We blogged about Tesla just over a year ago, looking at what we called the company’s “liquidity burn.” We thought they only had about a year’s worth of liquidity left. Since then, burning through liquidity hasn’t been Tesla’s biggest problem.
Instead, Tesla’s troubles have been with burning cars. Three of its sleek Model S cars have caught fire recently, and that may hurt sales or force a recall.
Can Tesla afford it? A slowdown in sales or a recall would hurt cash flow, which has been improving lately. Free cash flow was $25.8 million dollars in the third quarter this year, driven by the success of the Model S.
If cash flow falters, Tesla’s next line of defense will be its liquidity reserves, which also have grown a lot in 2013. Tesla used to keep about $200 million in liquidity in the form of cash and short-term investments.
But in May 2013 the company raised $660 million in the convertible bond market and $617 million in the equity markets, using $452 million to repay its loans from the U.S. government and $178 million to hedge the convertible bonds. Tesla used the remaining $647 million to recharge its liquidity reserves. At the end of September 2013, they stood at $795 million.
Is that enough? The size of a liquidity reserve should be based on the company’s ability to generate free cash flow and its vulnerability to event risk. Event risk is the unexpected need for cash caused by natural disasters, accidents, and product recalls.
The cost to Toyota for its 2009 recall of 8.1 million cars for faulty break pedals was about $250 per car, and that includes repair costs and lost sales. Tesla believes it can get rid of the fire hazard with a simple software change. But assuming $2,500 for each of the 18,000 Model S cars sold through September 2013, a full-blown recall to upgrade the battery shields might cost Tesla $45 million.
That would drain two quarters’ of free cash flow at current levels. It would hardly make a dent in the company’s cash reserves. So Tesla may have car trouble, but it’s not likely to burn through its liquidity any time soon. Recall risk looks like just so much debris in the road for them; even if they can’t evade it, they should be able to afford the repairs.