In this week's Industry Focus: Energy, host Nick Sciple chats with analyst Jim Mueller about the latest in the never-ending press spectacle that is Tesla (NASDAQ: TSLA). First, an update on Tesla Insurance. The insurance site went live, and customers were told they might snag rates 20% to 30% lower than the competition. Where is Tesla Insurance getting those 20% to 30% lower numbers? That's unclear, and the website was abruptly closed for an "algorithm update."
The story that's been grabbing even more headlines, though, is the solar roofs at Walmart. Nick and Jim talk about why the SolarCity acquisition is turning out to be a big problem for Tesla, how that problem could get even worse in just a few months, where the roof fires fit into it all, and how Tesla could turn this around.
Stay tuned to the end for a ray of hope for the struggling carmaker.
A full transcript follows the video.
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This video was recorded on Aug. 29, 2019.
Nick Sciple: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. Today is Thursday, August 29th, and we're discussing Tesla, once again. I'm your host, Nick Sciple, and today I'm joined in studio by Motley Fool analyst Jim Mueller. How's it going, Jim?
Jim Mueller: Hey, Nick! How are you?
Sciple: I'm doing great! It's been a while since we've had you in the studio, Jim. How has life been?
Mueller: It's been well. It's been pretty good. Enjoying the weather here at the end of August, which is a strange thing to say in the D.C. area, but it's actually nice out today.
Sciple: Yeah. Labor Day weekend. I'm heading down to Atlanta for a kickoff college football. Very excited. Last time I had you on the show was a little bit under a year ago. We were talking about the U.S.-China trade war. We were talking about tariffs. We're talking about, when we get into 2019, maybe this will slack off. Any updates on what's going on there, Jim?
Mueller: Yeah, no such luck on the slack off there. It's going fast and furious. The effects are actually beginning to be felt now by U.S. companies and will likely be felt by consumers soon. For instance, Deere lowered the guidance -- the maker of the big farm equipment -- because farmers are not buying the equipment because they're not being able to sell a lot of their crops to China. Qualcomm lowered their guidance recently, as well, because they're a chip supplier into China, where they use the chips to manufacture all kinds of consumer electronics. Importers are dealing with the tariffs in many different ways. They're not raising wages. They're actually passing on prices to consumers. For example, Walmart recently said they're going to have to raise the prices of the stuff they sell in their stores, just in time for Christmas. That's going to make it painful for American consumers. And then, the whole shifting supply chains thing. President Trump urged American businesses to get out of China recently. Companies are already trying to, but after decades of building up China as the manufacturer of the world, and the web that involves the suppliers to the manufacturers and the suppliers to the suppliers, it's not easy to make shifts away from China and find, hopefully, as inexpensive manufacturing, but then, the support infrastructure is not there. It's just a hot mess right now.
Sciple: Yeah. I think literally and figuratively, you could say there are a lot of moving parts here. A lot of things to navigate. It's been tough for folks. Not even [just] in the U.S. Germany has talked about slowing auto markets in China as a result of this. It's hurt their economy. A lot of trickle down issues. Hopefully, it gets resolved. But we're not that different from where we've been a year ago when we were talking about this.
We are talking about Tesla today. The main topic we're going to talk about today is Tesla Solar, which has really been in the news a lot recently. But we did get some more Tesla news last night, which has been interesting. Tesla Insurance launched in California last night. We've been waiting for that product launch since it was first mentioned by Elon Musk and Tesla back in May. It finally launched last night in California. However, three hours later, the product was pulled down for an algorithm update. I checked Tesla's website today -- that's still ongoing. Obviously, things are continuing to play out. But just high-level thoughts on this rollout and what's been going on so far?
Mueller: I don't know what Tesla's experience is in insurance. Are they the ones pricing the insurance? Or do they have another company pricing the insurance for them, and Tesla's just being the front man? It's not really clear, at least not to me. One thing that does concern me is an item that says that Tesla owners will be able to get rates 20%, maybe even 30% cheaper than they could at other insurers. That makes me wonder whether Tesla or the underwriter actually has enough data to justify a lower price like that. Insurance rates are set by data, both by how much it costs to repair the cars, how often the cars get into accidents and have to be totaled, yada yada on that line, as well as the driver him or herself, how often they get into accidents or make claims, and so on. Is there enough data for any underwriter at this point to say, "Hey, we're going to give you a 20% lower rate because you deserve it and because the data backs us up?" And it's that "data backs us up" part that I'm not too sure about in this situation.
