Tesla – Symptoms of poor governance pile up

Tesla Logo.png

US Tech stocks were my first love in my investing journey. That said, I’ve never felt compelled to jump on the Tesla (NASDAQ: TSLA) bandwagon. I initially didn’t bother because I hated the car manufacturing business. Slowly as the years went by, I saw Tesla as a company that at best was not operating to its fullest potential, at worst was a dysfunctional managerial mess.

With the recent public controversies over CEO Elon Musk’s tweets over a potential privatisation of Tesla and his emotional stress, I thought I’ll run through some of the symptoms that kept me away from buying into the Tesla story.

Symptom 1: Consistent inability to hit internal production targets

Tesla has faced manufacturing delays and struggles since they started making Model 3s, their entry model. The magic number currently thrown around by Musk for the longest time was 5,000 Model 3s a week. This was consistently missed until early July 2018 when they finally hit it, but not without having to put up temporary tents to assemble the cars. This landmark was celebrated with tweets of employee photos.

Is it worth celebrating though? For comparison, Toyota manufactured 13,400 cars per day in Japan back in 2014.  That’s about 94,000 cars a week, way outpacing Tesla in 2018.

Symptom 2: The Solarcity Acquisition

Tesla acquired Solarcity, a company Elon Musk co-founded with his cousins, in a cool USD2.6 billion all stock deal in late 2016. Setting aside all the conflict of interest issues with such a deal, the justification of such a deal goes against financial logic. A company with known cash flow issues going out and acquiring another with negative cash flows in a commoditising business boggles the mind. There may be strategic reasons for such a acquisition, but at face value, Solarcity was not a good fit for Tesla.

Symptom 3: Starting to fund the company through debt

In September 2017, Tesla issued bonds to fund its working capital needs instead of using equity as it had always previously done. For people who understand corporate finance, this is a pretty boneheaded move for 2 reasons:

1) There is no tax advantage

One advantage debt has over equity is that interest expenses are deductible against income, reducing the amount of taxable income. That said, it is only an advantage if Tesla was profitable and had income to be taxed. The last I checked, this was not the case.

2) Easy access to equity capital

Given the personality cult surrounding Elon Musk, it should be easy for Tesla to raise equity capital. It will dilute Musk’s share of the company yes, but a small percentage of a valuable company is still worth more than a significant percentage of a defaulted company.

If control was such a concern, I’m sure Musk can find solace in his god-like status among investors and a weak board which he easily controls.

What is going on?

The key problem with Tesla is the failure to adhere to good corporate governance principles arising from having a revolutionary CEO like Elon Musk.

Maverick genius, but poor operator

Having such a brilliant and strong minded CEO like Musk has been simultaneously Tesla’s greatest strength and weakness. On the one hand, it has produced some of the sexiest cars one can buy as well as some pretty sweet tech. On the other, you have a CEO with an immense ego and a predisposition to micro manage. All this is fine if the CEO is able to execute well. Tesla’s struggles with manufacturing indicate otherwise.

Not being able to manage well is common for tech company founders. Founders, like Amazon’s Jeff Bezos and Google’s Larry Page & Sergey Brin, struggled operationally at different points in their company’s life cycle. What is more important is recognising that weakness and hiring suitable people to manage those areas, something Musk’s ego and absolute need to micro manage (I’m speculating here) currently prevents him from recognising / doing. The fact that Tesla does not have a Chief Operating Officer to share the burden with Musk indicates this.

Rubber stamp board of directors

In a case where management is misfiring on all cylinders, the Board of Directors has to step in to make the tough decisions to right the ship. Unfortunately, a look at the board composition shows why the Board is potentially rubber stamps Musk’s decisions:

  1. Elon Musk – Chairman and CEO
  2. Kimbal Musk – Brother of Elon Musk and significant shareholder
  3. Brad W. Buss – Long time board member (since 2009) and ex-employee
  4. Ira Ehrenpreis – Venture Capitalist and SpaceX investor
  5. Antonio J Gracias – Venture Capitalist and SpaceX investor
  6. Steve Jurvetson – Venture Capitalist and SpaceX investor
  7. Robyn M. Dunholm – COO of Telstra (Australia telco)
  8. James Murdoch – CEO of 21st Century Fox
  9. Linda Johnson Rice – CEO of Johnson Publishing Company

Firstly, nobody really jumps out as a famous name other than James Murdoch who might combat Musk. Secondly, Musk is both Chairman of the Board and CEO, which is a huge concentration of power sitting in one person. Thirdly, about 2/3 of the board is kind of friendly to Elon Musk (The first 6 names on the list), who might be less challenging to his decisions. Lastly, there is little to no technology or car manufacturing brain trust on the board, leading to potential difficulty in offering constructive advice to Musk.

Dysfunctional finance function

Symptom 2 and 3 is indicative of a CFO who is either doesn’t know what he’s doing or doesn’t have the power or strength to push back on potentially financially disastrous moves. CFO Deepak Ahuja has been with the company since 2009, with a hiatus between 2015 to 2017 due to retirement. His deep historical ties with Tesla and the fact he came out of retirement to “save the company” may indicate a close relationship with Musk.

What Next?

A company with the best and most revolutionary tech in the world can fail with poor execution. Tesla is tethering on the brink, but it is currently not irretrievable.

The immediate change that I feel Musk and the Board should consider is hiring a capable COO, someone with car manufacturing experience preferably. This allows him to delegate day to day operations to somebody so that he can concentrate on the areas he is good at, like design and being the big picture thinker. This also helps with succession planning.

The board should re-look at board composition to include more truly independent directors, preferably till at least a 50-50 ratio. This will allow the board to truly be able to function properly and challenge managerial decisions.

Lastly, Musk should learn to delegate and let go more. Given his disinterest in answering investment analyst questions, let CFO Deepak answer and manage them. Also, forget about the short sellers. The best way to get back at short sellers is to manage your company well and defy their expectations, and not to break false stock price moving news over Twitter.

Only when these moves and a substantial drop in share price (my personal reference price is $180) happen will I then start considering Tesla as a investment again.

Happy Hunting,
KK

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