NIO follow-up: fun and games in the 20-F

Due to the enthusiastic response to my first missive on NIO, I thought I would delight all my fans 🙂 with a quick follow-up post the 20-F (annual report) filing today. Here are my main takeaways; the overarching conclusion remains ‘alarm bells are ringing’ and if anything I think the cash needs at the company are more intense than I first anticipated.

In no particular order, here’s what jumped out at me from the filing (with pagination so you can find it within the doc if you like): –

Capex: they are guiding to $600mm in calendar year 2019, a good deal higher than my baseline $500mm cash burn/qtr run-rate estimated (I had been assuming capex would actually fall a little from last year’s level, $400mm, since they decided to kill the manufacturing plant). In other words, if they hit their capex spend and all other assumptions stay the same, quarterly cash burn is more like $570mm (not the $500mm I anticipated). The nature of the capex, too, seems of questionable value: only $26mm was spent on power solutions/infrastructure for their energy network, with ‘R&D equipment’ being a key expenditure (amongst tooling, office equipment, leasehold improvements, etc). They do not disclose how much R&D they are effectively capitalizing in this way. They explicitly mention that equity/debt financing will be conducted if the proceeds of their convert offering are insufficient to cover capex needs (p113).

Users on their app: I thought the disclosure around their user base was a little…strange. The bulls like to talk about the ‘800k+ community of Nio app users’ as evidence the company has built meaningful scale. Here is the precise disclosure from the 20-F (p. 69): We aim to engage with users and create an environment conducive for user interaction both online and offline. Our mobile application had over 760,000 registered users as of December 31, 2018 and over 190,000 daily active users on peak days in 2018 (my emphasis). Clearly this is not the standard definition of ‘daily active users’ as they don’t even specify the time period (typically this number would be calculated monthly or quarterly with the peak usage only incorporated on this basis). Putting aside how they define ‘active’, though, if they only had 190k users on peak days, who knows what the real DAU number is, 100k? 50k? In any case it is suggestive of a far smaller fanclub than the 800k number bandied about by the sell-side. Anytime the company can’t give you a simple number on a standard metric like DAUs, it’s a concern.

Expensing of points: they disclose that one of the ways they get people to sign in to their app is for ‘Nio Credits’ which can be used to then get merchandise, other discounts, etc. There is one tiny disclosure on the cost of this program (F-19, in the notes to the financials) – they expensed 144mm CNY in 2018 on this program. This constituted the bulk of their Sales & Marketing expense (218mm CNY in 2018). But in any case, these Nio Credits alone meant that they spent $22mm to acquire their app users, oh which they had only 190k active on ‘peak days’ and thus, assuming 50-100k real DAUs, customer acquisition cost (CAC) from this cost line item alone is $220-440. This seems incredibly high…especially as it takes into account only a tiny part of the brand-building expenses actually being incurred (Nio Houses, etc).

JAC manufacturing fees/cost absorption: they disclosed a total of 223mm CNY payments to JAC, their manufacturing partner, in 2018 – broken down as 97mm CNY of manufacturing fees and 126mm of loss reimbursement. This equates to 8k CNY of manufacturing fee per unit prouction (fixed per vehicle), and 17k of loss reimbursement per unit. The most interesting thing about this is that they had accrued 65mm of loss reimbursements as of end June 18 – meaning 60mm CNY or so of losses related to 2H last year. This is a problem because it means their outsourced manufacturing solution is still unprofitable even with higher volumes (25k annualized run-rate production in 2H’18) and suggests they will be gross margin negative for 2019 as well (lower volumes on ES8, ramp/higher costs on the new model from 3Q).

Reservations: they stopped disclosing ES8 reservations in the filings (this was mentioned on the conference call at 4Q earnings) so not a surprise but there is nothing written down about ES6 reservations in hand either. These were specifically discussed on a conference call, and ES8 reservation numbers formed a meaningful part of the (written) IPO narrative. Furthermore the rationale given on the call for stopping disclosing ES8 reservations was that the vehicle was already in production. But that clearly doesn’t apply to the ES6, so why the unwillingness to put reservation numbers down on a formal filing? Are they suffering many cancellations? Are they worried about getting in trouble with the SEC?

Employees: this one really needs an explanation. In the detailed discussion of why expenses were up so much in 2018 vs 2017 (p108), they say an increase in the number of our research and development employees (including employees of our product and software development teams) by approximately 75% from 2017 to 2018 was one of the main factors. The only problem is according to their own disclosures later in the document, R&D employees only went up by 14% yoy (from 3052 to 3492) – that doesn’t sound like ‘approximately 75%’ to me. Overall employee numbers did skyrocket (+40% yoy to around 9800) but the vast majority of these were in ‘Sales, marketing & service’ – ie customer facing roles, which, primarily in China, you would think garner only a fraction of the salary of engineers. Notably, the overseas R&D employee numbers – where a bulk of the very high comp would theoretically sit – didn’t change that much (844 vs 724, so +16% yoy).

I am not sure if this is a big deal or not – but I was already concerned they were massively over-spending on R&D and now it appears they are at the very least unintentionally saying they’ve hired a ton more engineers than they really have. Who knows where the spending is really going – but if the reported numbers are to believed then average R&D employee salaries went from $49k to $79k in a single year, while average company-wide salaries went from $41k to $62k (+50% yoy, not bad)…and remember this is almost all in cash, stock comp was but a very small part of total comp (just 7% of total opex).

So all in all, many more yellow flags and not much to really assuage my worries that they will hit the market for another $1bn+ in cash as soon as practicable. Clearly stock has rallied (my timing is always impeccable ;)) but still a high conviction short.

Disclosure: short NIO

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