There exists a large population of investors that seems to be overly excited with any negative news regarding Tesla Motors (TSLA). From February 8, the day a New York Times writer bashed the Tesla Model S for its apparent lack of range, the stock promptly dropped nearly 4% in the two days following. After the February 20 earnings call [see transcript], during which the company announced earnings losses greater than expected, the stock price plummeted 12% over the next two days. Tesla's stock seems to be a target for daily shorters, taking advantage of the fragility of the electric vehicle manufacturer. But I do not want to discuss Tesla's day-to-day stock price. I'd rather dive into whether or not the company will survive over the long run and lead us into the next generation of travel.
Before I talk about why I believe Tesla will succeed I want to dismiss the primary argument of the non-believers and shorters.
The World is Not Ready
The primary argument against Tesla's future success is that the world is not ready. This statement baffles me. What does that mean? I imagine a point at which "the world" decides at one point in time that it is ready for electric cars. Needless to say, there will not be a point at which the world decides it is ready, and then waits for an electric car to be manufactured. Without pioneer companies like Tesla, the point at which the world will be "ready" for an electric vehicle manufacturer would be when we run out of oil to put into our gasoline-powered cars.
According to a study by Deloitte, 54% of Americans are either considering being an early adopter in purchasing an electric car or might consider purchasing one at some point, and 78% of Americans said they would be more likely to purchase an electric vehicle if gas prices hit $5.00 (you may think that is unreasonable now, but in 1999, when a gallon cost just $1.17, you probably thought today's price nearing $4.00 would be unrealistic).
I believe that Tesla will, in the long run, succeed. Ten years from now we as investors will look back at Tesla's stock price in 2013 and wonder, "How did we not see this coming?" I believe this because of five key growth drivers:
1. Not The First, But The First Best
Think about iPod. The iPod wasn't the first MP3 player. It could be argued that it wasn't even the most practical or realistic MP3 player at the time of its release. But, what Apple (AAPL) did to begin its massive turnaround was to introduce a high-end product that would eventually change the industry. At $400, the iPod was out of reach for most consumers. Why would anyone pay $400 for a music player when you could spend a meager $25 on a portable CD player? The iPod faced the same early challenges that Tesla faced a few years ago and is beginning to overcome. At the time, paying $400 for a music player seemed ludicrous to most, as does paying a premium for an electric car today. However, as we realized what a great product the iPod was, our priorities changed, and we changed our purchasing behavior.
The same series of events occurred with Apple's iPhone and iPad. Ask someone in 2005 if they would spend $700 on a phone, or $600 on a computer-like device that would not replace their laptop or cell phone but instead would perform fewer functions than each and would fit between the two. The demand was not there until after the product arrived, which is what is happening with electric vehicles. Steve Jobs famously once said "people don't know what they want until you show it to them." Over time, buying preferences are changing and consumers are becoming more open to purchasing an electric vehicle at a slightly higher cost. Tesla, as was acknowledged by the unanimous decision to name it Motor Trend Car of the Year, has made the first best electric car.
2. Lithium Ion Battery Prices Are Decreasing
Why is a Tesla so expensive? Well, aside from it being a luxury car and offering luxury car features, a substantial portion of the cost of production lies in the assembly and materials of the lithium ion battery. Although the true price of the battery pack in a Tesla is known only to the company, analyst estimates range from $10,000 to $25,000, or roughly 20% of the price of the car. With gross margins around 25%, that means that the battery pack is as much as 25-30% of the production cost of the car.
The below graph depicts production prices for automotive lithium ion battery packs. As you can see, prices have fallen about 15% each of the past three years:
A study by McKinsey & Company suggests that lithium ion battery prices could drop by another 25% by 2020, suggesting a compound annual price drop of roughly 4-5% going forward.
As Tesla ramps up production to 20,000 units per year and beyond, these cost decreases will only be exaggerated with higher volume purchasing and production, as their fixed costs will be spread more widely over the cost of each car produced. As a result, and with its increasing customer base and annual sales, Tesla will, in the future, be the first company to be able to offer an electric car with a reasonable range at an affordable price. Lower costs and higher sales will contribute to increased profitability.
