I’m more than a little surprised that Nio (NYSE:NIO) stock has traded so well of late. Certainly, shares have seen significant volatility amid the gyrations in the broad market. But the stock at least has held up, trading down less than 4% year-to-date.
I’d have expected a much bigger decline. I thought NIO stock was overvalued at the start of the year to begin with.
It would seem a prime candidate for selling given both the impact of the coronavirus on the Chinese economy and the “flight to safety” we’ve seen in recent weeks. That hasn’t quite happened even though shares have pulled back from their highs.
I still believe that case for Nio is too thin, however. And the good news simply isn’t that good. I’ve been surprised NIO stock has held up so far, and I’m skeptical it will much longer.
There are some pieces of good news so far in 2020 to which NIO bulls can point.
First, U.S. counterpart Tesla (NASDAQ:TSLA) has been one of the market’s best stocks. Tesla has gained 79% so far this year. Among over 700 stocks with a market capitalization over $10 billion, that’s the third-best YTD performance. (Interestingly, a Chinese name, GSX Techedu (NYSE:GSX), has been the best large-cap performer with a 96% gain.)
Those gains should bleed over to NIO to at least some extent. Many investors valuing NIO use Tesla as a comp. NIO shouldn’t, and usually, doesn’t, get the same valuation as its American peer, just as Alibaba (NYSE:BABA) trades at a discount to Amazon (NASDAQ:AMZN). Still, a higher valuation for Tesla stock does suggest at least the potential for a higher modeled price for Nio stock.
More importantly, Nio has raised a significant amount of capital. With a $235 million convertible bond issuance on Thursday, the company now has issued $435 million in bonds so far this year.
But the big prize was a $1.4 billion investment from the municipal government of Hefei in China’s Anhui province. With over $1.8 billion in cash raised, the funding issues that raised investor concerns seem to be past. Nio can invest in its business as it tries to achieve dominance in the high end of the Chinese luxury electric vehicle market.
But a closer look suggests the good news isn’t quite as good as it seems. Yes, TSLA stock has soared — but in part due to its own entry into China. Tesla in fact plans to build its Model Y in Shanghai. That company already has annual production capacity of 150,000 units at the factory. Nio, which doesn’t even manufacture its own vehicles, has sold less than 34,000 cars ever (as of the end of January).
As for the funding, there are issues as well. $1.8 billion is a solid amount of capital to raise. But Nio has been burning between $300 million and $400 million in cash every quarter. Headcount reductions should lower that burn rate, but it’s still possible Nio bought itself only two, and maybe three, years’ worth of time.
Even that ignores the fact that the Hefei deal will require Nio to move its headquarters and no doubt meet employment targets. Both requirements will eat some of the cash raised. The terms of the convertible offerings show Nio’s negotiating leverage is limited.
The offerings are short-term capital raises — Thursday’s offering matures in a year — at high costs. The bonds convert into equity at substantial discounts to the current price; indeed, the $235 million offering converts at a price about 10% below Wednesday’s close, implying an effective interest rate in the 11% range.
Nio’s existing bonds, meanwhile, trade at yields to maturity around 17%. The debt markets aren’t always correct, but they, too are signaling a company in financial distress. If the Hefei deal — which hasn’t yet been signed — falls through, Nio will be in even more trouble.
The Path Out to NIO Stock
Looking forward, the path for Nio simply seems too difficult. The company has to drive enough sales growth to keep investors funding the business until free cash flow turns positive, which will take years.
There’s no room for error. Nio has been looking for capital for months, yet in the public markets only managed to raise less than a year’s worth of cash on onerous terms. Further capital from the government is unlikely (though the central government may restore electric vehicle subsidies, which could provide a boost to demand). Nio still has a cash problem, even assuming the Hefei deal closes.
And growth is not guaranteed. Tesla will be a fearsome competitor. General Motors (NYSE:GM) this week launched its line of electric vehicles, many of which will be sold in China. Those are far from the only rivals. As of last year, there were nearly 500 EV manufacturers registered in China, some of which are state-owned. Industry leader BYD (OTCMKTS:BYDDY) benefits mightily from support from its own provincial government.
Of course, in the short-term, the spread of the coronavirus in China adds another source of pressure. Nio’s January deliveries were down 11% year-over-year. Numbers in February and March no doubt will be even worse.
This is not a company that can afford even a pause in demand. Lower sales will accelerate cash burn and further weaken the balance sheet.
So far equity investors have mostly shrugged off these worries. I don’t think they’ll do so forever. For all the hype, Nio simply is a niche electric vehicle manufacturer with a weak balance sheet and intense competition. That’s not enough to support an equity value that still sits at $4 billion. Truthfully, I’m not sure it’s enough to keep the company out of bankruptcy.
Vince Martin has covered the financial industry for a decade for InvestorPlace.com and other outlets. He has no positions in any securities mentioned.