Sciple: Yeah. Obviously, still a developing story. They're doing this algorithm update. We'll see how those rates materialize. But something to watch going forward.
The main topic I want to talk about today, though, is Tesla Solar. In the past week, it's been all over the news. SolarCity, since the 2016 acquisition by Tesla for $6.5 billion, the solar business has flown under the radar. The solar roof has been a lot in the news. Musk will periodically surface and say, "Hey, we're about to ramp up the solar roof." But solar has really been brought front and center in recent days following a spate of legal filings and some associated articles. Can you just introduce us to those, Jim, at a high level?
Mueller: The big legal filing that probably hit the news most surprisingly is Walmart filing suit recently, saying that it was, what, 140 roofs that they had?
Sciple: It was over 200 roofs, seven that had fire issues.
Mueller: Seven had fires over the last couple of years, and they could, they felt reasonably secure that they could trace that back to the solar panels that SolarCity had installed. The claim was that SolarCity employees -- that is, Tesla employees -- were not inspecting the roofs on a regular schedule, were not maintaining them as they were required to, and therefore, Walmart believes that Tesla Solar was in breach of contract. And basically, I think they want the solar panels removed, and Walmart reimbursed for the expenses of having to close down the stores, the loss of inventory, the damage, the repairs, and all that stuff.
Sciple: Yeah. This is a dispute that, if you read through the legal filings, has been ongoing going back [to] 2018 and earlier, but finally reached the point where Walmart filed a lawsuit. Obviously, it's a legal filing, but some very aggressive language in there. I think "utter incompetence" were the words they'd used. So obviously, this affected the company.
And then, over the top again, this week on Sunday, we got Bethany McLean, very famous for outing the Enron scandal, coming into this Tesla story, publishing an article in Vanity Fair titled "He's Full of [S**t]: How Elon Musk Fooled Investors, Bilked Taxpayers, and Gambled Tesla to Save SolarCity." Jim, just another high level, what is McLean talking about in this article?
Mueller: What she's talking about there is that Elon Musk forced through the purchase of SolarCity by Tesla. She's basing her article on reporting by the Buffalo News, especially David Robinson, in that the bailout was basically misleading investors and shareholders who had to vote to approve it. Even though Musk and the Reeve brothers and Kimbal, I believe, all recused themselves from the vote, everyone knew what these guys wanted to happen, so there was pressure for that. There was a big presentation, which launched the idea of the solar roof, and Musk presenting what appeared to be solar roofs already installed on some buildings. Turned out to be just a mockup, installed on the set of, what was it, Desperate Housewives?
Sciple: Yeah. It was the backlot.
Mueller: Backlot film, used in Desperate Housewives. And this was going to be the saving grace of SolarCity. It was going to cause a bunch of cash flow into Tesla, which would be great for the company, and instead has led to all kinds of problems, including debt issues, debt repayments, declining sales of solar panels by SolarCity, halting of their marketing themselves, and going out to the house and doing the inspection themselves. Now, the homeowner is supposed to take pictures and send it to SolarCity to have the product figured out. It's just been going downhill, and it has the potential to really cause some serious problems for Tesla, unfortunately.
Sciple: Sure. The other issue that you mentioned there, as well, is that the business, when they had first acquired the factory, received $750 million in financing from New York State. At the time, Tesla had planned to build 10,000 solar panels per day, create thousands of jobs in Buffalo. As a condition of that funding from New York State. SolarCity, which became part of Tesla, later got a 10-year lease on the property in Buffalo for $1 a year, was tasked with: employing 1,460 high-tech jobs at the factory, another 2,000 in support and sales installation folks, another 1,440 jobs in the state, and pledged to spend $5 billion in New York State over the next decade. However, as Jim mentioned, we've seen installations decline, and they haven't quite hit those job numbers yet.
Mueller: Even the employee numbers. Tesla itself said there were only a few hundred employees in the state and only a fraction of those in Buffalo itself. Then we have Elon Musk coming out and saying, "Hey, we're ramping up production of the solar roof." I don't know if he actually said they expect to make 1,000 a week by the end of this year, whether that was an expectation or a hope or whatever, but with only a few hundred employees at this plant in Buffalo, it really doesn't seem as if the company's even going to be able to make that target even if it is making solar roofs today, which is in doubt itself, unfortunately.
