How High Can Tesla Fly? Part Two: Mass Market

Alexander is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

After Tesla Motors (NASDAQ: TSLA) reported that it will be profitable for Q1 2013 on both a GAAP and non-GAAP basis, investors bid shares of the automaker higher causing the stock to break through the $40 per share level. With this news out, many investors are more confident in Tesla’s ability to succeed as an automaker and are wondering what could be in store for investors in a successful Tesla. In this article, we recognize the challenges that will continue to face Tesla, but we will examine what Tesla can become if it handles these challenges like it has handled the others this underdog automaker has so often beaten. After looking at Tesla’s future as a luxury automaker, here we will examine Tesla’s potential as the mass market producer of electric cars it hopes to become.

Stage two: Mass market automaker

One of the biggest criticisms of Tesla Motors is that the company is only building cars for the one percent. First of all, many Tesla owners are not part of the one percent and are upper middle class individuals who finance their car and take energy savings into account. Second, Tesla’s decision to develop cars for the high end of the automotive market does not stem from a sort of electric elitism, rather it is the easiest way for a start-up automaker to turn a profit.

To survive in the tough world of automotive start-ups, Tesla needed to produce a car to get their name out (Tesla Roadster) and then another to earn profits while producing a relatively small number of cars compared to major automakers (Tesla Model S). But the automaker’s plan from its founding was to eventually produce a car for the mass market. With the Gen III sedan on its way in a few years, we must look even beyond this car to see a Tesla available in the sub $30,000 range.

Among the best known “electric cars” on the road today is the Chevrolet Volt, developed by General Motors (NYSE: GM). I wrote “electric cars” is quotations because the Volt is not actually a pure electric car. With a range extending gas engine, the Volt is actually a plug-in electric hybrid that has about 40 miles of range on battery power alone. GM cuts its sales targets for the Volt after initial sales failed to live up to expectations. But sales have been increasing year over year suggesting demand for the $30,000 range Volt is picking up.

However, GM cannot be judged on sales of the Volt alone. Even the target of 45,000 Volts sold annually pales in comparison to the millions of conventionally powered vehicles the company sells. Sales of EVs have a similar effect on Toyota (NYSE: TM). Toyota has introduced a plug-in version of its now commonplace Prius gasoline-electric hybrid as part of an expansion of the Prius line from one Prius to four. But Toyota sells millions of other vehicles so the plug-in Prius sales serve mainly as a way to build the Prius image and run a real world test of the automaker’s EV technology.

When Tesla comes to the mass market, it will probably happen in stages as the automaker introduces new models one by one. In this way, Tesla will not spring into Toyota overnight and the entire process of entering the mass market and building a full line-up could easily take more than a decade. But it is worth taking a look at what Tesla hopes to become as part of an ultra-long term horizon on a Tesla investment.

The General and Tesla

Does Tesla want to become General Motors? The Silicon Valley carmaker seems to like the scale of GM and the profits that could be produced. But throughout its history, Tesla has made its image of being the anti-GM. Where GM has aging factories in Detroit, Tesla has the relatively modern former NUMMI facility in Fremont, California. Where GM sells gas guzzling SUVs, Tesla sells all electric passenger cars. And where GM has giant car dealer lots, Tesla has sleek Apple-esque stores inside shopping malls. In short, Tesla wants the scale of GM without the other things associated with the mega manufacturer.

As of now, GM and Tesla couldn’t be more different in their valuations. GM is valued at 9.4 times earnings suggesting investors are not willing to pay as much for it as they are for Toyota and Honda which trade at 21.6 times and 18.7 times respectively. In contrast, Tesla has yet to report a full year of positive earnings giving it a meaningless P/E ratio and a forward P/E ratio of nearly 30 times (source: yahoo finance). While neither GM nor Tesla pay a dividend, their reasons for doing so are quite different. GM has just emerged from a bankruptcy coupled with a government bailout, whereas Tesla is using all the cash it can to fund the development of new models and repay the Department of Energy loan it received.

The Toyota-Tesla tie-up

Among the major automotive players, the closest comparison for Tesla may be Toyota. For the last few years, the two automakers have worked closely together with Tesla supplying parts for Toyota’s EV program. As part of a financing agreement, Toyota purchased $50 million in Tesla stock giving the mega automaker a small equity stake in the company. But perhaps the biggest help to Tesla was Toyota’s sale of the former NUMMI facility to Tesla for only $42 million.

Despite being rivals for the top of the sale charts, Toyota’s market cap is roughly five times the size of GM’s. At $187.4 billion, Toyota is an automotive giant that swiped market share right out from under the Big Three’s noses by producing reliable cars that gained acceptance among the car buying public. But it took decades for Toyota to become what is has today and unless Tesla invents something beyond revolutionary, Tesla will have to work hard for a long time to get anywhere near the size of Toyota.

Investors interested in a Toyota-sized Tesla must have extremely long investment horizons. But for those who do, if Tesla succeeds, they could be richly rewarded. With the current 114.5 million shares outstanding at market cap of Toyota’s size on Tesla would make shares worth about $1,600 per share. By this time, however, it is reasonable to expect share dilution from capital raises and option exercises to increase the total shares outstanding. In examining Tesla as a luxury automaker in a previous article, I used a ten percent increase in the share count but since mass market success would occur farther is the future, I will approximate a twenty percent increase in outstanding shares. With the same Toyota-sized market cap, Tesla shares would be worth about $1,400 per share under this situation. Additionally, Tesla may even begin paying a dividend like Toyota does now in an effort to return capital to shareholders.

Going this far out we do have to keep in mind that the global automotive market will be larger by this time and a company Toyota’s size will likely be worth more. Consequently, Tesla shares may exceed the estimates above on this basis. However, looking this far out investors need to factor in inflation over that same time period, another factor that remains unknown. As a result, these are only general estimates about what a fully expanded Tesla could be worth and should not be taken as set in stone.

Building an electric future

Few companies have attracted so much interest from both the long side and the short side as Tesla Motors. With longs insisting the automaker has a bright future ahead of it and shorts worried about the financials at the company, this electric car maker has become center stage for the electric car debate. While there are still challenges ahead, the sky looks clearer for Tesla than it ever has before. And by analyzing the values of comparable automakers, we can see that Tesla has the potential to not only change what we drive, but to grow our portfolios through its financial success.

Alexander MacLennan owns shares of Tesla Motors . The Motley Fool recommends General Motors and Tesla Motors . The Motley Fool owns shares of Tesla Motors . Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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