Tesla Reports 3Q2019 Net Profit – But Hold the Champagne

Perhaps not precisely every minute, but often enough to 

fulfill demand for "wise" investors

The market is abuzz with comments like “Tesla Shares Soar After Crushing Third Quarter Earnings” and “Tesla Wows Analysts with Quarterly Net Profit”.

So how excited is Abu Arqala?  Not much.

Has AA changed his view on Tesla?  No.

Why?

First, let’s look at Tesla’s 3Q2019 “performance”.

Reported GAAP net income is USD 143 million.

Sales of regulatory credits are USD 134 million.

That USD 134 million is 94% of the quarter’s net profit.   It has nothing to do with Tesla’s fundamental businesses making a profit.  Rather it is (another) gift from Uncle Sugar.  Corporate welfare.  See my earlier post.

Excluding that amount Tesla’s automobile and other businesses generated a “massive” net profit of USD 9 million in 3Q19.   AA is suitably un-wowed.

And of course there are likely to be other non-automotive regulatory credits sold, e.g., by Solar City.

On a simple proforma basis, that’s USD 36 million a year from the businesses.  An amount so large that in order to calculate it, AA had to employ both the supercomputer and electron microscope he used to calculate Saudi investment banking fees for an earlier post.  Saudi investment banking fees were much larger.

Net income for the first nine months is a loss of USD 967 million.  Excluding regulatory credit sales, the net loss is USD 1.428 billion.

AA thinks it’s interesting that regulatory credit sales were not mentioned in the breathless hype over Tesla’s “crushing” or “wowing” earnings. Are our financial journalists reading more than the press releases?  Do they understand the importance of regulatory credit sales to Tesla's business.  One (that would be AA) sure hopes so.

And a bonus link on an accounting change adopted in 2019 that makes Tesla look better on paper.

"Better" is a relative term -- as in USD 967 million in losses is "better" than USD 1.428 million.

Great Moments in Capitalism: Tesla – He Built It All by Himself or Did He?

"Daddy, read me the story about how the Power Ponies saved the Job Creators"

There are many stirring yarns of dogged entrepreneurs who by dint of their prodigious intellects, hard work, and business smarts built businesses all by themselves.  Giants of the business world.

Secular saints for our national—and dare I say international--religion:  Steve Jobs, Henry Ford, even according to some, Papa John.  Visionaries, pioneers, rugged self-reliant individuals.  The kind that disdain handouts.

According to these tales, more often than not these hardy individuals have had to struggle against the heavy “dead hand” of governments that seem more interested in crushing their visions than stepping out of the way to allow them to succeed.  Men like Hank Rearden.

In today’s installment, we look at but one slim chapter from the storied career of Elon Musk—visionary technology investor, entrepreneur, engineer, and product architect.  

An  immigrant to these shores and to Canada in more tolerant times, he’s built many businesses all by himself demonstrating, though no demonstration is really required, that a hard working smart individual can succeed on his own without government handouts.

But would you be surprised if I told you that Musk like many other of our secular saints had a silent partner who helped make his dreams reality?

An unsung hero.  One that AA will now reveal.

To set that stage some information from Tesla’s financials. They say that numbers never lie, though they rarely ascribe that virtue to all accountants.

TESLA REGULATORY CREDIT SALES (RCS)
Millions of US Dollars
Year	RCS	Net Loss	RCS/NL	NL-RCS
2009	$8	($557)	1.5%	($565)
2010	$3	($154)	1.8%	($157)
2011	$4	($254)	1.5%	($258)
2012	$41	($396)	10.2%	($437)
2013	$194	($74)	262.7%	($268)
2014	$216	($294)	73.6%	($510)
2015	$169	($889)	19.0%	($1,057)
2016	$302	($773)	39.1%	($1,075)
2017	$360	($2,241)	16.1%	($2,601)
2018	$419	($1,063)	39.4%	($1,481)
TOTAL	$1,716	($6,695)	25.6%	($8,411)

Regulatory Credit Sales are from Zero Emission Vehicle Credits (ZEV), Green House Gas (GHG), and since 2016 credits associated with Solar City.  You can read about it here on page 11 of Tesla’s 2018 Annual Report.  Data above is from that AR and earlier ARs.

Tesla has also indirectly benefited from the USD 7,500 tax rebate given purchasers of its cars by the Federal Government.  To be fair Tesla is not the only company that has benefited.  That tax rebate is not reflected above as it accrues to the purchasers not directly to Tesla.

However, without Uncle Sugar’s discount, Tesla cars would cost more and sales would be less.

Tesla has reached the 200,000 car sales milestone at which point the credit halves and then haves again this year.  Unless Tesla and other electronic vehicle manufacturers are successful in their efforts to “save the environment” by having a usually compassionate Congress extend the rebate program, an important support for sales will be lost.