Sciple: Yeah. Just to back up, with the SolarCity acquisition, Tesla had acquired a business that had two-thirds of the residential solar market in the U.S. They claimed that it would add more than $500 million dollars to Tesla's balance sheet over the next three years. In reality, what has materialized is that it has drastically increased Tesla's debt position, their market share has declined meaningfully down to 7% of the U.S. residential solar market, their installations have declined about 85% since that date. So as a result, what is Tesla left with after this transaction today?
Mueller: Tesla's left with a business that seems to be in decline and disappearing, actually. Tesla Solar only installed 29 megawatts of panels in the second quarter of this year. That's down from 200 megawatts installed just two years prior in the second quarter of 2016. With the solar roofs not really out there yet, I don't know where SolarCity is going to be able to generate any sort of revenue or cash flow for the company. What that leaves Tesla and Tesla shareholders saddled with is a bunch of debt that Tesla also bought when they bought SolarCity. One of the pieces is coming due on November 1st. It's a $556 million convertible bond. The bond holders have the choice on November 1st of either converting their bonds into shares of Tesla or receiving their cash investment back plus any unpaid interest. Given that the conversion prices are in the $500 to $700 range of Tesla, and where Tesla shares are trading today -- in the low $200 range -- no holder in their right mind of any of those bonds is going to say, "OK, I don't want my cash. You can keep the cash. Just give me shares of Tesla when I'm asking for something that's worth a third less than what I gave you." So Tesla's going to have to come up with $556 million plus a little bit of interest and pay that off. If they don't -- and this is an unfortunate consequence of the purchase of SolarCity -- if they don't pay that when it comes due in two months, that can have serious consequences.
If they miss that payment, then other bonds that they have out -- for instance, there's a convertible bond due in March of 2022 that says, "If you fail to pay off any other mortgage or bond or borrowing worth $150 million or more, then our bond is going to be declared to be in default, and we have the right to accelerate the payment." And that particular bond, on June 30th, had a balance of $977 million. So if Tesla fails to pay that $556 million, then all of a sudden, they could be asked to pay another $977 million, and then the other bondholders -- there's just this whole cascade effect that could happen if Tesla fails to pay this.
Now, is Tesla going to let that happen? I don't think so. They have to be aware of the covenants of the bonds they've issued. So unless they've already spent -- what did they have, $5 billion in cash on the balance sheet?
Sciple: As of June 31st.
Mueller: As of June 30th. There's no June 31st. [laughs]
Sciple: [laughs] I'm not here for my calendar skills.
Mueller: [laughs] Right. So if they've already spent a good chunk of that money elsewhere, such as paying back suppliers money that they owed their suppliers for the car business, or if they cannot somehow negotiate with the bondholders coming due and move the bond down the road, delaying payback like they've done with another bond several times, then if worst comes to worst, the cascading effect of multiple bonds coming due and there's no cash to pay it back could potentially lead to Tesla's bankruptcy. It would be a terrible thing for the shareholders and, I believe, for the world in general. Let's face it, Elon Musk has done a lot to get electric cars into the forefront of society's mind and to the big car manufacturers. VW is supposed to go all electric by 2025, something like that. BMW, Jaguar, GM, Toyota, everybody you can name is now making electric cars, and I don't think that tide is going to reverse. It'd be a real shame if Tesla was not there to enjoy the fruits of their labor.
Sciple: Yeah. Whether that's going to happen, I don't know. The takeaway here, I think, from this whole SolarCity acquisition, is you had a transaction where shareholders were promised --
Mueller: One thing.
Sciple: -- were promised that they'd have a company that could make lower-than-market-rate solar panels that would have a dominant market share, that would continue growth into the future, and would meaningfully contribute to the company's bottom line going forward as part of its master plan. What has materialized is a declining operating business, a large amount of debt that has saddled the company with a number of complicated issues. Now, you have to allocate cash that otherwise should be going to capex [capital expenditures] to build your new cars, all those sorts of things, needs to go to servicing this debt, as well. And then, to bring this back to the Walmart issue, and Amazon issue, as well --
Mueller: We didn't mention that one. Amazon also reported a fire on a roof of theirs that had SolarCity panels on it.
