Risk Management in Tesla Inc

Introduction

Risk management in multinational corporations has expanded greatly in the past decade and has led us to better understand the benefit of a well-built and structured risk management models and programme, and the reduction in those risk management models. Managing risk, especially in a multinational company such as Tesla is crucial for the operation of the business, not only does it help reduce cost and failure for the company, it also helps in adding value to the company. Multinational corporations face both external and internal risk factors, and when not handled effectively or successfully, these risks can cause a disruption to the operations of the business. Tesla is one of the leading clean energy automobile companies in the market, competing with fueled automobile companies like Audi, BMW etc, and also other leading clean energy automobile companies. This essay will investigate the different risk factors Tesla is currently battling with and formulate relevant and appropriate risk management strategies and models they could adopt to reduce those risks

Tesla

Tesla is an American clean energy motor company supplying electric cars, based in Palo Alto, California. They design and manufacture electric vehicles, also providing energy storage and systems and products. The company operates in two segments, automotive and energy generation and storage. Its energy storage products are provided to homes, commercials and utility sites, selling directly to customers through their websites and retails stores. There are multiple production and assembly plants, located in the United States and Shanghai, China. Tesla also has multiple showrooms and retail stores across the United States, and also in Dubai and South Korea. As of 2019, they ranked the world’s best selling plug-in passenger car manufacturer, beating BYD Auto. Their global sales rose 50% in 2019. Its market capitalisation reached $166 billion on February 20 2020.

Risk factors affecting Tesla

Tesla INC is vulnerable to many risks which are mainly associated with their international operations and overseas expansion. Unfavorable regulatory environment, political turmoil, taxation laws, law & Order situation and labor laws in oversea territories put themselves in a susceptible position and that can harm the business activities of the company.

Governance risk

One of the main risks regarding Tesla’s corporate governance is that any failure on a higher managerial level can result in negative publicity, and as a consequence harm the business’ reputation and operating results, as well as Tesla’s access to additional funds and capital (Tesla Annual Report, 2019). Furthermore, Tesla is highly reliant on both the services and the public image of its CEO (and the biggest stockholder) Elon Musk. Such a dependence poses a risk to the firm's stock, making it extremely vulnerable to the actions of one person, who, having a broad public exposure, is subject to numerous public offences, prone to making questionable statements and not fully devoted to the company due to his CEO and CTO positions at Space Exploration Technologies Corp. (CBS, 2018). As such, the situation has already proven to dissatisfaction investors, harm the firm’s stock price, and even cause four of Tesla's directors to leave the company, what proves for the existing risk of similar events reoccurring in the future (Waters, 2019). The significant risk for the cited organisation is its unclear position on its entitlement regarding the public or private sector organisation. The CEO of the cited organisation made a remark about taking the public company to the private, which misled the investors. Such remarks led towards allegations on Tesla, and significant corporate governance risk occurs in the form of losing trust from the investors. It can create risks on the leadership positions as well where Musk might need to resign from prominent positions (Mont, 2018). Thus, the corporate governance risks revolve around leadership, losing trust from investors as well as structural risks for Tesla. The retirement of old board members might create an impact on the corporate governance of Tesla as it could lead towards the shaky situation within the organisation. New investors could come into the organisation, and it could bring instabilities if the interests are not aligned with each other or actual organisational philosophies (Hull, 2019). Thus, the changes in shares should be done painstakingly else it could lead towards interest based conflicts which are one significant corporate governance risk for Tesla. Moreover, such conflicts or risks could affect stock performance as well. The governance risk for the cited organisation can also be witnessed during the event of an acquisition. It is analysed through cited company's annual report that the board of directors have the rights and power and delay the acquisition process, which itself creates confusion at governance levels. Such changes can cause again operation as well as acquisition risks and if not appropriately controlled then could lead towards the financial risks for Tesla. Further, the issues like cash burning, employee lawsuits, vehicle safety and manipulation in information also give birth to corporate governance risks. Its relationship with its stakeholders, especially government and the authorities, could be hampered negatively (Slane, Makower, & Green, 2018).

Political risk

Political risk for Tesla INC having international operations are due to numerous factors which can negatively affect Tesla’s income, growth, revenues, operations and /or complicate its current business strategy. Political environment includes factors like macro-economic issues in a country for example high or unstable interest rates, social problems like civil unrest. government actions, like seizing the most valuable assets, unstable economic trends, trade deficits, import & export policies etc. In the case of Tesla INC, following are the external political factors which are significant and have huge impact on its business strategy.

Government encouragements for electric automobiles manufacturers (this is in the favor of Tesla)

G to G trade agreements

Political environment (stability / unstable in the countries in which Tesla is operating or planning to operate

Tesla Inc. has got the opportunity to support its business operations and achieve desired financial performance through the incentives which they have been receiving from various governments (Stobbe, 2019). Due to the minimized carbon emissions of its automobiles and other operations. Various countries have taken these policy decisions and encourage those companies who have low carbon emission products and environment friendly operations and abide by Environmental, social governance framework. Few of them are China and Russia (apart from other European countries). Tesla received favorable responses from these countries. Also, Tesla has ensured that they must enter and expand their business in relatively stable and growing economies.

