The stock of Tesla Motors Inc. has been as much bulldozer as sports car, bashing and crushing its critics with a rise of nearly 500 per cent this year. The shares are now priced as if the Silicon Valley upstart will join the musty old big three of Detroit as a major American auto maker.
So it may be churlish to pick at Tesla’s accounting decisions, suggesting the company’s bottom line isn’t all it’s cracked up to be. Why do 2013’s results really matter when the big prize, several years down the road, is what’s driving its current $23-billion (U.S.) valuation?
Perhaps because it was Tesla’s first “profitable” earnings report in May that made investors believe the company had turned a corner. The shares have been in high gear ever since, despite questions about Tesla’s accounting.
Among the questioners is Gradient Analytics, a small Arizona research firm. It started coverage of Tesla earlier this year, and promptly issued a report that gave the firm an “F” grade for its quality of earnings.
“Though we love the car and the passion of the firm and its CEO, we continue to be concerned about the economics of Tesla’s business and the quality of its earnings … we continue to believe that Tesla is the most dangerous stock one could possibly trade, whether long or short,” says analyst Donn Vickrey, author of the report.
If you’ve followed the Tesla debate, you may be familiar with some of these issues. For one, the company boosts revenue and profit by selling millions of dollars of “zero emissions vehicle” tax credits to other auto makers, a business that is declining, according to Tesla’s results and earnings guidance.
Other issues are less understood. In isolation, they are minor in terms of their dollar amounts.
Taken as a whole, however, they paint a picture of a company that’s legitimately but aggressively pulling a myriad of accounting levers to pretty up its results. (The company declined to comment.)
For instance, Tesla prefers to emphasize its “non-GAAP” revenue, which doesn’t conform to U.S. generally accepted accounting principles. The company says it prefers the non-standard measure of sales because it “align[s] with the underlying cash flow activity and timing of vehicle deliveries.” It doesn’t hurt, though, that non-GAAP revenue happened to be $551-million in the second quarter, compared with $405-million as calculated under GAAP.
Why the big difference? Tesla has guaranteed some of the buyers of its Model S that they will be able to resell their used vehicle at a particular price.
This “guaranteed residual value” triggers the need for lease accounting under GAAP, which defers revenue. In contrast, Tesla’s non-GAAP measure includes $146.8-million in “estimated” revenue on the guaranteed-value cars.
Tesla has also accrued expected warranty expenses on its vehicles in line with the mainstream auto makers, even though the warranty on its electric battery – four years – is longer than conventional guarantees, and covers a new and relatively unproven technology.
Some of the recent plaudits Tesla has won for quality, including a top rating from Consumer Reports magazine, may justify the company’s confidence. Mr. Vickrey observed, however, that Tesla’s most recent quarterly report disclosed the company recorded an accrual of $3.2-million for changes in liabilities for pre-existing warranties – in effect, suggesting warranty accruals on cars sold in prior periods simply weren’t high enough.
There are more items of concern, like a number of accounting errors the company has disclosed, most recently in the second quarter, or a lengthening of depreciation schedules that cuts the amount of expense recorded each quarter.
Let’s conclude, however, by looking at Tesla’s second-quarter “profit.” Like its revenue figures, it is non-GAAP. To reach the number the company emphasizes, Tesla adds back a number of items, including “gross profit deferred due to lease accounting.” This, Mr. Vickrey says, “assumes that it will not lose a dime on a single Model S residual-value guarantee.”
Tesla also uses a share count to calculate earnings per share (EPS) that excludes shares it could issue because of its convertible debt. By leaving them out, the company increases EPS by having a lower share count. “We can think of no reason for doing this, other than to further boost the company’s first non-GAAP EPS figure,” Mr. Vickrey says.
In sum, all these accounting issues prompt Mr. Vickrey to conclude that Tesla’s non-GAAP computations “strike us as indicative of a firm struggling to find a way to justify its current share price with increasingly complex, apples-to-oranges non-GAAP earnings computations.”
Tesla bulls can afford to laugh off such concerns today, given how doubters have so far been left in the dust.
But if this particular ride ends in a crash, at least we know there were signs along the route that we chose to ignore.
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