At this moment prospects don’t appear good for the “Driving American Forward” Bill.  Senate Bill.  House Version.

Let’s assume that this noble effort falters.

Ignoring the reductions in 2019 in the rebate, and assuming that anyone who buys a Tesla has at least a USD 7,500 Federal tax bill, then Uncle Sugar has supported Tesla’s business to the tune of at least an additional USD 1.5 billion.  Or USD 3.2 billion in total.

Beyond that Tesla benefited from a US Government Guaranteed  USD 465 million loan under the ATVM program.  Tesla repaid the loan prior to its maturity.

Tesla also benefits from various state incentives.

There are a lot of Sugar Daddies out there for struggling corporations and the deserving rich who can afford to buy Tesla’s product.

With partners like these it’s hard to see how Tesla can fail, unless you look closely at the financials. 

Dana Gas - Potential Negative Effects from Proposed UD 350mm Pearl Petroleum Bond

Great White Whale or Great White Tiger -- AA Stays in the Hunt Until the End

This post is an “early warning” about a potential negative impact of the proposed USD 350 million new Pearl Petroleum bond on the creditworthiness of Dana Gas’s Nile Delta Sukuk.

As the italicized words in the previous sentence indicate, we won’t know the extent of the impact until the final terms of the proposed issue are published and the deal is placed.

Reuters reported that Pearl  in the market for a USD 350 million bond and has hired Bank of America Merrill Lynch and Morgan Stanley as “joint global co-ordinators and book runners” with  Shuaa Capital as a “co-manager”.

At this point, I’d note that the term “underwriter “ has not been used which may indicate this is a “best efforts” transaction – reasonable given the preliminary subzero (non-investment grade) credit rating.

More detail—though still preliminary--on the proposed issue can be found here in a Fitch Ratings press release on its preliminary rating for this transaction. Fitch has assigned preliminary  B - rating (non-investment grade) to the proposed issue, subject to satisfactory review of the final documents.

What are the implications for the unfortunate holders of the Nile Delta Sukuk?

First, as a matter of law, debt service payments on the new bond will have priority over Pearl dividends to shareholders.  Thus, reducing the amount of cashflow to Dana Gas.

How much?  The amount of reduction will depend on Deal Terms (final maturity, the principal amortization schedule--AA hopes this isn’t a bullet--, and the coupon) which are currently unknown.  As well, it will depend on underwriting standards applied.

Second, looking at the Fitch press release a couple of additional potential problems emerge.

The issue is a senior secured facility.

Two consequences.

Pearl’s assets are going to be pledged for the new bond.  While DG’s interest in Pearl isn’t pledged as security under the Nile Delta Sukuk, these assets do provide support for DG’s creditworthiness.

Fitch estimates that in the case of a going concern reorganization or sale of Pearl, the USD 350 million bondholders are likely to have a 50% recovery.  That means nothing for DG or the other Pearl shareholders in this case. If the company goes completely bust, then the USD 350 million bondholders will have the first “cup of pain”.  Pearl’s shareholders will be no worse off unless they have provided some support on the bond.

To put this into context as of FYE 2018, some 26% of DG’s reported assets were its share of Pearl’s assets.  And that USD 818 million “share” was  some 32% of equity.

Given Pearl's dismal rating, AA would hope (but is prepared to be disappointed) that the bondholders will place solid "protective" covenants on Pearl.  A key area would be controls on cashflow. That would directly affect DG.

On that topic Fitch notes that it expects dividends starting in 2020 to be lower than this year’s projected USD 550 million (DG share roughly USD 193 million), probably because that is included in the draft documents it has seen.

How much lower isn’t specified. Presumably that will be related to the Deal Terms.   Hopefully, this bond will not repeat the Sukuk’s unfortunate failure to relate dividends to cashflow.

Pearl is a significant contributor to DG’s cashflow.  Constraints on Pearl’s dividends paid will have an impact on DG’s ability to repay the sukuk.  Keep in mind that DG has use of cash when it receives dividends from Pearl.

Note that DG’s financials show DG’s share of Pearl’s cash and receivables.  But those amounts are not directly available to DG.  See Note 15 2018 Annual Report.

According to a very rough analysis of that Note, DG may be reporting as much as USD 100 million in its “Cash and Banks” that belongs to Pearl.  Money that DG cannot use until Pearl issues dividends.  See that analysis here part of an earlier post recently amended.

Sadly there is more.

If you'll read DG's 2Q2019 Investor Presentation, you'll see that DG is considering the strategic sale of its "fine" Egyptian assets.  Potentially good news for the Nile Delta Sukuk holders as these assets are pledged to them.

But for the shareholders probably not so good.

DG appears to think it's a good strategy to focus its "portfolio" on Pearl, essentially turning DG into a Kurdish investment. I trust I don't have to spell out the risks in that strategy.  .