We live in a world where many people (or as I call them sheeple) blindly follow "smart" people. Two recent examples we all know were when many investors followed billionaire hedge fund managers on their out-of-touch bets. Bill Ackman, a very active, long position on JC Penney (JCP) and David Einhorn, a very loud, short position on Chipotle (CMG). At a broader level, HFRX Global Hedge Fund Index returned just 3.5 percent in 2012. By comparison, the S&P 500 Index returned 16 percent.
I believe there is another company many "financial pros" miscalculated as well, Tesla Motors (TSLA). Not any high profile ones like Ackman or Einhorn but a lot of the "young guns", all shorting Tesla, holding on with their dear lives although the company has been on a very successful path. According to the Nasdaq website, Tesla has 47.75% of its float shorted as of April 12th, which would take about 23 days to cover based on average daily volume. Is this the epic short-squeeze people will still be talking about years from now? I think so, but let's look at the reasons why people have taken short positions on Tesla…
Tesla is the epitome of a controversial stock. It has been on the news for almost a decade, way too often for a company of its size. Most of these news were negative although Tesla's mission is clearly a very positive one, "To increase the number and variety of electric vehicles available to mainstream consumers in order to speed up humanity's move from a mine-and-burn hydrocarbon economy towards a solar electric economy, which is the primary, but not exclusive, sustainable solution."
Electric vs. Internal Combustion Vehicles, Carbon Emissions
There have been numerous studies proving electric vehicles (EVs) cause significantly less carbon emissions than their Internal Combustion Engine (ICE) counterparts. This varies on how electricity is produced in a region. In California where the top three sources of electricity production are natural gas, hydro and nuclear power, an EV produces 4,000 lbs of CO2 equivalent annually vs 13,000 lbs by an ICE car (70% less). National averages, on the other hand, show coal, nuclear and natural gas as the top three sources for electricity and 8,000 lbs of CO2 equivalent caused by EVs vs 13,000 lbs of CO2 equivalent by ICE cars (30% less). Experts also mention inefficient coal-fired plants are rapidly being replaced by cheaper-to-build natural gas and renewable energy plants. This progress along with Tesla's expanding SolarCity-powered, free-forever "Supercharger Network" should improve these numbers substantially in coming years. Another very important point, Europe is impressively ahead of US in reducing per capita CO2 emissions, 7.5 tons vs. 17.3 tons (57% less). EVs will definitely help accelerate our transition into renewable energies.
Fossil fuels are non-renewable, limited in supply and will one day be depleted. We can't get excited about short term reserve increases and forget about the inevitable end. Even if we are extremely short-sighted and selfish (think about your kids and their kids), many oil experts point out that increased oil production in the US won't mean cheaper gas since oil is traded globally and thus won't have much impact on global prices. Also since drilling for oil is such a capital intensive business, especially in recent unconventional wells, prices can never decrease significantly. Very simply, non-renewable resource vs. renewable resource, limited vs limitless. Aren't conservatives the ones claiming spending, even in the short term, to jolt the economy is bad? How is spending a limited resource in the long term as if it will never end a smart move?
Electricity vs Gas, Savings over 10 years in US & EU, Tesla vs BMW M5, Audi A7, Mercedes E63
GAS vs ELECTRICITY
|
M5 / A7 / E63 AMG
|
Model S 60 Kwh
|
Model S 85 Kwh
|
EPA Rated MPG (City/Hway Combined)
|
19
|
95
|
89
|
Miles Driven Annually (National Average)
|
12,000
|
12,000
|
12,000
|
Cost in 1 Year
|
$2,501
|
$500
|
$533
|
Total Cost in 10 Years (US)
|
$25,010
|
$5,002
|
$5,339
|
Model S Savings over 10 years (US)
|
$20,008
|
$19,671
| |
Total Cost in 10 Years (EU)
|
55,768
|
$7,086
|
$7,564
|
Model S Savings over 10 years
|
$48,682
|
$48,204
| |
***US Avg. Premium Gas / Electricity Price
|
$3.96/gallon / 0.12/Kwh
| ||
***Europe Avg. Premium Gas / Electricity Price
|
$8.83/gallon / 0.17/Kwh
| ||
*** Tesla is scheduled to begin production of Model S for Europe in June and deliveries in July 2013, followed by Asia deliveries in Q4. Looking at above table and seeing the electricity vs gas savings over 10 years, investors should be very excited. I wouldn't be surprised if Model S Europe sales exceed US sales towards the second half of 2014.
