Tesla’s Cash-Strapped Shanghai Plant Construction Is Hurtling Forward—What Could Go Wrong?
Tesla’s Cash-Strapped Shanghai Plant Construction Is Hurtling Forward—What Could Go Wrong?
Why Investors Should Be Concerned At How Fast Tesla Is Throwing Up Its New Assembly Plant In Shanghai
Tesla (TSLA) has finally received its "first comprehensive acceptance certificate" from inspectors of its hurriedly constructed assembly plant going up in Shanghai. The certificate was awarded just three days following its application, setting "a new inspection and approval timing record for the local government."
Such haste is not encouraging, coming just as waves of troubling news over the past week have highlighted serious consequences of Tesla's chronically poor manufacturing and service, from blowing a sizable order from a major customer over inexcusable flaws and defects in newly delivered cars to getting hit with a lawsuit from Walmart (WMT US) claiming fires in rooftop solar panel installations caused by Tesla's "gross negligence" and "utter incompetence or callousness, or both” (see my report with updates Tesla: Not At Your Service on 8/19/19).
Investors should be concerned. Few companies seem to generate more colossal risks and unintended consequences to employees, suppliers, customers, and investors than Tesla when it's under pressure—and in a hurry.
No Time To Waste!
The Shanghai assembly plant has been problematic from the start (see Tesla - Shanghai Surprise). I was concerned when Tesla broke ground on the plant in January even though it couldn't afford to finish the project without significant debt-funded additional cash. This was a huge risk, I had warned, given "Tesla's persistently weak financial condition, its seriously depleted liquidity, its inability to provide sufficient collateral, and its long track record of poor execution made the company a poor credit risk for Chinese lenders. Starting construction on the plant anyway severely weakened its bargaining leverage."
As I expected, it took months for Tesla to finally secure even limited financing from local Chinese banks. "Then the wary bankers only agreed to [just over] $500 million in short-term, limited purpose financing, barely enough to get the factory up and running—much less versus the more than $2 billion it will cost to build out the factory even to half its projected 500,000 car annual capacity (although indications suggest demand may be far lower by the time the factory is completed)" ("Tesla: Now We Know the Y But Not the How).
My concerns were just confirmed by our colleague JL Warren Capital who recently learned that Tesla's cash available for the project is indeed "tight" as I expected. So tight that it has been demanding drastic discounts of 30-40% from potential local suppliers, terms they have been unwilling to accept.
No surprise there, as I warned in Tesla Q219 10-Q Notes and Big Red Flags, given its history as a "notably petulant manufacturer already known to pay suppliers late or not at all." But time is running out since Tesla's key suppliers also will need time to ramp up to meet ambitious production targets just months away. So far it appears Tesla has only signed up one battery supplier, LG Chem Ltd (051910 KS), as of last week.
Moreover, it seems that Tesla was lucky, as I suspected, even to get the loan at all—which means getting additional funding could be even tougher. JL Warren Capital learned Tesla's loan finally was approved because of a "political mandate" which trumped the financial risk assessment process resulting from normal loan underwriting. JL Warren Capital warned,
"If Tesla China becomes delinquent/bankrupt, SOE OEM(s) could take over the G3 [Gigafactory 3 plant] for its automated production lines. For example, Saic Motor Corp Ltd A (600104 CH) has a factory that makes Roewe in the area. It could potentially take over the distressed factory if TESLA does not sell enough cars to pay back the loans. The SAIC Roewe factory in the area has been closed for the past two months due to low demand" (see "Takeaways From Exclusive Interview with Local Government Re TSLA Shanghai Factory").
So Tesla is throwing up this assembly plant at a breakneck pace on a shoestring budget funded by wary bankers already planning contingencies if it defaults, not helped by precarious local demand trends.
What else can go wrong? Plenty, according to Feng Shiming, executive director of Menutor Consulting Shanghai, who told the Global Times, "the factory's construction pace is too fast, which is set to leave some problems such as insufficient equipment testing and staff training."
