I have written about NIO (NYSE: NIO), everyone’s favorite cash-guzzling EV company, a couple of times (see here, here and here). The company just reported in 4Q’19 numbers and I thought it would be worthy of a check in to see if anything with the original bearish thesis had changed (TL;DR – it’s actually worse than before).

Here are some of the proximate issues as I see them today:

Unsustainability of business model: NIO sold a record number of cars in 4Q (8224) yet gross margins are still negative (-6%). To put this into context, they shipped 3553 units in the June quarter, but margins – adjusted for recall costs – were ‘only’ -5%. This is because NIO is progressively shipping lower ASP models (the ES6); but also having to resort to massive price discounts to move units. Cutting prices to drive negative margin volumes, clearly, only lasts as long as you have cash to burn…

Ongoing cash burn:…which is a big problem as once again NIO seems basically tapped for cash. They ended 4Q with just 974mm RMB in cash – despite generating a 2bn RMB inflow from negative working capital in the quarter! That’s right, they have completely stopped paying suppliers/vendors (and they ran down inventory aggressively in the quarter as well). Still, that means entering 2020, they had barely 1 month worth of cash burn, on hand – explaining why they had to do a series of largely-dilutive convertible deals in Feb/Mar.

Working capital boomerang: The problem for NIO now is sales are cratering (due to the coronavirus, partially) which means the negative W/C will likely boomerang back against NIO in short order. Consider what happened to NIO last year, between fiscal Q4’18 and Q1’19:

You can see there was a 1.3bn W/C outflow – that is, a cash drain – between these periods; during this time car deliveries fell from ~8k to 4k (making sense then since negative W/C businesses see capital flow out of the business when revenues decline, and vice versa when revs are growing). Of course this explains why NIO was so desperate to shift units at the back end of last year…but now it means the cash needs of the business through 1H this year almost certainly demand further highly dilutive financings (or worse).

I think its quite likely W/C outflow alone in 1Q will be 800mm RMB (as per above). This seems generous as it implies the following cash conversion cycle – still almost double the width, in days. YoY versus the comparative period last year (I assume NIO simply demands better terms from their vendors):

However even in this optimistic scenario, and assuming NIO burns ‘only’ 2.3bn RMB in the operating business (versus 2.8bn in 1Q) – I am giving credit for cost cuts, etc – then the cash out of the business (working capital + cash burn) is still a heady 3.5bn – or around $500mm USD.

In other words – by the end of March – that is, basically today –  NIO will have burnt, through the business and the supply chain, more than the $435mm they raised in the last couple of months (forget repaying any of the debt of course!). This all but necessitates ongoing, further dilutive financings…the only difference being that the broader environment has now changed (hello, coronavirus and attendant melt-down in global debt markets) and NIO’s stock is $2.6 not $4.5. So the idea that NIO can progressively tap capital from Asian funds at similar spreads is – to me – ludicrous. I fully expect new convert deals to price with strikes lower than $2, and to occur every month hereafter.

The Hefei ‘bailout’ – smoke and mirrors? Or game over for NIO Inc?

There is one potential ‘hail-mary’ of sorts, and that is the ‘announced’ Hefei bailout (see here for a news article). If this deal ever closes, there is the prospect of a large amount of capital to see NIO through at least 2020 – good news, right? Not so fast. So far we have heard or seen no binding terms and these discussions have been going on for the better part of a year with local Chinese governments – to me there is considerable risk Hefei ever tips in the cash. Furthermore, on the recent earnings call, NIO executives made it very clear this $$, if it enters the business, will be to recapitalize NIO China, not NIO Inc (the ADR offshore entity). Since all the $1bn+ in cash is supposedly earmarked for fixed-asset investment and to create jobs locally, I cannot see how or why Hefei will allow it to cash out existing ADR debt/converts; or to fund ongoing business cash burn. In other words there is a reasonable chance that the NIO China transaction, if/when it is formalized, is akin to an out-of-court restructuring where NIO Inc offshore stock and bondholders take significant if not full impairments to their investments. Have a read of the 4Q transcript – to be fair to NIO’s executives, they laid it out in fairly vanilla terms. Perhaps that’s the real reason NIO included the going concern language in their recent two quarterly filings?

Maybe this is also why Chinese banks – who were previously large lenders to NIO Inc – have progressively cashed out of the business over recent quarters. By my math, they have reduced their exposure from a peak of >3bn in 2018 to 1.7bn today – including >500mm in reductions during 4Q alone (when the company was starving for cash). Why would domestic lenders be so wary of supporting a Chinese company that was apparently on the brink of a state-sponsored bailout/cash injection? Why was NIO forced to tap hideously expensive offshore financing all along?

Suffice to say, NIO is still a high conviction short, and still, in my mind, an equity donut. This has lasted longer than I expected, but still ends at zero, and probably in 2020.

Disclosure: short NIO