Liquidity risk

Current Ratio of Tesla has experienced an unstable performance of being above 1 in 2016, and dropped below 1 in the years of 2016 and 2017. In 2019 Tesla generates enough current assets to cover its short term liabilities. Quick ratio from 2016 to 2019 is below 1, which means that the company doesn’t have enough liquid short term assets. Operating Cash Flow Ratio is negative in 2016 and 2017 because Tesla suffered losses in operating activities, and the company started to produce profit in 2018 that shows in positive Op. ratio in 2018 and 2019. To determine if the ratios of Tesla are appropriate in the industry, ratios of General Motors and Ford Motor are calculated. Ford shows best results in Current ratio and Quick Ratio, General motors is below 1. All 3 companies can’t produce enough cash flow from operating activities that are shown in ratios. Even though Tesla doesn’t have sufficient liquidity it meets that criteria’s of the industry therefore it can be said that the automotive industry has high liquidity risk, and Tesla’s liquidity is adequate in the industry but company carries a higher risk of bankruptcy compared to other automotive companies for being a new innovative auto company. It should be noted that for the company to increase its liquidity it will need to increase its sales, which Tesla relies on new gigafactories in Shanghai and Nevada(Annual Report, 2019) but to do that they need to attract other sources of liquidity and cash flows. Investors have high expectations for Tesla according to ( Forbes,2020) as the share price of Tesla hitted all time high, as a result topping the expectations therefore Tesla can still hope to attract even more sources of liquidity.

Credit risk

Credit risk is the possibility of a loss result from borrowers inability to pay the lenders. Tesla’s great potential for future growth and its unpredictability meant that it is a high-risk, high-reward stock. Up till November 2019, the company’s total debt outstanding was 13.3 billion and has a FRISK score of 3. (Creditriskmonitor.com, 2020) This indicates that it is at high risk as is designated in the “red zone”. One of the characteristics of being in the red zone is high financial leverage. By looking at the recent financing, Tesla has a total debt outstanding of $13.3 billion, if debt financing costs trend higher, it would place further pressure on pre-tax profit and free cash flow (Creditriskmonitor.com, 2020)

Tesla has over $9 billion in debt with maturities ranging from 2018 to 2049

Tesla’s August 2017 5.3% debt that is due in August 2025 is trading at a 12% discount, or 88 cents to the dollar (Forbes.com, 2020)

By looking at Tesla’s account receivable ratios 16.9, compared to industry average of 88.8, we can conclude that they are relatively efficient in collecting receivables. On the other hand, the average account payable ratio for Tesla is 64, compared to industry median of 41.5. This indicates that the company has sufficient amount of cash

Interest rate risk

Fluctuations of interest rate impacts the cash flow that the company produces. It is important to take into consideration the capital structure of the company, the larger the debt amount of a company the more it is impacted by interest rates. Corporate bonds that are issued by the company lose value when interest rates rise. In 2019 Tesla’s debt to equity ratio is 3.95, which makes the company heavily dependent on debt. As interest rates are hitting all time low(Annual Report,2019), the risk of interest rates to rise is high.

Foreign exchange risk

Due to its large overseas operations, Tesla INC is greatly exposed to exchange risk movements, because when the supply chains went beyond borders, currency exchange risk turned out to be a key consideration for every company (Gilson, 2017). For example, during 2016, the Japanese yen was appreciated against dollars, although this is a pure external effect, but this had a huge impact on Tesla, as the price for imported batteries from Japan recorded huge spike and resulted in higher cost of production and lowers the profitability. The situation would be reversed if the dollars were appreciated against yen. The policy consideration, Tesla INC management were applying to mitigate the risk of currency exchange risks are as follows:

Re-examine the supply chain for the company, increase reliance on local suppliers e.g instead of buying batteries, steel, fleet, oil & gas and other elements from abroad, try to minimize dependence on overseas suppliers and import only those elements which are not available in the local market.

Trying to make agreements to deal in local currency

Dealing in currency derivative to hedge the currency exchange risk (But derivative usually create other risks also)

Weighted Average Cost of Capital

The current share price of Tesla INC is US$ 914 with a total market capitalization of US$ 169 Billion. The capital structure of the company is heavily skewed towards the equity side and has the great capacity to raise long term debts. The WACC calculations are as follows:

Analysis on risk management strategies and recommendations for Tesla

Tesla currently doesn’t adopt any hedging strategies against their foreign exchange risk. Over the past year, the company has seen a gain of $48 million and $2 million in foreign currency in their income (expenses) in 2019 and 2018 respectively (Annual Report,2019). There is great risk for the company without any hedging strategies against adverse fluctuations, as continuous gains are not guaranteed. Foreign exchange risk management strategy of forward contracts is recommended to hedge the risk. Forward contracts eliminate uncertainty in the exchange rate risk as a fixed currency exchange rate is agreed on for a set date and time for future transaction. Although forwards can hedge against currency losses in the case that the currency value depreciates, it also eliminates any possibility of profit if the currency value appreciates. Tesla can go into a forward contract with their supplier, this sets a currency rate that they will exchange on when purchasing materials in a set date and time in the future. Looking at Tesla’s interest rate risk strategies, according to their annual report of 2019, they are using derivative tools to hedge some of their risks. However, using these might not be effective enough to hedge. Another strategy Tesla can look into is the use of forward rate agreement. This agreement allows the company to agree to borrow at a set interest rate on a set period of time with the lender. The FRA is a flexible hedging option for both parties, and can be closed by an offsetting FRA at a new price. The company is also currently exposed to liquidity risk. Looking at their cash flow for the recent year, it states that the current accounts receivable is at -$367 million, which means that money is owed to customers -- this directly affects the firm’s cash flow negatively. A strategy that the company can take on is selling these accounts along with other accounts payable to a discount house. This would allow the company access to more cash and increase its liquidity.

Bibliography

Hess, M.F. and Andiola, L.M., 2018. Fraud Risk Brainstorming at Tesla Motors. Issues in Accounting Education, 33(2), pp.19-34.

Gilson, S.C. and Abbott, S., 2017. Tesla Motors (A): Financing Growth. Harvard Business School case study (218-033).