Category Archives: Industry Analysis

auto leasing

March 31, 2017 By in auto leases, Autos, Uncategorized Tags: , , , , , Leave a comment

I’ve been reading an article in the Wall Street Journal this morning reporting Fed data that indicates auto loan defaults are on the rise in the US, particularly in poorer areas in the southern US.  This follows recent comments from automakers that the market for new cars is peaking and from used car dealers that prices declined last year and will dip further in 2017. Part of the downward pricing pressure is due to a larger number of cars coming off lease.

car leases

All this should come as no surprise, since the auto industry is cyclical and we’re closing out year eight since the US economy bottomed in 2009.  If there is still a shoe to drop–and I think there is–it will come in the car leasing market itself.  Here’s why:

Let’s say I want to buy a $30,000 car on a three-year lease.  What determines my lease payment?

The leasing company buys the car I want to lease from the auto company and rents it to me.  Its charges consist of:  interest on the purchase price; recovery of the loss in value of the car over the lease period; and the price at which the leasing firm figures it can sell the car for at the end of the lease.  The key figure here is the lender’s estimate of what the car will be worth when I turn it in.  This is called the residual value.

Examples:

1.  The lender estimates the car will be worth $15,000 in three years.   At 4% interest, that’s a monthly payment of $490.  In total, I’ll pay $2743 in interest charges (an average of $76/month) over the three years and $15,000 in principal.

2.  If the car is estimated to be worth $20,000, that translates into a monthly payment of $360, with a total of $10,000 repayment of principal + $3029 in interest ($17.50/mo).

At rates close to zero, an interest rate change makes little difference.  The difference between $490/month and $360 is the residual value assumption.

(Note:   real world leases can be much more convoluted, but these are the economic basics.)

how leasing companies get into trouble

Historically, lenders–and especially those affiliated with automakers–have made the residual values too high.  Why?  To my mind, it’s because a lower monthly payment (i.e., a higher residual value estimate) makes the car sale easier.  In the moment, the day of reckoning appears to be far in the future.  It can also be that the accounting framework the lender uses permits assumed profits on new loans to offset realized losses on old ones.  If so, as long as lease volumes increase, reported profits probably won’t reveal the damage being done.

Experienced auto stock investors are doubtless already worrying about the potential negative effects of leasing.  I imagine, though, that as/when the issue becomes better known–that is, when writeoffs from leasing operations start to emerge–this will be more bad news for auto stocks.

 

Tencent (700:HK) now owns 5% of Tesla (TSLA)

March 29, 2017 By in Autos, Uncategorized Tags: , , , , , Leave a comment

The Chinese internet conglomerate Tencent filed a 13G form with the SEC yesterday, fulfilling its legal requirement to declare 5% ownership of a publicly traded US firm–in this case, TSLA.

Filing a 13G rather than the better-known 13D indicates Tencent intends to remain a passive investor rather than seeking a voice in TSLA operations.

According to the filing, Tencent acquired its 8.2 million shares (at a cost of $1.8 billion) both by participating in TSLA’s public offering on March 17th and through market purchases.  Tencent reached the 5% level on March 24th.

When I first heard of the stake, it struck me as peculiar that Tencent would make open market purchases, in which the money goes to third parties, rather than arranging for a private placement of stock from TSLA, in which case all the money would go to fund TSLA.  Looking at the 13G a little more closely, however, I realized that Tencent’s total cost implies an average acquisition price of $219 a share, meaning Tencent has been patiently accumulating shares at lower prices.  Now I’m thinking that Tencent took part in the recent offering to provide some financial support to TSLA–and then rounded its position up to 5% during the following few days in order to file a 13G that publicly declares its backing.

the TSLA offering

The TSLA offering raised about $1.3 billion, through an issue of $400 million in common stock plus $1 billion minus in 2.375% convertible five-year notes.  The conversion price is $327.50, a 25% premium to the stock price at the time of issue.

The notes are convertible, at the option of the holder, but, practically speaking, only if they are trading at a 30% premium to conversion value.  To my mind, though, they represent a much better deal than fixed income investors have gotten in prior TSLA offerings.  This seems to me to imply that these buyers see much greater credit risk with TSLA today than they have in prior years.

Tesla (TSLA) raising funds

March 22, 2017 By in Autos, public offering, Uncategorized Tags: , , , , 2 Comments

Last week TSLA announced that it is raising $1 billion in new capital, $750 million in convertible notes due in 2022 + $250 million in common stock.

The offering itself isn’t a surprise.  TSLA has been chronically in the situation where analysts can see a point on the near-term future where the company could easily run out of funds.  This is partly the lot of any startup.  In TSLA’s case, it’s also a function of the firms continuingly expanding ambitions.  Elon Musk has been saying for some time that TSLA will will need new capital, too.

What is surprising, to me at least, is that the offering is not bigger   …and, more significantly, that the stock went up on the announcement.

To the first point, why wouldn’t TSLA give itself some breathing room by raising more money?  Of course, it’s possible that the small size is a marketing tactic and that the underwriters will soon announce that, “due to overwhelming demand,” it’s raising the size of the offering to, say, $1.5 billion.  Otherwise, I don’t get it.

To the second, this is just weird.  TSLA shares rose by a tad less than 30% in the first six weeks of 2017 and have been moving more or less sideways since.  So the idea that investors are willing to buy the stock can’t be surprising positive news.  And I don’t see the plus in some commentators’ claims that the market is relieved the offering isn’t larger.  I think the market should be mildly concerned instead.

