Tesla Motors (TSLA) is trying to wrench the two trillion dollar automobile industry from its dependence on fossil fuels and internal combustion engines into a more earth-friendly future of zero tailpipe emission electric vehicles. And make a fortune for its stakeholders in the bargain.
Tesla's story is that of a brilliant strategic plan, executed, so far, to perfection, pointed at accomplishing the nearly impossible. Yet despite the company's incredible, almost magical march from raw start up to production of 400 luxury electric cars a week, the game is far from won.
Let's look first at the positives
The Model S
Tesla's second offering, the Model S, which came to market in the U.S. in June 2012, has captured Motor Trend's car of the year award. The Model S can travel over 200 miles on a single charge, rocket from zero to 60 in under five seconds and deliver its passengers in a cabin worthy of a high-end luxury sedan; while running entirely on electric power with zero tailpipe emissions.
The Model S is the epitome of cool. To see its sleek lines and plate proclaiming "Zero Emissions," is to want one for yourself and feel guilty about the fume belching, air fouling climate destroying gasoline powered car you are driving. According to one commentator the Model S is sold in clusters -- you buy one, you drive it for awhile, you fall in love and are not content until you have sold a few to your friends, who then sell it to their friends.
Tesla has combined an innovative product with an innovative business model. Tesla's cars are sold (or reserved, the current waiting list is 20 thousand customers long) either from its website or through a series of company owned stores patterned on Apple retail stores. There are no dealers in the middle to siphon off profits.
Inherent Simplicity of Design/Unique Service Model
The Model S has far fewer moving parts than its internal combustion engine counterparts -- no transmission, no exhaust, no gearbox among other things -- and should prove considerably more reliable than any gasoline powered car once the new vehicle bugs and kinks of are shaken out over time. This potential reliability advantage allows Tesla to employ a unique service model -- a modest number of service centers strategically scattered, a "Ranger" traveling service provider, but most of all a reliance on software to fix and tune problems -- software which can be downloaded directly into the vehicle.
Super Charging Stations/Free Power for Customers
It takes many hours to charge the battery of a Model S (or any other electric car) from a conventional electric outlet. However the Model S can be charged using DC "super chargers," which fully charge the battery in a single hour.
Super charging stations, some solar powered, are popping up all over the place, though the bulk are still in California. Tesla claims that super charging stations will stretch across the USA by the end of this year enabling the Model S to cross the country. For Tesla owners use of these stations is free -- making Tesla's zero fuel cost vehicles.
Most disruptive innovative start-ups like Tesla are headed by inexperienced, often very young CEO's, e.g. Mark Zuckerberg of Facebook (FB). Tesla is headed by 42-year old Elon Musk the co-founder of Pay Pal -- an innovative, disruptive company, which was bought by eBay (EBAY) and continues to function as the world's largest all online bank. Mr. Musk has also founded two other cutting edge disruptive companies. This polymath appears to combine world-class business acumen with hands on knowledge of technology and design, all coupled with a powerful drive to create a better future for us all. Don't know about you, but if I owned a share of a crazy shoot-for-the-moon company like Tesla, Elon Musk would be the guy I'd want running it.
It is one thing for a Silicon Valley start-up with a charismatic CEO and an audacious business plan to attract brilliant engineers and designers who invent great technology -- that's what start-ups are supposed to do. It is quite another to build factories and production lines. Hire thousands of blue collar workers, deal with work rules and unions while negotiating with the myriad of suppliers needed to create a reliable, cost-effective supply chain. These tasks are not only difficult and ordinarily beyond the capabilities of start-ups, but immensely costly as well. Tesla has been burning cash since day one. As far as I can determine it has gone through something like 1.5 billion dollars since inception in 2006. Seed capital, most put up by Musk, venture capital, government loans, an IPO in 2010 and a secondary offering in 2012. It appears to have around 200 million left after the most recent earnings release. According to Musk, Tesla will be profitable this quarter. Wall Street doesn't seem to believe him as the stock tanked after earnings. But even if it is profitable going forward it is not going to generate huge quantities of cash for awhile. Two hundred million dollars for a company attempting to create new automobile designs while simultaneously hiring blue-collar workers, building factories and securing supply chains is very thin financing indeed.