*** Let's not forget about GEN III. ~$20K savings in US over the lifetime of the car means a ~$30K Tesla sedan is almost paying for itself in long term. In Europe, GEN III will not only pay for itself but save the customer a handsome ~$18K to spend elsewhere.
Tesla's Master Plan
Auto manufacturers tried producing unattractive, low-price electric cars for decades and constantly failed. Tesla took a different approach that makes much more business sense to me as well.
Simply put, producing a high-price/low-volume "concept" car (Roadster), followed by a mid-price/mid-volume car (Model S), and finally a low-price/high-volume car for the masses (Gen III).
Tesla is two thirds into this plan and things are going much better than most people expected, including me.
Main negative arguments against Tesla
1. Advanced Technology Vehicles Manufacturing (ATVM) Loan Program
ATVM Loan Program was chartered by Congress and signed into law by President George W. Bush in 2008. As part of this program, Ford (F) and Nissan (NSANY.OB) received $5.9 billion and $1.9 billion respectively which makes Tesla's $465 million loan look like pocket change. On March 7, 2013, Tesla announced it will be paying this loan back 5 years ahead of schedule.
Many conservatives including Mitt Romney, Sarah Palin, and Bill O'reilly have called Tesla a "loser", claiming this loan was a part of "Another failed Obama program", "Another reason why government should never interfere in economic affairs". What do you think they will say when they see tens of thousands of all-American made Tesla Model S rolling around in the US and the world?
2. Electric cars are unappealing, slow, short-ranged… (Pre-2006)
Enter Tesla Roadster, a sexy, 0-60 in 3.7 seconds sports car with 244 miles EPA rated range. Roadsters were built with Tesla drivetrains on Lotus Elise influenced chassis and have been on the roads around the world for about five years now.
3. Tesla would never be able to produce a car from scratch
Say hello to my Tesla Model S, made entirely by Tesla Motors in California and selected "Car of the Year" by Motor Trend, Automobile Magazine, Yahoo Autos and many others. It's truly the Car 2.0. Until riding in one, nobody should be allowed to write an article about Tesla, nobody.
4. Tesla targets a niche market and will always stay a rich liberals' toy
Elon Musk and Tesla corporate strategy repeatedly said their goal is to mass produce electric cars. Musk also confirmed many times that the company is already working on Gen III, a ~30K sedan, in his own words "Slightly smaller than Model S, 200+ mile range and with some really cool tech that we can't talk about yet".
5. "Range Anxiety", "EVs can't be used for road trips"
- According to DOE, 96% of daily commutes in US are less than 20 miles, even if you add running errands, dropping and picking up kids from school, etc. Tesla is clearly safe here with its two range options, 215 and 265 EPA rated MPG. Since you can plug in every night and wake up to a fully charged car, there is no range anxiety for daily use. So long gas stations, it's been real!
- Regarding road trips, let's be honest, many of us opt for flying since it costs almost as much as gas and it's much more convenient. Let's not forget most families own multiple cars so they have the option to drive the second one for the occasional road trip. But if you do go on monthly road trips, Tesla is working on that too. It's building the aforementioned Supercharger Network, which is free forever for Tesla customers thanks to SolarCity panels. They can fill up 150 miles of charge in 30 minutes, 300 miles in an hour. Most people stop to fill up gas, use the bathroom and get a bite to eat every 3-4 hours of driving anyway so supercharging sounds great. (Did I mention it's free forever?) 8 of these stations have been officially open and used by drivers since October 2012. Tesla was originally targeting to have over 100 of these stations in the most strategic points in continental US by end of 2015 where coast to coast traveling will be easily achieved. Elon Musk mentioned in Geneva Auto Show that he has very exciting news about the Supercharger Network expansion in US and Europe so stay tuned.
6. "Battery replacement costs", "Bricking" and "Energy storage depreciation over years"
All Tesla batteries have solid warranties. Model S 60kWh version is covered for 8 years or 125,000 miles, whichever comes first. The largest battery, 85 kWh, is covered for eight years and unlimited miles. A Battery Replacement Option allows you to pre-purchase a new battery to be installed after eight years for a fixed price: $10,000 for 60 kWh batteries and $12,000 for 85 kWh batteries.