3. Lithium Ion Batteries Are Becoming More Efficient
Seemingly one of the largest hurdles to mass adoption of electric cars is so-called "range anxiety," the fear of running out of power without a charging station nearby. There are two drivers of this fear: the capacity of the battery and the prevalence of charging stations. First, I will address the former issue.
Tesla boasts the highest energy densities of its lithium ion battery packs in the automotive industry, at 132 watt-hours per kilogram. Yes, this comes with a price premium, but it is still impressive.
Twice in the last four months, lithium ion battery development firms have announced significant breakthroughs in lithium ion battery technology. In February of this year, Envia Systems announced that it developed an automotive-grade battery that can pack up to 400 watt-hours per kilogram, three times Tesla's current battery capacity. Envia Systems is partially owned by GM, and while GM has rights to use Envia's systems, this will undoubtedly put pressure on Tesla to match the energy density capacity. Last October, California Lithium Battery announced that it had developed a lithium ion battery technology with up to 525 watt-hours per kilogram of capacity, a fourfold increase over Tesla's current batteries.
Yes, these battery technologies are not mass-production-ready quite yet, but CLB believes that its technologies will be in use within the next two or three years. Should Tesla become involved with one of these technologies, or develop its own competitive technology, a huge hurdle will have been overcome. Imagine an electric car with four times the capacity of today's Tesla Model S, able to drive 1,000 miles on a single charge. This probably won't happen in the next few years, but it is not unreasonable to expect it 7-10 years from now.
4. Charging Station Buildup Is Increasing Rapidly
The second piece of range anxiety is the lack of charging stations. There are currently over 14,000 public electric vehicle charging stations in the United States. Pike Research estimates that in 2017, there will be 1.7 million charging stations in the United States.
While this estimate may seem high, even half that, 850,000 charging stations, would mean a charging station every 5 miles, on average (I understand this is a large assumption because there will not be chargers in low-population areas, but the chargers will be most densely packed where population is dense). Even with today's low-end Model S range of 160 miles, American drivers would have plenty of charging stations to ease their range anxiety.
5. Governmental Support Is Steady
State laws support the purchase of electric vehicle production. The price of a Tesla comes down $2,500 in California, up to 6,000 in Colorado, exemption from insurance surcharges in Florida, and the list goes on to include a total of about 17 states with governmental support for electric vehicles, with many more considering taking action. State governments are beginning to realize that it is in their best interests (as far as limiting air pollution) to promote the production of these vehicles.
The United States federal government has also taken a strong pro-EV stance over the past few years. Currently, a $7,500 credit is available for any electric vehicle with a battery larger than 16kwh, which is a hurdle easily jumped over by even the cheapest electric car manufacturers (this size battery would result in a range of just 30-40 miles). Even the hybrid Nissan (NSANY.OB) Leaf and Chevrolet Volt have batteries large enough for the full $7,500 deduction. The credit expires when a manufacturer reaches an annual production rate of 200,000 vehicles, but at the point we won't be talking about whether or not electric cars are here to stay.
As the cost to produce lithium ion batteries, and vehicles in general, comes down these government subsidies will become relatively larger. A $7,500 credit on a $53,000 Tesla brings down the price just 14%, but when input prices come down and Tesla is able to introduce a $40,000-range model, that subsidy becomes almost 20% of the price and drops the price down to $32,500, very close to the average price of a new car today.
Additional forms of support that only reiterate the government's support of these companies include DOE grants to lithium ion battery developers, a $465 million loan to Tesla, and a $529 million loan to Fisker Automotive.
Tesla Will Thrive in the Long Run
I acknowledge that there are several counterarguments against Tesla, but I firmly believe that the long-term pros outweigh the cons. I am long Tesla not because I want to make an exit 6 months or a year from now, but because I believe this is the next true addition to the oligopoly of American car manufacturers. I do realize this investment is risky and involves speculation, but to speculate is all we can do at this point. Any counterarguments to Tesla's case are based on pure speculation as well.
As Nikola Tesla, the man for which this great company is named, once said, "It is quite evident, though, that this squandering cannot go on indefinitely, for geological investigations prove our fuel stores to be limited. So great has been the drain on them of late years that the specter of exhaustion is looming up threateningly in the distance..." We investors cannot afford to ignore the future of travel, because it will be led by Tesla Motors.
Disclosure: I am long TSLA, AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.