Why Canoo Cares About Customer Credit Ratings
On more than one occasion Canoo's CEO Tony Aquila has talked about the credit rating of their business customers. Quoting him from the Q&A portion of the Q3 FY22 ER, Canoo is "only focused on grade A, triple B credit customers...because we'll finance those POs at range that gives us favorable cash flow from when we start to produce those orders."
What he is referring to is known as 'Purchase Order Financing' or 'PO Financing'. Why would Canoo need or want to use this tool and what does it have to do with customer credit ratings?
Having large purchase orders come in is obviously really good for companies. The PO is issued from a buyer to a seller, the seller(in this case Canoo) needs to pay suppliers and vendors immediately in order to begin production of said product, but the buyer(Walmart for example) isn't going to pay upfront as they might have lengthy payment terms up to maybe something towards 120 days. Walmart will not be placing a single order for 4500 vehicles, they'll come in smaller batches. However, with such an expensive starting price even a smaller batch could disrupt operating cash flow and present problems for fulfilling said orders.
Being able to get the POs financed and paid upfront by a 3rd party provides funding for Canoo to pay their suppliers and smooth out cash flow. This won't come without some downsides of course, these 3rd parties won't be financing the POs out of the goodness of their hearts, they will exact a fee to provide their services. This is why Tony mentioned Canoo is focusing on Grade A or BBB credit customers; the better the credit rating of the customers means there is less risk associated with them not paying for the orders which in turn means better financing terms for Canoo as less risk equals lower fees.
We should point out that the fees mean that each vehicle is in turn more expensive and hurts margins. The automobile industry is notoriously low margin and typically the profit comes with scaling up production volume considerably which takes time. We don't know what kind of margin Canoo is expecting to make but we assume initially there will be slim to 0 profit margins, until the operation scales. By smoothing out their cash flow, PO financing will allow Canoo to focus on delivering a solid product and ensuring happy customers without being bogged down trying to manage volatile cash reserves.
To put a bow on the topic, we really want to emphasize the following: PO financing is non-dilutive and we're happy to see that Canoo is including this valuable tool in their financial toolbox to use when the time is right.
Authors disclosures: I am long Canoo - I own common shares, warrants and call options.
#Financing #Walmart #Manufacturing