Man, I wish we had some extreme, real life statistics on battery depreciation, it's really freaking me out not to know what would happen in the worst case. Wait, what? There's a crazy German dude who drove his Tesla Roadster for ~160,000 miles under 4 years? You can't make this stuff up, I mean who drives a $120K sports car more than 40,000 miles a year? Well, apparently Hans does. You might have to ask Google to translate the article from German depending on your browser settings. But here's the summary,
"A well-known Roadster driver, Hansjörg von Gemmingen has driven his Roadster for more than 160'000 miles in 4 years and is at battery depreciation rate of 70%."
Now, this guy is clearly an exception and he abused his Roadster to a point no Model S owner will. Taking into account Model S battery technology improvement since the Roadster, we can conclude battery depreciation over the warranty life will not be significant enough to be worried about. Plus, Model S won't have all the wear and tear of an ICE car in the long term. No engine, no transmission, spark plugs, valves, fuel tank, distributor, starter, clutch, muffler, catalytic converter... According to howstuffworks.com and many other experts, "Electric cars require considerably less maintenance than gas-driven cars, about one-third."
7. Lithium Ion Batteries are dangerous, Tesla will have the same issues Boeing is having
Boeing's (BA) 787 batteries suffer from "Thermal Runaway", a condition in which the temperature of a battery cell starts to rise dramatically and the heat spreads quickly to other cells inside the battery. Boeing uses a battery with a grouping of 8 large cells; Tesla's batteries contain ~7,000 smaller cells that are independently separated to prevent fire in a single cell from harming the surrounding ones. Tesla uses its own (patented) thermal management and safety system. In case of a thermal runaway, this system will immediately shut down cells surrounding the problematic one and display an alert to the driver as well as sending an alert to Tesla Service Center for the battery to be examined.
Unfortunately, the pack architecture supplied to Boeing is inherently unsafe. Large cells without enough space between them to isolate against the cell-to-cell thermal domino effect means it is simply a matter of time before there are more incidents of this nature.
He also concluded, "They [Boeing] believe they have this under control, although I think there is a fundamental safety issue with the architecture of a pack with large cells. It is much harder to maintain an even temperature in a large cell, as the distance from the center of the cell to the edge is much greater, which increases the risk of thermal runaway."
Roadsters (which have an older version of the battery and the Tesla thermal management system) have been on the roads around the world for 5 years now. There has been one battery fire incident so far, one customer called and reported a smoke and possible fire behind the right front corner of his vehicle. The customer was driving by a local fire station, where the fire was extinguished.
Tesla engineers figured out the problem, a 12-volt cable was improperly routed, allowing it to be pinched or abraded. This only applied to Roadster 2.0 and 2.5 versions. Tesla recalled these 439 Roadsters and fixed the problem, no incidents reported since. And again, with the improved battery and thermal management system in Model S, this small risk is further minimized. There have been 149,458,000 auto recalls in US since the year 2000. Hopefully neither Tesla nor other auto manufacturers run into many of these, but if they do, they will recall and fix it. Thus this isn't only a risk to Tesla but all auto manufacturers. I should also mention that Tesla Model S received 5 stars in its NHTSA crash tests.
Tesla's Revolutionary Leasing Model (or Financing Model)
So none of the major negative arguments holds up and Tesla's plan is working successfully. Tesla is also ahead of schedule in Model S deliveries in 2013 and became profitable on both GAAP and Non-GAAP basis. Then came even better news, you can now "lease" a Model S with Wells Fargo and US Bank, under 3% interest and no down payment (other than the federal tax credit and/or state credits). After 36 months, you have the option to keep the car or sell it back to Tesla with the same residual value percentage as Mercedes S Class. This value is not only guaranteed by Tesla but also personally by its billionaire CEO Elon Musk. Wow, great deal, you're building equity while "leasing" the car and have the option to keep or give it back at a max. value. This will help many shoppers that don't have $60-$70K to drop and/or skeptical about electric cars' future. Once again, Tesla seems to be flawless.
