Tesla – Electric Dream or Shocking Nightmare?
Ian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Fans see a car from Silicon Valley far closer to the dream cars of Maranello, Munich or Newport Pagnell than to anything from Detroit.
Detractors contend that any vehicle requiring an hour to recharge is hopelessly impractical and will never attract the mass market, especially when you take into account the high manufacturing cost of electric vehicles.
But perhaps the problems of "range anxiety" have been a little overstated. According to a study by Columbia University, 98% of all single-trip journeys are less than 50 miles in length, and trips over 70 miles account for just 1% of all single-trip journeys. The Tesla Model S has a range of up to 300 miles. Drivers making long journeys will usually take a break of an hour or so to eat and freshen up, ample time to recharge (for free!) using Tesla’s ever-growing supercharger network. For the vast majority of the time, the Tesla will recharge at home overnight – eliminating the tiresome trip to refill with fuel every week or so. Far from being an inconvenience, the real ownership experience is actually an improvement over that of running a car based on liquid fuel.
Let’s put aside for the moment the question as to whether Tesla will eventually succeed and look at what sort of return we could get from an investment.
Tesla has a market capitalization of $3.9 billion, loses money, and has revenue of $413 million. It has a price to sales ratio of 10.7. For an early stage internet stock with a bright future ahead this would be acceptable. But for a low-margin automotive manufacturer this is somewhat troublesome. By comparison Ford has a P/S ratio of 0.38 and General Motors has a ratio of 0.25. Is there more to this story?
Tesla is currently just starting a massive ramp up in sales. Revenue in the 4th quarter, on sales of 2,400 cars, was up 500% from that of the previous quarter. If expected production targets of 20,000 units are reached in 2013, this would equate to sales of $1.7 billion at an average selling price of $85,000. Musk estimates world demand at about 40,000 vehicles per year. If we assume that the company reaches that production target in 2014 it would result in a turnover of $3.4 billion for model S sales. The Model X will come on stream next year, if that produces similar revenue to the model S, we should reach revenues of $6.8 billion. In another year or so, a mass market car at $35,000 selling 100,000 units would add another $3.5 billion for a total turnover of $10.3 billion.
So what would that mean for the share price? Keeping things simple, a net margin of 10% and a P/E of 10 would give a market cap of $10.3 billion, or a share price of around $91 as compared to $38 at the time of writing.
At that point, Tesla would have about a fifth of the market capitalization of Ford. So if you are a real believer, you may see further room for significant growth into the future.
It is clear that if things work out, this stock could produce very good returns for the investor. But these numbers look ambitious and this is a very big IF.
The first big question is, ‘Can you believe in Elon Musk?’.
Let’s look at some of the things he said in a recent lecture at Oxford.
"It was clear that the internet was going to be something important for the future ... it would fundamentally change the nature of humanity ... would be like humanity gaining a nervous system ... I wanted to be part of building that."
"I wanted to pursue the two other things I thought that would most affect the future of humanity ... sustainable energy; arguably the most pressing problem of the 20 century ... the other one was the extension of life beyond earth."
So you may think, oh yeah, this guy is just a delusional idiot – he thinks he can single-handedly change the world.
Until, that is, you look at the facts.
He was part of building the internet, creating two successful internet companies, the second of which – PayPal – has played a major part in revolutionizing online commerce.
And what about "the extension of life beyond earth?"
Musk’s SpaceX company has been delivering payloads to the International Space Station and has contracts in place with NASA for delivering astronauts to orbit. And his plans for creating a self-sustaining colony on Mars are already in the early stages of execution.
As for "sustainable energy," his company SolarCity is a leader in the field. Of course, Tesla itself aims to make a major contribution by eliminating the need for cars to burn hydrocarbons.
So this is a guy that not only thinks big, but also delivers big. Perhaps his record of flawless execution at Tesla is no fluke.
The next big question is ‘How can a car company produce the sort of margins needed to justify the valuation?’
Here's an analogy: my background is in software. I always avoided selling hardware because "everybody knows" that hardware is a low-margin, high-maintenance business – a mug’s game. And then this company called Apple came along...
I have heard the Model S described as "Aston Martin on the outside – Apple on the inside." Steve Jobs used a phrase about the positioning of his products: he wanted to ‘impute value’. By selling through classy stores in fashionable retail locations, and by pursuing an absolute determination to focus on quality and service Tesla is imputing value. And that value will be realized in the margin Tesla will make on its sales.
The margin is an important factor when we consider how Tesla stands up as compared to other domestic manufacturers such as Ford (NYSE: F) or General Motors (NYSE: GM). The Model S is a luxury vehicle that doesn’t just compete head to head with rival, traditional vehicles – it comes out winning - as evidenced by the recent Motor Trends ‘Car of the Year award. It is important to realise that Tesla could not compete in any other section of the market. Starting at the high-end is a super-smart move as it allows them to maintain high margins and generate the cash needed to complete their development programme and fulfil their goal of launching a high-volume/low-price vehicle, the ‘Gen III’. (See The Secret Tesla Motors Master Plan (just between you and me) note the date - 2006)
The approach taken by Ford and GM is somewhat different. Their starting point is their existing low-end models. The Ford Focus Electric has just 76 miles of range at a retail price of $39,200. GM’s Spark EV is likely to have a 70 mile range at a price under $25,000 - a little closer to a sensible price point, but the car is small. GM is making noises about an EV with a 200 mile range, but details are sketchy.
These compact, anaemic vehicles are hardly inspiring. Perhaps that is the point. Traditional manufacturers just cannot get excited about electric cars. And it shows. Because of government directives and incentives, they feel they have to run an EV program, but I get no feeling of real conviction or enthusiasm behind it.
Can Tesla maintain an innovative lead over larger competitors with far greater resources? When it comes to innovation, I‘ll back the guy who just sent a rocket to the international space station over the guys who have spent the last hundred years doing the same thing - especially when that guy has a driving passion for the product and a 24% stake in the company.
So that raises the question, what will it mean for traditional automotive manufacturers if Tesla succeeds and the ‘Gen III’ ultimately becomes a reality? This is a question with big implications that traditional producers such as Ford and GM don’t seem to have grasped.
Imagine a scenario where you have a choice between 2 cars equivalent in price and appearance. The difference is that one uses expensive fuel, which is only available at specialist outlets and has complicated mechanics that require expensive, regular maintenance. The other conveniently recharges at low cost at your own home, requires very little maintenance, produces no cancerous gases, and has much superior performance and handling. Under this scenario, the car based on the internal combustion engine looks about as relevant and attractive as a PC requiring a floppy disk drive. And conventional manufacturers, whose competitive edge comes from 100 years of experience developing and refining their combustion engines, will find it as useful as Kodak found 100 years of experience in photographic film when the digital camera arrived.
Investors in any conventional automotive manufacturer will need to keep a close eye on the development of electric vehicles. When change comes it tends to come swiftly.
As for Tesla investors, will they be living the dream, or sleepwalking into a nightmare? If Tesla can overcome the perception of "range anxiety," and avoid any serious production glitches, its execution to date is certainly encouraging.
Risky? Yes. But for me the dream lives on.
Ian Richards owns shares in Tesla, has sold puts on Tesla, and owns options to buy shares in Tesla.