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Is Tesla's Financial Plan a Game Changer?

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Tesla Motors Inc. (TSLA - Free Report) has introduced an automotive financing plan, partnering with Wells Fargo & Company (WFC - Free Report) or U.S. Bancorp (USB - Free Report) , that would make its banked-upon product Model S electric sedan more accessible to customers. Nevertheless, the stock dipped more than 7% to $41.10 yesterday. It seems that investors didn’t get what they hoped for a week after company CEO Elon Musk’s “exciting” tweet comment.

What is Tesla’s Plan?

According to the California-based automaker, customers would need to sign up for a 66-month, 2.95% loan for purchasing a Model S with a price tag of $69,900. The plan relieved car buyers for making a big down payment as U.S. Bancorp and Wells Fargo will provide 10% down payment. The down payment would be covered by U.S. Federal and state tax credits, ranging from $7,500 to $15,000, for electric car buyers.

The plan also included a personal touch from Musk. The CEO himself has guaranteed the resale value of the car, which would be equal to the residual value percentage of the Mercedes S class of sedans, manufactured by Germany’s Daimler AG (DDAIF - Free Report) , a partner of Tesla. The customers have the right but not the obligation to sell the vehicle after 36 months as per the plan.

The company also revealed that the lease-like financing plan, savings from using electricity instead of gasoline, depreciation benefits and other factors would bring the monthly expenses for owning a Model S to less than $500.

What Can Go Wrong?

Investors initially became happy right after the CEO’s tweet comments when Tesla revealed that it expects to be fully profitable in the first quarter of the year rather than modestly profitable due to better-than-expected sales of Model S. The news even sent the stock to 52-week high of $46.68 on Apr 1.

The financing plan also offers significant opportunities to the company in terms of business growth. It could boost Model S sales, as the vehicle would become affordable to a larger population.

The improved sales could increase cash flow and help Tesla increase market share. This could eventually led the company to expand production (Tesla expects the deliveries of Model S to go up to 20,000 this year) and invest in new technologies and facilities. All these would ultimately reduce production costs and boost profits.  

But there are downsides. First, the plan did not appeal to investors in a way the company has imagined. The investors simply considered it as a conventional auto loan with a buyback option despite its colorful packaging.

Secondly, the plan sent an ominous signal to the investors by bringing the uncertainties and risks associated with the niche electric vehicles (EVs) market. This is because the investors have perceived it as Tesla’s trick to attract and retain a certain buyer count for a definite period and cash in on that due to the bleak outlook of the EV market.

The viability of electric cars has been questioned for a long time due to their higher price tag, short driving range and lack of charging stations. The overall outlook was so discouraging that Obama administration had to back away from its goal of putting 1 million electric cars on U.S. roads by 2015 recently.

The viability issue poses a bigger risk for Tesla if we look at its financing plan. Its promise to provide a specific resale value could make it ended up paying a much higher amount than the market value, if demand for EVs falls significantly.

Currently, the stock retains a Zacks Rank #3, which implies a short-term (one to three months) Hold rating.

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