Tesla's First Mistake
When I got on the Tesla website and saw the "$500 PER MONTH" sign and "TRUE COST OF OWNERSHIP" calculator, I knew something was off. First of all, Model S is truly Car 2.0 and even if you compare it to Audi A7, BMW M5 and other cars in its so-called segment, why promise a $500/month payment? You have an amazing product that's much better than all of the $800 - $1200/month products that won't let you build equity while "leasing", don't guarantee a resale value so why promise something like this? And then we get to play with the "magical" calculator which first takes into account some real, long term benefits such as "EV INCENTIVES", "ELECTRICITY vs GASOLINE". But the marketing disaster starts when you see the out-of-touch "benefits" such as "BUSINESS TAX BENEFIT", "SHORTEN YOUR COMMUTE" and "AVOID THE GAS STATION". I'm not a tax expert but writing off a family sedan as a business tax deduction sounds pretty welcoming for an audit. Assuming time spent pumping gas and saved using carpool lanes at $100/hour is also wrong on Tesla's part. (Recently changed to $50/hour on the website) These are definitely nice to haves, having a car with full range every morning and not having to go to gas stations, being able use carpool lanes at all times, etc. but displaying them at $100/hour to new, interested customers is just plain stupid and out of touch. Especially for a very young company that's trying to win over customers. Great job Tesla Marketing team, you made a lot of naysayers very happy and many investors like me feeling embarrassed. The last thing Tesla needed was to look like a sleazy car salesman and you made that happen. Tesla is battling Auto Dealership Associations, not trying to look like them.
I really hope Tesla will correct this $500/month sign and the dubious calculator. As Confucius said, "If you make a mistake and do not correct it, this is called a mistake".
Tesla Roadmap and Pricing Model
The best thing about being a Tesla investor is knowing the product roadmap and product details for the next 3-4 years. I haven't seen this "luxury" with any other company so far. You can build a pricing model based on the scheduled product launch times, your knowledge of company's income statement and estimates for global deliveries. Below are the summary of my model and points to consider.
Full Year 2013
|
2014
|
2015
|
2016
|
2017
|
2018
|
2019
| |
# of Cars Delivered
|
22,250
|
30,000
|
40,000
|
75,000
|
150,000
|
250,000
|
500,000
|
Total Revenues
|
$1,958,750
|
$2,550,000
|
$3,310,000
|
$4,445,000
|
$7,830,000
|
$11,340,000
|
$22,600,000
|
Gross Margin
|
25.00%
|
25.00%
|
25.00%
|
25.00%
|
25.00%
|
25.00%
|
25.00%
|
Net Profit / Loss
|
$209,556
|
$312,915
|
$429,915
|
$590,828
|
$1,130,055
|
$1,474,875
|
$3,269,301
|
Net Profit Margin
|
10.70%
|
12.27%
|
12.99%
|
13.29%
|
14.43%
|
13.01%
|
14.47%
|
Net Profit/Loss per Common
Share (113,763 shares) |
$1.84
|
$2.75
|
$3.78
|
$5.19
|
$9.93
|
$12.96
|
$28.74
|
Estimated Average P/E
|
40
|
40
|
40
|
40
|
40
|
40
|
40
|
Estimated Average Share Price (Minimum)
|
$73.68
|
$110.02
|
$151.16
|
$207.74
|
$397.34
|
$518.58
|
$1,149.51
|
1. This model is based on Tesla's "mega" factory in Fremont; CA. NUMMI, New United Motor Manufacturing Inc. Tesla purchased this ex GM-Toyota plant for $42 million, which is less than 5% of its $1 billion value. Current production takes only a small part of the factory and NUMMI has the capacity to produce 500,000 cars annually hence no further capital expenditure needed. (Tesla's Tilburg Plant in Holland will only be used for assembling parts produced in NUMMI Plant.) I'd highly suggest this NatGeo documentary on NUMMI.
2. I held things pretty conservative for the first three years since Tesla will still be working on production ramp-up, increasing efficiency/margins, improving customer service, marketing, etc. Also the epic short-squeeze will seriously affect these numbers.
3. Production rates can be increased by adding a second shift.
4. Model X demand may be higher than expected.
5. GEN III production may begin ahead of schedule.
6. I also kept P/E at 40 which is pretty conservative for a high growth company in a world where investors are crazy enough to jump on Facebook (P/E ~1700), Linkedin (P/E ~900),etc.
7. Can analysts please stop comparing Tesla to Detroit's Big Three for evaluation purposes? Tesla isn't weighed down by unions, health-care liabilities, pension liabilities, decades of bureaucracy, etc. It's more of a very lean Tech/Auto company thus its margins will be much more impressive.
Major Risks Associated With Tesla
1. A major recall, a mechanical one that is. I said mechanical since most of the car's functions are controlled by a computer with 17" touch screen and it's wirelessly upgraded in case of a bug or a feature to be added. For instance, when first Tesla drivers said they miss the "creep mode" of an automatic transmission car (car moving forward when you take your foot off the brake), Tesla updated all cars wirelessly and voila! You have the option to creep away! If a true mechanical recall does happen, it's not the end of the world. Again, there have been 149 million auto recalls in US since 2000. I'm sure a recall by Tesla will shock investors much more than an established manufacturer since people are so used to them. Although in the long term it shouldn't affect much unless it's a fatal mistake in battery technology. But then the roadsters with older technology have been on the roads for 5 years without any fatal issues. And how many mechanical issues can you have with a vehicle when you don't have that many mechanical parts? Again, no engine, no transmission, spark plugs, valves, fuel tank, distributor, starter, clutch, muffler, catalytic converter...
