Streetwise Professor

May 22, 2013

Mr. Musk’s Wild Ride-At Your Expense (9 figures in 1 Quarter)

Filed under: Economics,Energy,Politics — The Professor @ 10:51 am

My main beef with Tesla Motors is that it is a major beneficiary of government largesse masquerading as a free market success story.  The company received a $450 million loan from the Federal government to set up operations.  It has just paid back that loan, but does not justify granting the loan in the first place: indeed, it illustrates the heads-Musk-makes-a-lot-of-money-tails-the-taxpayers-eat-it aspect of the loan.  It socialized the risk of loss, and privatized the gains.  That’s bad, on principle.  (Things might have been ameliorated had the warrant the government received allowed it to participate in the upside, but the exact opposite happened: the warrant went away precisely when the stock price went parabolic.)

But the loan isn’t the biggest source of government support. The $7500/vehicle federal subsidy to purchasers and California’s Zero Emissions Vehicle (ZEV) credit program are.  When you look at the value of these subsidies, they dwarf the much ballyhooed profit Tesla reported for the first quarter (and those profits were driven by the write-down of the warrant and non-repeatable gains on yen exposure).

I’ve done some back of the envelope calculations to estimate just how much these subsidies benefited Tesla’s shareholders.  The basic idea is to calculate profits with and without the subsidies based two assumptions about the demand for Teslas: a constant elasticity demand curve and a linear demand curve.

The linear case is easiest to explain.  The equation is P=A-bQ, where P is price and Q is quantity sold.  A and b are constants that need to be solved for.  P and Q are known for the first quarter: I’ll use $75K for P (the average price of a Model S) and Q is 4750.  If Tesla was maximizing profits, it would set its marginal revenue equal to marginal cost, where the marginal cost nets out the subsidies.  The relevant equation is C-S=A-2bQ.  I derive C from the cost of generating revenue reported in the 10Q.  I divide this sum by Q, and then multiply by .6 because the cost number includes some fixed costs (e.g., tooling) and I want marginal cost: it turns out that the results I derive aren’t that sensitive to the multiple.  For S I add $7500 and Tesla’s ZEV credit revenues (reported in the 10Q) divided by the number of vehicles sold.  I now have 2 equations, and can solve for the unknown constants A and b.

I now have all I need to know to figure out revenues (including subsidy payments) net of variable costs.  This totals $206 million.  I can also figure out the price and quantity of Teslas sold without the subsidy.  Absent subsidy, Tesla would choose Q to satisfy: C=A-2bQ, which gives Q=(A-C)/2.  This can be plugged back into the price equation.

Doing this gives a no-subsidy quantity of 3558 (about 70 percent of the with-subsidy sales) and a price of $91K.  Using these numbers, and the assumed unit cost gives a no-subsidy profit (before fixed costs, etc.) of $116 million.

In other words, in this specification, Tesla pocketed about $90 million due to subsidies in one quarter alone.  That represents about 18 percent of its auto sales revenues, and dwarfs its profit even including the one-time boosters.

In the constant elasticity specification, I need to solve for the demand elasticity and the constant multiplying the Q raised to the elasticity.  Given the price, quantity, cost, and subsidy numbers, I can solve for these two constants using the demand equation and the marginal revenue equals marginal cost equation.  Given these constants, I can figure out profits with and without subsidies.

In the constant elasticity case, profit with subsidies (before fixed charges) is again $206 million, and profit without the subsidies is estimated to be $139 million.  So in the constant elasticity specification, subsidies pad Tesla’s profits by $67 million.

These are numbers for one quarter, folks.  This is money out of your pockets, or the pockets of shareholders of Ford, Toyota, etc., who have to buy ZEV credits.  Tesla would still be drowning in red ink absent the fat subsidies.

I sure hope you are enjoying Mr. Musk’s Wild Ride at your expense.  Your enjoyment being completely vicarious, of course, expect for the paying for it part.  That’s something you experience personally.

I would hope that these figures put the hype in perspective.  Tesla cars are fueled by electricity.  Telsa Motors is fueled by government money.  Your money.

One more thing.  Tesla and Musk are neck deep in a relationship with Goldman-Sachs, aka Government Sachs.  Think that it’s just maybe possible that Goldman will deploy its notorious political heft to keep the rain of government manna going?  If you doubt that, can I interest you in a bridge connecting two boroughs in NYC?  Which makes it doubly ironic-and nauseating-that many of the Tesla Kool Aid Gang also declaim against crony capitalism.  Well, so do I, except I at least do so with a modicum of consistency.

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  1. so a startup green electric car company should watch all the major, established gas burning car companies receive mountains of bailout funds to survive while they get left to die. Is that what you’re saying? Yeah that sounds fair.