Sciple: Yeah. This story, on a number of levels, has also had a negative effect on Tesla. You have a perception issue when you have a very strongly worded negative lawsuit coming out from a major retailer like Walmart. As well, you have some amount of uncertain liability if this roof issue goes to other residential installations across the country. We've seen some follow-up reporting from Bloomberg on that.
Mueller: And how much will it cost Tesla to settle with Walmart? And how much did it cost to settle with Amazon? And how much will it cost to settle with all those homeowners? And on and on and on.
Sciple: It's a bag of worms that has really created a lot of issues for the company. We will say, Tesla has continued to tout the solar roof as something that is going to shift the narrative around the business. Again, customer trust has been impacted, as well. It's been a while since we've seen this come out. What are your thoughts on the prospects of the solar roof to turn the solar business around for Tesla?
Mueller: If they can do it, and if the product meets the high bar that Musk set for it -- cheaper than a regular roof, longer lasting than a regular roof, and that's not even counting the electricity the roof is going to generate for you -- if they can do that, then that could indeed turn the situation around. There are several questions. One, does that solar roof actually exist? Or is it engineering drawings still on paper and not in production? Two, how soon can they get those out? Three, how rapidly can they ramp it up, given the other constraints on their cash and their cash flow? And four, are they too late to the market? I mean, SolarCity has declined as a big player in the solar panel market. Are customers willing to come back to them and try a brand-new product that hasn't been tested, that's not even out there yet, and might not come to the promises that have been given so far?
Sciple: And has publicly caused a lot of fires?
Mueller: Well, the roof hasn't.
Sciple: True, true. It's to be determined. A lot of things with Tesla, there's always this promise out in the future, whether it's full self-driving or the solar roof or the Chinese factory. We'll see how things materialize. I will say that the solar roof has been promised since October of 2016 when the SolarCity merger was beginning to happen. We're today, in August of 2019. Likewise, self-driving was promised around that same time and has not materialized. Those things are the sorts of levers that, if Tesla can pull them [off], all these question marks arguably could go away. But lots of things to navigate. It's a tough time to be navigating these issues if you're management at Tesla today.
Alright, Jim, any positive thoughts going into Labor Day weekend? What are your plans?
Mueller: Well, there was some positive news for Tesla, actually. Moody's, the bond rating agency, had some good news for Tesla. They affirmed the bond ratings they had for Tesla's current bonds. That means they didn't make it worse. They improved what's called the speculative grade liquidity level, which is a rating of the risk that a company that will not be able to meet its short-term liabilities. That's a definition I'm reading off The Free Dictionary. Level from four to three, four being the worst, one being the best, most liquid. So four to three. That's an improvement. They also changed the outlook on the company from negative to stable. That's a big thing for a company when it has to negotiate new debt or roll debt out or what have you. Having a stable outlook from one of the major bond rating agencies is good news for Tesla.
Sciple: Yeah. We just had Elon Musk speak in China last night with Jack Ma, so we do have the China factory, also positive news coming down the line for Tesla. There's been some rumors that they're going to reveal that first vehicle they've produced at that factory. That'll be exciting to see. But lots to follow with this company in the future. It's always in the news, Jim.
Mueller: That it is. That's what makes being a shareholder exciting, I guess.
Sciple: It's a rollercoaster ride, for sure. Thanks for coming on, Jim, as always!
Mueller: Thanks for having me!
Sciple: As always, people on the program may have positions in the companies discussed on the show, and The Motley Fool may have formal recommendations for or against the stocks discussed, so don't buy or sell anything based solely on what you hear. Thanks to Austin Morgan for his work behind the glass! For Jim Mueller, I'm Nick Sciple. Thanks for listening and Fool on!
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Jim Mueller, CFA owns shares of Amazon and has the following options: long January 2020 $1370 calls on Amazon, short January 2020 $1380 calls on Amazon, short January 2021 $200 calls on Tesla, long January 2021 $200 puts on Tesla, short January 2021 $230 calls on Tesla, long January 2021 $230 puts on Tesla, short January 2021 $240 puts on Tesla, and long January 2021 $270 puts on Tesla. Nick Sciple has the following options: long January 2020 $50 puts on Tesla, long January 2020 $100 puts on Tesla, long January 2021 $100 puts on Tesla, and long January 2021 $50 puts on Tesla. The Motley Fool owns shares of and recommends Amazon, Moody's, and Tesla. The Motley Fool owns shares of Qualcomm. The Motley Fool has a disclosure policy.