2. Second risk associated with Tesla is major automakers using their economies of scale to squash tiny Tesla before it starts mass production of GEN III. As of today, there is no major automaker with a product comparable to Model S. GM is the only one with plans of producing an EV with 200 mile range but hasn't even displayed a prototype yet. Toyota's Vice Chairman Takeshi Uchiyamada told Reuters in September 2012 thatthey no longer have plans to develop an electric vehicle. "The current capabilities of electric vehicles do not meet society needs, whether it may be the distance the cars can run, or the costs, or how it takes a long time to charge".
All other manufacturers are producing either EVs for compliance reasons or so unattractive even hippies wouldn't want to be caught driving them. If history is any indication, major manufacturers will be too late to the game. Think Apple vs Microsoft in PCs, Amazon vs BestBuy, Apple vs Blackberry in smartphones, Google vs Yahoo in search… And even better news, there's so much room for EVs to grow that even if all manufacturers catch up to Tesla, it will still be a very successful company. Elon Musk repeatedly said that he'd like to see all manufacturers produce EVs, not just Tesla. Looking back at my pricing model, it stops at 500,000 units annually. Again, that ceiling number is very small compared to Detroit's Big Three's ~14 million annual US sales and all manufacturers' ~60 million global sales.
Model S
|
4,750
|
Mercedes S Series
|
3,077
|
Lexus LS
|
2,860
|
BMW 7 Series
|
2,338
|
Audi A8
|
1,462
|
*** Tesla is still in the process of production ramp-up
What about after 2018-2019? Well, Elon Musk got you covered, he's already talking about Tesla trucks, "I have this idea for a really advanced electric truck that has the performance of a sports car but actually more towing power and more carrying capacity than a gasoline or diesel truck of comparable size".
I say sky is the limit, electric trucks, buses, motorcycles, semis... Also I was thinking more about mass adaptation of Tesla GEN III by corporate world, car rental companies, government, etc. due to its tremendous cost savings in the long term. Apparently this is even possible on a small scale with the luxurious Model S, "Zappos.com CEO Tony Hsieh ordered 100 Tesla Motors Model S electric cars as part of his vision to turn Las Vegas into the most connected and community-focused city in the world."
Now that Tesla is profitable on both GAAP and non-GAAP basis, it still has a significant backlog of orders globally (without even having a single display car in EU or Asia until February). Deliveries for EU, Asia are scheduled to begin in Q3 and Q4 respectively. I don't see any "major" risks to the company's finances thus I removed additional financing risks from my analysis. Speaking of backlog orders, don't be surprised if they start diminishing from the 10K+ numbers as Tesla is delivering 5K+ cars a quarter. I can already hear shorts screaming "See, reservations number is going down, Tesla is doomed!" As stated on previous earnings calls, Tesla aims to ramp up production and bring down the purchase time to several weeks if not days. Why would a successful company want to make its customers wait months and months for its product?
Conclusion: So what does all this information tell a forward-looking investor? Are many people not aware that Tesla already has a very cool product that fulfills their needs? I don't like it when most people compare Tesla to Apple and Elon Musk to Steve Jobs. What Tesla and Musk are trying to accomplish are much more beneficial to humankind, unless you think revolutionizing MP3 players, cellphones and PCs are more important than freeing humans from their dependence on fossil fuels, decreasing CO2 emissions significantly, speeding up adaptation of solar panels, restarting space exploration and making humans multi-planetary. Don't get me wrong, revolutionizing cell phones was very helpful also and Steve Jobs is clearly a genius CEO and Marketer. But Elon Musk is on a different level. Going back to most people being unaware of Tesla and its products, I still can't help but quote Steve Jobs, "It's really hard to design products by focus groups. A lot of times, people don't know what they want until you show it to them."
Well, Musk is definitely showing it to them.
Additional disclosure: (I completed writing this article on April 14, 2013. My apologies for not being able to publish it then but I believe it covers all the risks and upside potentials associated with Tesla for a very long period. I am long TSLA@$29, CMG@$282, KORS@$41)
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