    Comment by Russ — May 22, 2013 @ 10:59 am

  2. Ah. The Sock Puppet Army makes a near real time appearance.

    Look, Russ. It’s pretty simple. N wrongs don’t make a right. I was critical of the auto bailouts in 08 and 09. I’m the one being consistent here.

    I get so tired of these “well X gets a benefit so Y should too!” Neither should get it.

    The ProfessorComment by The Professor — May 22, 2013 @ 11:12 am

  3. You state the repayment of the loan doesn’t justify the government making the loan in the first place. You should change that to read that the loan doesn’t justify on a rational economic basis the government having made the loan in the first place. There is amply justification for the government having made the loan, just not ample economic justification.

    The question would be what the motivation was for haing made the loan if it wasn’t based on an economic basis. If the loan wasn’t made on an economic basis, does it even matter if the loan was repaid?

    Comment by Charles — May 22, 2013 @ 11:22 am

  4. @Charles-you’re right. When I said “justify” I meant justify on a rational economic basis, rather than on some other basis. But given the bogus arguments that are often advanced to “justify” these things, I should have made explicit what type of justification I meant.

    It’s an ex ante vs. ex post issue. Repayment ex post doesn’t mean that it was an economically sensible transaction ex ante, which is the only thing that matters.

    Ironically, I just got off the phone with a KTRK reporter looking into swaps that Harris County entered. I was just trying to explain hedging, and how ex post performance of the swap doesn’t tell you whether it was a good idea to do the deal or not. It’s a simple concept, but it’s one that a lot of people just don’t get.

    The ProfessorComment by The Professor — May 22, 2013 @ 11:32 am

  5. @Prof – When you are a reporter, its easy to claim the insurance policy that was purchased but wasn’t needed was a waste of money. Likewise, if you are an investment manager and you reduce the variance of the portfolio, the costs of doing so can be claimed by non-professionals to have been wasted capital.

    As for the Tesla loan, it never had a thing to do with economic analysis, with being a responsible steward of the public’s money or with trying to nurture evolving technology for the common good. In short, it was never about economics. Politicians have time and again been proven to be lousy venture capitalists and for this reason (amongst others) I have long been against politicians using public money to fund private ventures the private sector has rejected. In a world where investors demand adequate risk adjusted returns, I am continuously amazed how ventures such as Tesla are not evaluated on a risk adjusted return basis and left to the voters to decide whether the politician who promoted the project was or was not a proper steward of the public’s money. If only there was an academic who could calculate risk adjusted returns for certain public investments in private ventures….

    How was Gallipoli? Inquiring minds want a blog posting.

    Comment by Charles — May 22, 2013 @ 1:34 pm

  6. Key point in this analysis: If Tesla’s car were less attractive to customers, its demand curve would be shifted to the left and its ability to pump subsidies out of the system would be lower. No other EV company has been as remotely successful in attracting customers and sucking up the subsidies. So we are left in the peculiar position of damning Tesla relative to all the other EV would-be subsidy suckers because its product is so much better. Theory of the second-best rears its ugly head.

    Comment by srp — May 22, 2013 @ 6:12 pm

  7. I don’t get it. If subsidies account for ~ $100 mm of $200 mm profits, then how would taking away the subsidies make the company drown in red ink?

    Comment by aaa — May 23, 2013 @ 1:53 am

  8. @aaa The company reported earnings of less than $20 million. Take away $100 mil, and they are drowning in red ink. The earnings deduct for other costs not included in my analysis because they are fixed costs. I was careful in my phrasing-revenues minus variable costs.

    The ProfessorComment by The Professor — May 23, 2013 @ 8:10 am

  9. […] […]

    Pingback by Welfare is a dirty word in the US | Dizzynomics — May 24, 2013 @ 3:51 pm

  10. So…..does the WSJ read the SWP?

    Comment by David Hoopes — May 25, 2013 @ 7:46 pm

  11. @David-I know they have in the past. I’ve been quoted in their editorials, a blog post has been excerpted in “Notable and Quotable”, and my post-2008 election rant was featured in the Political Journal.

    So I know what you’re thinking, and it’s a possibility. But I think it’s another example of Merton’s multiples.

    The ProfessorComment by The Professor — May 25, 2013 @ 8:55 pm

  12. @ SWP: I suppose.

    Comment by David Hoopes — May 27, 2013 @ 6:37 pm

  13. @David. Meaning that I’m being too generous in suggesting a Merton multiple?

    Well, it wouldn’t be the first time that one of my posts has been, um, adapted by a major publication. I am near positive that the Economist did it a couple of times.

    The ProfessorComment by The Professor — May 27, 2013 @ 7:14 pm

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