Tesla's Free Cash Flow (FCF) Fallacy
Tesla Earnings & the TSLA Free Cashflow Fallacy
Through 2018 TSLA managed to incinerate a whopping $11 billion of free cashflow.Normally, the market doesn’t take kindly to cash burning at that magnitude, but the Model 3 was rolling out, fully automated vehicles were coming soon (6 months maybe, 12 definitely), solar tiles were just around the corner, etc. etc. The $11b was viewed as an investment in TSLA’s future and soon the cash would be rolling in.In 2019, TSLA worked hard to support the narrative. With the M3 ramping globally TSLA gave the bulls what they needed and generated $1.1 billion of free cashflow. Helpfully, they even did the math for us saving everyone the trouble of reading their financial statements…As shown above, 2019 was Tesla’s first cashflow positive year, a cause for celebration! Except, the $1 billion didn’t happen, and 2019 was NOT free cashflow positive. In fact, TSLA managed to lose about $1 billion that year.TSLA manages its free cashflow sleight of hand two ways, the first is pretty obvious and should be caught by most analysts, the second is better hidden and more impactful. I’ll refer to them as BS1 and BS2.BS1Why should depreciation on leased vehicles be added back to operating cashflow? Unlike DDA on PPE, it represents an actual cash cost to TSLA. Leased vehicles are depreciated to the cost basis in the residual value of the cars. It’s a very real cash cost, and one that won’t be recouped. Had TSLA sold those units outright, it would have booked cost of goods sold and wouldn’t have been added back.Naturally, TSLA does not disclose the amount of DDA attributed to the leased cars so there isn’t a precise figure we can derive. However, we can see how much of their reported depreciation is due to PPE. By adding back the total DDA reported in operating cashflow and then deducting how much came from depreciating PPE, we can get a more accurate representation of true operating cashflow.BS1 accounts for about $800m of 2019’s reported operating cashflow.BS2TSLA makes aggressive and clever use of “finance leases” to add productive assets without having a day one cash outlay. Essentially, TSLA “rents” factories, the Gigafactory in particular. There is nothing wrong about using finance leases to acquire PPE, many companies do it. However, there is something wrong when you don’t make it clear to investors the burden it imposes on free cashflow.GAAP’s byzantine rules treat these leases bizarrely. The value of the “rented” factory is placed on the balance sheet as both an asset, in PPE, and a liability, in Leases. Since there is no initial cash outlay, there is nothing recorded as cap ex on the cashflow statement. Worse, as the “rent” gets paid back to the lessor, it is booked as “principal payments on finance leases” in cashflow from financing.The net result is the actual expense of acquiring the factory is completely OMITTED from the free cashflow calculation. This is wrong and needs to be accounted for in any assessment of actual free cashflow. Either one needs to show how much was “paid” to rent the factory, or one needs to show what it’s costing in “rent” each period.More honest companies understand this and take pains to point out to investors.  Amazon has an entire schedule in their earnings release to map this out. Conservatively, AMZN chooses to show the “value” of the rented asset in the period its acquired. This is conservative because they pay for it over time and not necessarily all at once. Below is an example from AMZN’s 1q19 earnings presentation.“Equipment acquired under finance leases” is being deducted from operating cashflow to alert investors to the capital expenditure AMZN is incurring on those assets.Additionally, AMZN is showing the “principal repayments” on other finance lease contracts that were not included in that line item. Those principal payments represent actual cash outlays incurred by AMZN.So how does this relate to TSLA? Well, the market’s favorite vaporware purveyor has acquired over $2b of PPE through the magic of finance lease accounting. Nowhere, does TSLA take pains to point out the impact on free cashflow. Had TSLA bothered to inform investors, they’d point out that their “free cashflow” in 2019 was overstated by at least $754 million.BS2 accounts for at least $754 of TSLA’s reported 2019 free cashflowPutting BS1 and BS2 together you get a very different, though more accurate, representation of TSLA’s true cash generation. If they can’t generate cash after record vehicle sales in 2019, when are they going to?