There’s no sign that the trade war between the United States and China will be ending anytime soon. In fact, markets were broadly lower Wednesday due to the Trump administration planning yet more tariffs against China. Not surprisingly, this is a big deal for Tesla Inc (NASDAQ:TSLA). In the long-run, Tesla wants to sell a great many vehicles in the Chinese market. As such, the escalation of trade wars could be a major negative for TSLA stock.
Given that backdrop, it shouldn’t be too surprising that CEO Elon Musk made a big announcement on the China front this week. The company’s founder stated that Tesla will be making a major expansion there, with plans for a gigantic factory in Shanghai. As is so often the case with Tesla-related news, both bulls and bears are excited with this development. Let’s take a deeper dive into the story.
Tesla’s Asian Ambitions
Elon Musk was in China this week to announce the company’s next steps. Reportedly, Tesla has reached an agreement with the Chinese government to build a new plant in Shanghai that would double the company’s vehicle manufacturing capabilities. Tesla intends to start producing vehicles two years after construction begins, with the factory reaching full capacity of 500,000 vehicles a year two to three years after that.
This would give the Chinese plant the same manufacturing capacity, more or less, as is intended at its already-existent Fremont site. That said, the production ramp-up at Fremont has been problematic, so investors should take stated plans for China with a grain of salt.
Regardless, this is an interesting strategic move. It gets Tesla ahead of the curve as far as tariffs go, and is a necessary step if Tesla is to become a major international automobile company. Given California’s taxation environment, it would have been difficult for Tesla to manufacture all its vehicles there and compete successfully with other automakers that operate out of more business-friendly locations. China is certainly more economical for producing goods.
How Will They Pay For It?
Morgan Stanley’s Adam Jonas — who is generally about as bullish as anyone when it comes to Tesla — sees Tesla having short-term capital needs of almost $3 billion. He released that figure prior to Tesla’s announcement about China. Musk has repeatedly said that Tesla is about to become cash flow positive and will not need to raise more capital, but so far, reality has failed match up to expectations on that front. Given the company’s continued large losses and the difficulties of the Model 3 roll-out, it’s hard to imagine Tesla funding its operating cash flow needs, let alone building an enormous new Chinese facility, from current operations.
That means that Tesla is likely to need to raise more money in the near term. In theory, it could issue more bonds. In practice, that is likely to be difficult, since the price of Tesla’s last round of bonds has already eroded pretty heavily. The credit agencies also appear to be more skeptical of the company’s prospects.
Tesla could always issue more stock. The price of TSLA stock would likely go down with another secondary offering. Still, it’s probably easier for the company to dilute shareholders at today’s high stock price rather than selling more bonds.
The Most Bullish Scenario
Arguably, the best outcome for Tesla would be to find a major Chinese partner for the factory. This would solve several problems in one move.
For one, it would give Tesla the funds necessary for building the factory at reasonably attractive terms. I’m pretty sure that Musk would prefer not to have to tap American equity or credit markets right now, given all the bad press Tesla has been getting lately. Attracting a flagship investor from China would rebuild credibility in Tesla’s story while also clearing up its near-term cash shortfall.
Additionally, a local investor would help pave the way for Tesla to take share in the Chinese market. Foreign firms have often had a difficult time getting a handle on local market conditions and regulations. Given Tesla’s spotty record of execution in general, most folks would feel better knowing that Tesla had competent on-the-ground managers handling the red tape in the Chinese market.
For short sellers, Tesla finding a Chinese backer would be the nightmare scenario. Bears have become convinced that TSLA stock is about to plummet. The combination of Model 3 problems, Musk’s rants on social media, and the increasingly negative media coverage have short sellers thinking that Tesla’s stock price is about to crash. So far, however, Musk has always managed to figure out some way to keep the stock price elevated. Like other past publicity moves, a huge Chinese partnership would distract the market from the company’s shortcomings and reset the narrative for TSLA stock.
TSLA Stock Verdict
My outlook for Tesla stock hasn’t changed much in recent months. Despite the barrage of news, the facts remain as follows: Tesla is run by a brilliant, visionary leader who has demonstrated significantly less brilliance in running the day-to-day affairs of his company.
This makes TSLA stock almost uninvestable, either as a buyer or short seller.
As a long, TSLA stock is highly risky, given the company’s massive losses, and the high probability that losses will continue for many years to come. Tesla will need to raise more capital, contrary to Musk’s claims, and doing so could cause TSLA stock to plunge.
That said, Tesla stock is also an exceedingly difficult short sale proposition.
There are fundamentally two different groups involved in Tesla stock. The bulls see a brighter future, with clean sleek cars that help save the environment. They believe that over time, Musk can branch out, transforming energy, mass transit, and perhaps even space exploration. On his own, Musk is also great at keeping the company’s share price elevated through clever moves.
The bears ignore this vision, point to Musk’s track record of missed deadlines and say that the company is doomed to fail. If Tesla doesn’t improve its manufacturing process, quality control, and profit margins, this will eventually be true. But as long as Tesla stock is highly valued, the company will be able to raise more money. There’s no guarantee that Tesla stock will sink anytime soon. That leads me to a solid “avoid” call on TSLA stock.
Savvy traders can make money in TSLA stock, but for investors, the company is likely to produce headaches rather than profits.
At the time of this writing, the author held no position in TSLA stock.
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