Why Merrill Lynch, Morgan Stanley Are Wrong About Tesla

NEW YORK (TheStreet) -- Bank of America's (BAC) Merrill Lynch last month reinstated its coverage of Tesla Motors (TSLA) with a "neutral" rating and a target price of $33. Earlier this week, Morgan Stanley (MS) raised its rating from "underweight" to "overweight" and increased its target price from $45 to $50.

Both reports included a fundamental financial modeling error that overestimates Tesla's year-end cash position by roughly 200%.

The error was simple. Both firms accounted for expected sales and expected new reservation payments during the second half of the year. Neither firm properly accounted for the fact that reservation payments and cash will decline by $40,000 for each Model S Signature Edition and $5,000 for each additional Model S Tesla deliveries this year.

Merrill Lynch forecast 2012 Model S deliveries of 5,000 units. Reservation deposits for the first 2,000 Model S Signature editions were $40,000 each for a total of $80 million. Reservation deposits for the next 3,000 standard Model S versions were $5,000 each for a total of $15 million more. Overall, the total Merrill Lynch error was $95 million. Morgan Stanley was more conservative at 2,230 Model S deliveries. So its error was $81 million.

As of June 30, Tesla reported $211 million in cash, $133 million in reservation payments, $31 million in working capital and $62 million in stockholders' equity.

In its report, Merrill Lynch forecast a second-half loss of $129 million and year-end balance sheet values of $149 million in cash, $242 million in reservation payments, a working capital deficit of $86 million and a stockholders' equity deficit of $54 million.

Similarly, Morgan Stanley forecast a second-half loss of $158 million and year-end balance sheet values of $132 million in cash, $169 million in reservation payments, a working capital deficit of $127 million and a stockholders' equity deficit of $74 million.

Since June 30, I've been cautioning readers that Tesla's working capital would be eradicated by the end of July, its stockholders equity would be obliterated by the end of August, and its planned cash low point left little or no room for errors, delays or other uncertainties.

I was surprised when two of the most highly regarded investment-banking firms in the country didn't share my reservations. Now I understand why and so do you. Their financial modeling was catastrophically wrong and Tesla's year-end cash balance is on track to come in at about a third of the estimates disseminated to their clients.

Disclosure: I have no direct or indirect interest in Tesla, and I have nothing to gain or lose from its success or failure.

John Petersen, a lawyer and CPA, has specialized in advising companies on corporate finance and business development for more than 30 years. He writes the deathless prose and dire warnings investors read in offering documents and SEC reports. While Petersen has served as a board member or executive officer for a handful of public companies, the bulk of his work is behind the scenes where precision and a passion for detail are essential. Petersen�s investing style is that of �elephant hunter,� and nothing grabs his attention like a �multi-bagger� in the rough. His investing time horizon is two to four years. On the long side, Petersen looks for blood in the streets and stock prices that have been beaten down to unconscionably low levels. On the short side, he seeks out high-profile companies that trade at unsustainable levels while hype-intoxicated executives make the same tactical mistakes he�s suffered through with clients. Petersen�s sector focus is batteries and efficient transportation because he has almost a decade of experience in the industry, including a three-year stint as board chairman of an R&D-stage battery-technology developer. He�s convinced these sectors are emerging investment mega-trends.