The central problem with all electric cars are the batteries that provide their power. Batteries are expensive, heavy, large and hold limited charge. The expense of a stack of batteries, sufficient to give a fast accelerating comfortable car a reasonable range between charges currently cancels out the inherent simplicity of the rest of the automobile. Although the battery expense can be partially hidden in a high-end luxury vehicle like the Model S, in a more modest car the cost of the batteries might make up to 25-35% the cost of production. Currently most of the inherent cost disadvantage of electric cars is mitigated by government subsidies. In the future, in order for Tesla to be a viable economic alternative for a mass market, either battery cost goes down, gasoline goes up or the subsidies offered by government increase.
On the other hand, internal combustion engines have been tweaked and optimized for more than a hundred years. They aren't going to get much better. But sophisticated electric power drive trains are a new thing. And battery technology has a long ramp of improvement in front of it. Wouldn't take much for Tesla cars to be cost competitive without subsidies.
As in my previous articles, I will attempt a scenario-based valuation of Tesla. I will try to look (however dimly) eight years into the future and see, under a variety of potential circumstances, what the company might be worth in the winter of 2021. With a company like Tesla, having a significant probability of going bankrupt, while at the same time having some reasonable chance of growing one hundred fold, I can't imagine any other way to even begin to give the stock an approximate value.
Before I begin let me point out that the multiplicity of potential futures for Tesla is complicated by the fact that outcomes for the company are enmeshed in the politics of global warming and alternative energy and may rise and fall based on actions taken by governments as well as unpredictable black swan events.
Scenario 1: It Was a Great Idea Whose Time Hadn't Yet Come
Tesla hangs by a slender thread. It must succeed, become cash flow positive, probably within 18 months, or face bankruptcy. It could easily overshoot -- hire too many people, order too many parts, overestimate demand for the Model S. Or something could be found unsafe in the car causing a recall, which the company does not have the resources to manage. Or any number of other things. So in scenario number 1 Tesla simply ceases to exist. The stock flatlines. All investor money is lost.
Scenario 2: Never Makes it over the Hump
Try as it might, Tesla never makes it to the big time. Perhaps it becomes a boutique manufacturer of exotic electric cars, making 30 or 40 thousand vehicles a year, earning a hundred in profit. Or maybe Tesla gives up manufacturing complete vehicles entirely and becomes an OEM supplier of drive trains to bigger automotive companies. Or, more likely, Tesla gets bought out by Toyota (TM) or Daimler -- companies Tesla now sells drive trains to -- for Tesla's technology; or even by Apple (AAPL), a merger which makes vast sense, but that is another article. For scenario 2, rather than examining in detail all the possibilities, let's simply say that buying the company today at $35 a share, an investor would break even.
Scenario 3: Becoming a Serious Player in the Automotive Industry
Tesla, as advertised, delivers 20,000 Model S automobiles in 2013. By the beginning of 2014 it is producing 100 cars per day, has a backlog of 20,000 orders for Model S and 20,000 orders for the newly released Model X. There are hundreds of charging stations in high traffic corridors across the U.S. and Canada and a few in Europe. Tesla cars are the must have cool new device for the well-to-do. Small advances continue to be made in Lithium Ion battery technology, allowing the batteries to hold more charge longer, and be a tad lighter and cheaper to manufacture.
There are some hiccups. More service problems puts major stress on limited service capabilities. Performance in extreme cold weather continues to be a problem. But these are relatively minor issues.
By 2016 Tesla is making 400 vehicles per day and taking reservations for 500. Charging stations dot America, Canada, much of Western Europe and are beginning to appear in China, Korea, Japan and India. Tesla is starting to realize some efficiencies of scale. Battery prices have come down. Range on a single charge for some models is over 300 miles.
In 2020 Tesla sells eight hundred thousand vehicles at an average selling price of 30,000 dollars for total revenues of 24 billion dollars. Its net after tax margin is 10% yielding 2.4 billion dollars in profits, which, with 114 million shares, translates to an EPS of $21. It is still growing and its strong position in the expanding and uber-trendy all-electric automobile industry earns it a P/E ratio of 20, and a share price of 420 dollars.