These are exactly the problems Tesla long has exhibited across the board with all its endeavors, as we were reminded again last week with the hot mess that has erupted from its years of shoddy rooftop solar installations that have caused fires. Such risks are compounded, I have warned, by Tesla's egregiously poor management oversight and accountability—a bad mix within the less regulated environment for the Shanghai plant.
Sure enough, the plant is hurtling toward completion in less than half of previous record building time of 17 months, thanks to generous cooperation by local regulators. The Global Times reported the "Lingang government on July 11 set up a special group to hasten the inspection progress of the Gigafactory's construction projects, in order to meet its target of "finishing inspection when the construction is done." The Shanghai Municipal Government also just announced "30 new measures" to further "relax restrictions" and help smooth the way for "transnational corporations to establish headquarters there."
Wheels thus conveniently greased, "Tesla's electric car Gigafactory in Shanghai received its first comprehensive acceptance certificate on Monday, within three days of making an application, which sets a new inspection and approval timing record for the local government."
Super.
Right on cue, pictures purported to be recently taken inside the plant were conveniently leaked to Electrek today:
Electrek excitedly reported that the images show "Model 3 Production Setup Tests" with "Model 3 bodies going through an empty production line, which appears to be dry runs to set up production and assembly stations."
Possibly, but where are all the people conducting these tests? Where are people doing any work anywhere in the vast space shown? Where did the Model 3 bodies come from?
It seems just as likely the pictures may have been staged to give the impression of such progress. Indeed, JL Warren Capital learned that as of very recently utilities at the plant "had yet to be installed."
The Show Must Go On!
After last week's public relations nightmares, Tesla is due for a happy diversion. I suspect this may be behind news now trickling out that promotes incredible progress at the Shanghai plant.
And what better way to bring this home than have a showy presentation from Elon Musk himself—in Shanghai.
As it so happens, Tesla said Musk plans to "attend the World Artificial Intelligence Conference 2019 in Shanghai on August 29."
Suspected countdown to some "amazing" announcement about the Shanghai plant: three days.
If so, Tesla probably hopes investors will be so dazzled they overlook such troubling issues as:
Tesla is raising prices in China again this week, sooner than it planned, on the US/China trade war currency impact. This comes as deliveries there already have been faltering as potential Chinese buyers have become irritated with the carmaker's erratic pricing strategies, not to mention slowing economic momentum.
Speaking of demand, we're just days away from learning whether delivery trends continued to sag in August as I suspect following soft July numbers. US delivery estimates may be posted near the 1st of September and China estimates may appear in two weeks. Signs already are materializing that Europe trends were weak.
Two straight months of disappointing deliveries will create even more pressure than usual for Tesla to meet its ambitious sales targets via its typical push for a huge final month in the quarter compared with stronger comps last year. Recall I have forecast that Tesla may fall short of projected 90,000-100,000 deliveries this quarter, and it really needs to average 101,000-121,000 the last two quarters to hit guidance of 360,000-400,000 for the year—which seems unlikely (see Tesla Q2 Results: Diminishing Returns).
We might hear any day about new regulatory probes triggered by the bombshell news out last week on Tesla's faulty rooftop solar installations which appeared to be fairly widespread and also unsuccessfully shielded by the company's quiet yearlong efforts via its "Project Titan" to fix potentially dangerous problems it refused to admit existed.
Tesla's bumpy ride is far from over.
TSLA 5.3% Senior Notes due 2025 are down slightly since my last report at 87.9 (7.9% ytw; 645 bps). That’s a measly 81 bps of spread per turn of estimated leverage by yearend 2019, woefully inadequate compensation for a volatile triple "C" rated issuer with such precarious prospects. Given Tesla's persistent uncertainty and escalating risks, we see 3-5 points of downside pressure from here. Maintain Underperform."
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