Something else must be going on.

The only thing I can think of is that Wall Street is beginning to believe that electric vehicles are going to enter the mainstream much sooner than it had previously thought.  At the same time, the Trump administration’s intended moves to make it easier for American car makers to sell gas guzzlers for longer may result in Detroit remaining stuck in the past, paying less attention to electric vehicles.  So market prospects for TSLA may be improving just as competition from the “Big Three” may be weakening.

However, that alone shouldn’t be enough to propel a well-known stock higher in advance of an offering.

 

 

 

why have oil production costs fallen so much?

March 21, 2017 By in oil, oil and natural gas, shale oil, shale oil and gas, Uncategorized Tags: , , , , , , Leave a comment

rules for commodities

From years of analyzing oil, gas and metals mining–as well as watching agricultural commodities and high-rise real estate out of the corner of my eye–I’ve come to believe in two hard and fast rules:

–when prices begin to fall, they continue to do so until a significant amount of productive capacity becomes uneconomic and is shut down.  That’s when the selling price of output won’t cover the cash cost of production.  Even then, management often doesn’t reach for the shutoff valve immediately.  It may hope that some external force, like a big competitor shutting down, will intervene (a miracle, in other words) to improve the situation.  Nevertheless, what makes a commodity a commodity is that the selling price is determined by the cost of production.

–it’s the nature of commodities to go through boom and bust cycles, with periods of shortage/rising prices followed by over-investment that generates overcapacity/falling prices.  The length of the cycle is a function of the cost of economically viable new capacity.  If that means the the price of new seed that sprouts into salable goods in  less than a year, the cycle will be short.  If it’s $5 billion to develop a gigantic deep-water offshore hydrocarbon deposit that will last for 30 years, the cycle will be long.

boom and bust spending behavior

During a period of rising prices, cost control typically goes out the window for commodity producers.  Their total focus is on adding capacity to satisfy what appears at that moment to be insatiable demand.  Maybe this isn’t as short-sighted as it appears (a topic for another day).  But if oil is selling for, say $100 a barrel, it’s more important to pay double or triple the normal rate for drilling rigs or mud or new workers–even if that raises your out-of-pocket costs from $40 to, say, $60 a barrel lifted out of the ground.  Every barrel you don’t lift is an opportunity loss of at least $40.

When prices begin to fall, however, industry behavior toward costs shifts radically.  In the case of oil and gas, some of this is involuntary.  Declining profits can trigger loan covenants that require a firm to cease spending on new exploration and devote most or all cash flow to repaying debt instead.

In addition, though, at $50 a barrel, it makes sense for management to:  haggle with oilfield services suppliers;  do more ( or, for some firms initiate) planning of well locations, using readily available software, to optimize the flow of oil to the surface;  optimize fracking techniques, again to maintain the highest flow; streamline the workforce if needed.   From what I’ve read about the recent oil boom, during the period of ultra-high prices none of this was done.  Hard as it may be to believe, getting better pricing for services and operating more efficiently have trimmed lifting expenses by at least a third–and cut them in half for some–for independent wildcatters in the US.

 

This experience is very similar to what happened in the long-distance fiber optic cable business worldwide during the turn of the century internet boom.  As the stock market bubble burst and cheap capital to build more fiber optic networks dried up, companies found their engineers had built in incredibly high levels of redundancy into networks (meaning the cables could in practice carry way more traffic than management thought) and had also bought way to much of the highest-cost transmission equipment.  At the same time, advances in wave division multiplexing meant that each optic fiber in the cable could carry not only one transmission but 4, or 8, or 64, or 256…  The result was a swing from perceived shortage of capacity to a decade-long cable glut.

My bottom line for oil:  $40 – $60 a barrel prices are here to stay.  If they break out of that band, the much more likely direction is down.

 

Intel (INTC) and Mobileye(MBLY)

March 20, 2017 By in Autos, Uncategorized Tags: , , , , , Leave a comment

A week ago, INTC agreed to buy MBLY, an Israeli company that makes cameras and car safety devices, for $15.3 billion in cash.  Its plan is to merge its existing auto components business with MBLY and have that company spearhead INTC’s entire Internet-of-Things effort to enter the auto market.

Why buy rather than build?

The main issue is time, I think.  Part of this is that the timetable for development of autonomous driving vehicles is accelerating.  More than that, however, and the chief reason for the acquisition, to my mind, is the way marketing to the big auto companies works.

Auto companies plan new models several years in advance.  If you want a component in, say, a 2020 model, you probably need to have already convinced an auto maker of its merits by late last year.  Also, unless a component maker has a unique technology, auto companies tend to move slowly.  They’ll initially buy a single component, or they’ll put a part in one car model, just to see how the part–and the supplier–perform.  If things work smoothly, it will consider expanding that part’s use and/or buying other parts from the supplier.

The result is that convincing a car company to risk of using a new supplier takes a long time.  Without MBLY, which already makes key auto components and has an auto-oriented sales force, I think it could easily be a half-decade before INTC would make any significant inroads into the auto market.  INTC probably doesn’t have that much time.

This is not, of course, to say that INTC will be wildly successful in the auto-related IoT.  Without MBLY, though, its chances for success would be considerably dimmer.