Scenario 4: The Toyota of Electric
Gasoline continues to increase in price. Global warming continues to have more and more visible impact. Governments continue to favor alternative energy sources. In 2016 the Democratic controlled U.S. Congress passes a $5/gallon gas tax and a huge 'gas guzzler' tax on consumer vehicles getting less than 30 miles per gallon. It also passes a 25% incentive for all-electric vehicles making electrics by far the economical choice for most consumers. Tesla continues to outstrip its competition in technology allowing the upstart company to compete with the giants on even terms. The charging stations are ubiquitous worldwide and only charge Tesla vehicles. By 2016 some models can go more than 400 miles on a single charge. By 2017 Tesla is producing 1000 vehicles per day including the breakthrough everyday best-selling Model Z sedan. After government incentives the car costs only 20,000 dollars in the U.S. and gets free fuel. Tesla takes reservations for almost 2000 per day of this model alone and desperately tries to ramp up production. In 2020 Tesla sells two million motor vehicles for 60 billion in sales. Simplicity of design, superior technology, and a superior distribution system allows it to realize a net after tax margin of 15% or 9 billion dollars or 80 dollars/share. At a P/E of 25 that translates to 2000 dollars/share.
Scenario 5: World Domination.
Sadly, in order for electric cars to replace gasoline-powered cars in a major way over the next eight years there will need to be a major ecological disaster. Perhaps the melting of Antarctic ice feeds on itself and accelerates, causing sea levels to rise at alarming rates. Or a category 4 hurricane smashes into the mid-Atlantic region of the United States, flattening the forest throughout Delaware, Eastern Pennsylvania, New Jersey and Southern New York, killing hundreds of thousands and leaving millions homeless. Finally the world wakes up. Governments everywhere, even in the United States, heavily tax gasoline and gas-guzzling cars and heavily subsidize electric cars. An almost feverish research race into battery technology yields a continuing stream of ever cheaper, lighter and more efficient batteries to power cars. Charging stations dot the world, many taking energy from the sun. Tesla technology dominates an electric car industry that is rapidly replacing the old internal combustion motor vehicle industry. Demand for the products is immense as it races to build factories worldwide, helped by the expertise of engineers and executives from failing conventional automotive companies who have joined the electric behemoth. By 2018 Tesla is selling 2.5 million cars annually and growing like crazy. In 2020 Tesla sells 6 million vehicles for a total of 200 billion in sales. The margin is 15% giving it 30 billion in profits or an EPS of 263 dollars. Still growing rapidly the P/E of 30 makes the stock worth a rather astonishing 7900 dollars/share.
Putting this all in a table is an eye-opener.
Tesla in 2021. Five possible scenarios.
|Scenario I||Scenario II||Scenario III||Scenario IV||Scenario V|
Share Value (SV = EPS * P/E
Probability (P) Sum =1.0
0.30 (i.e. 30%)
Scenario Value per Share (SV * P)
$35 (special case -- investors break even)
Adding the bottom row we get 473 dollars/share as the value of Tesla Motors in the winter of 2021, averaged over all the possible scenarios. Demanding a 10% compounded yearly return and backing that out eight years, yields a present value of the company as 473/2.15 = $220/share or more than six times Tesla's present value of 35 dollars/share.
Can this be? Can the market be this wrong? Or am I missing some important factor? For one, there is the risk. A 30 percent chance of losing all one's money might make some folks demand a greater return than 10% per year. But even if you demanded a 20% return, the present value would be more than three times the actual stock price.
And I can't see where this is overoptimistic. Obviously, Tesla has at least some chance of becoming a dominant auto maker. Out with the old, in with the new. It happens all the time in other industries. I am only giving Tesla a 2% chance of truly dominating. Is my middle scenario reasonable? I can't see how it isn't. There are powerful historic forces on Tesla's side. Couple that with six years of faultless execution, a proven world-class CEO and strong indications that it is about to make it to profitability, and it is hard to see how the stock is not a total steal at current levels.