Understanding Tesla's Need For Fresh Funding As Model 3 Launch Approaches

Tesla's Take On Recent Financing Round

The company's release said the proceeds, estimated at $1.15 billion through the concurrent offering of common stock and convertible senior notes due in 2022, is meant to be used for three purposes:

1. To strengthen its balance sheet.
2. To reduce any risk associated with the rapidly scaling of its business due to the launch of its mass-market Model 3 vehicle.
3. For general corporate purposes.

Before looking into what really necessitated the offering, let's take a look at how financially viable Tesla's business is.

Most Recent Financial Report Card

Tesla reported for 2016 revenues of $7 billion, up 73 percent from 2015. The revenue growth reflected a 63 percent increase in automotive revenues, achieved on the back of a 55 percent increase in vehicle deliveries to 50,700.

Why Is Model 3 Production Cash Draining?

Cost of revenues as a percentage of revenues was 77.14 percent in 2016 compared to about 91 percent in the year before. Operating expenses accounted for roughly 32 percent of the revenues. R&D expenses accounted for 11.9 percent of the revenues in 2016, down from 17.7 percent in 2015.

Consequently, Tesla reported a loss of $674.91 million or $4.68 per share in 2016 compared to a loss of $888.66 million or $6.93 per share in 2015.

Cash and cash equivalents at the end of the year stood at $3.39 billion, including $2.2 billion in money market funds.

In its 10-K for the fiscal year ended December 2016, the company said its current sources of liquidity and cash flows are used to fund:

• R&D expenses.
• Ongoing operations.
• Initial investments in tooling and manufacturing capital for its Model 3.
• Continued construction of Gigafactory.
• Expansion of its retail store, service centers and Supercharger network.

In the 10-K, the company also revealed that it expects to invest between $2 billion and $2.5 billion ahead of the start of Model 3 production in 2017.

The company also expects total vehicle production of 500,000 in 2018, double that of its original plan.

Tesla had a negative operating cash flow of $123.829 million in 2016, narrower than the outflow of $524.50 million in 2015.

The Model 3 is Tesla's upcoming all-electric, four-door, compact, luxury sedan, launched March 31. The company has hinted it would start producing the vehicle on a limited scale in July 2017, with the output expected to ramp up to 5,000 vehicles per week in the fourth quarter and 10,000 per week in 2018. The company indicated deliveries for new reservation would begin in mid-2018 or later.

The vehicle is priced at $35,000.

The company's stable currently includes the Model S, an all-electric sedan that began selling in June 2012, and the Model X, an all-electric SUV. Model X deliveries commenced in the second quarter of 2015. The Model S's cash price is $71,300, although it could come cheaper due to the federal tax credit and estimated gas savings over the years. Meanwhile, Model X is priced at $83,000.

Tesla's vehicles are also available on loans and leases.

Estimates released by Edmunds pitched the average vehicle transaction price in the United States at $34,077 in 2016, up 2.7 percent from 2015. The firm predicts a further increase in price to $35,000 in 2017.

With Model X's pricing affordable, demand has gone through the roof. It is estimated that pre-order numbers are running close to 400,000, with the frenzied interest forcing the company to give a pushed back deadline for new reservations. In comparison, Tesla produced 22,200 vehicles (Model S and Model X) in the fourth quarter of 2016, with the annual production at 50,700. The pre-orders suggest that Tesla has to ramp up production at double that of the current rate.

The strong demand and Tesla's precarious cash flow position makes it imperative for the company to tap the market for the incremental expenditure associated with the commercial launch of its Model 3 vehicle. The news on the offering is a proof that Tesla is leaving no stones unturned in its efforts to capitalize on the frenzy.

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