all invoices have to paid within 90 days), and they’re current on all invoices. (Generous assumptions, both.)

For each M3 in inventory, Tesla benefits by $82,500 ($40,000 from AP; $42,500 from the ABL).

They then lease out a car, and immediately cost themselves $11,500 in cash.

They get $27,000 from the lease, but have to pay back the $38,500 borrowed from the ABL. They might get to float this for a little while, but within a month, that $38,500 is gone. Plus, they still have to pay the $40,000 invoices on their AP balance (this cash goes to reducing their negative working capital).

Obviously, if the ABL is not maxed out, leasing cars will only cause Tesla to go bankrupt faster. Instead, Tesla should make the car, borrow from the ABL, and pay down their AP balance. They end up transferring cash from their ABL lenders to their vendors and pocketing $2,500 in the process (and then can sell the car).

2. When the ABL is Maxed Out

Once the ABL is maxed out, things change. All cars in inventory in excess of the number needed to support the ABL borrowing cannot be double-financed.

Each car over the limit is only being financed by AP, yield a cash benefit of $40,000.

Since the lease only generates $27,000, Tesla will still sink $13,000 of cash into the deal. The difference, though, is that they were going to have to pay the $40,000 anyway, so at least they offset $27,000 of that.

If we were talking about another car maker, there would be a financing partner, who would pay Tesla most of the $50,000 upfront ($27,000 for the lease + $23,000 residual value of the car - some profit factor).

Tesla would guarantee the $23,000 residual value of the car in return for getting paid upfront. The financing parter would earn the return on capital for financing the lease. Everybody’s happy.

But everything points to Tesla not being able to get a financing partner, especially not after destroying the residual value of used cars by slashing prices on 2/28. Without a financing partner, Tesla has to float the residual value of the car themselves (the $13,000 difference between AP and lease value + $10,000 in profit).

For a cash strapped company, this only makes sense if you already have the cars made. You would never build a car to lease it like this. You’d only be accelerating your downfall.

Estimating Inventory

If the leases only make sense if you already have the cars made, how many cars must Tesla have in inventory?

Let’s assume:

$2.2B effective capacity of the ABL

$42,500 borrowable amount of each M3

40% of the ABL borrowing base is M3 inventory

That means that Tesla must have over 20,706 M3s to attempt this leasing tactic. Further, they should only try to lease the cars in excess of 20,706—so what do you think? 25,000 M3s in stock?

That would be 50% of the Q1 delivery volume. Q2 is likely to be lower, meaning Tesla has to stop the production line now. Even if the leases are successful at moving metal, each on costs them $13,000 in cash without a financing partner.

This is not a sustainable path forward, but rather a way to offload a sliver of their excess inventory.

What Does this Mean?

Given that the math of offering a lease without a leasing partner is so inferior to borrowing against the ABL, we can draw three pretty solid conclusions:

Tesla’s ABL must be maxed out Tesla must have more M3’s in stock than the ABL can support DB must have denied a request for an increase in the ABL line

Conclusion #3 is especially important. One of the risks to the short thesis is that DB et.al. continue to make more and more money available to Tesla via the ABL. However, we can see that—if Tesla indeed offering these leases without a partner—they must have exhausted every other option.

In March, when they were out of cash, Tesla requested an increase in the ABL on got a $500M increase. Musk would almost certainly ask for another increase before going down the “leases without a partner” path.

This is a big milestone on the path to bankruptcy.