Will Tesla Solve Its Battery Problem?

Nov. 7.13 | About: Tesla Motors (TSLA)

Tesla (NASDAQ:TSLA) announced its quarterly earnings and many Seeking Alpha contributors (including me) offered their insight regarding the results. Now that we have had 24 hours to digest these results, it's time to dive into details and discuss some of the themes that came up during the conference call. In this article, I will mainly talk about Tesla's battery problem and whether the problem can be solved.

In the last year or so, a lot of people (including several Seeking Alpha authors) talked about the battery problem that Tesla would be facing soon enough if it wanted to ramp up its production to meaningful levels. This was the first time Tesla openly acknowledged the problem at a press conference and this was also the first mention of possibility that Tesla would open its own factory in order to build its own batteries.

Can Tesla build its own factory? Theoretically it can. The materials that are needed to build a battery such as lithium are pretty abundant in the world and Tesla could start its own factory and produce its own batteries. While this is very practical, the company would need massive amount of cash to get the job done. How can Tesla gets its hand on so much cash? There are several ways the company could accomplish this.

1) The company could raise debt. This would add a large block in the company's balance sheet under "liabilities" section and hurts Tesla's valuation further. Furthermore, since Tesla is not a well-established company with a strong credit history, it would have to pay a high interest on this debt and servicing this debt would hurt Tesla's already-thin margins even further. On the other hand, if the company became successful in building and selling a large number of cars, its margins would improve since Tesla's biggest cost item is batteries and building them "in the house" would help with the company's costs in the future.

2) The company could issue new stocks. This is another risky way to raise, especially when Tesla is already overvalued by every fundamental metric. Since the company already issued a secondary less than a year ago, issuing another one of those might backfire and lead to a sell-off. Because the company's current valuation already reflects all the future successes that may or may not happen, the investors will be very sensitive about dealing with further dilution. Still, if this means that Tesla will be able to build its own batteries, control its own fate and be able to reduce the cost of its most capital intensive item and increase the company's margins, a lot of investors may prefer this over raising debt. If we know anything about Elon Musk, we know that he will put his own money to work and buy some of the newly issued shares in order to sooth the investors that may be worried about a new offering.

3) There is one more way Tesla could finance a battery factory without hurting its finances or diluting its shares. It could do one of Elon Musk's favorite activities: start a whole new company from scratch. Elon Musk has started so many companies in the past that starting a new company wouldn't be too burdensome for him. He could start a battery company, give it a cool and catchy name (like Solar City or SpaceX) and raise the necessary funds in the market. Since the investment community sees him like a hero and the investors are willing to put their money in everything Mr. Musk initiates, he will have no trouble funding this new company, which will become the battery supplier of Tesla. If the company fails, Tesla moves on with new suppliers. Out of all the possible ideas, I like this one the most because it doesn't hurt Tesla in any way. Obviously this company (let's call it Super-Battery-X-City) would have to post profits, Tesla would have to pay some premium for batteries but it's better than getting under burden of huge debt or massive dilution.

By the way, a lot of people didn't seem to buy Tesla management's theme of "supply constrained" as they seem to think that the company is actually facing a weak demand. Even though Tesla stopped providing details on its backlog, we can check the company's balance sheet and examine the item called "Customer Deposits" under "Liabilities" section. Here, we see that the current customer deposits total $140.27 million, which is up from $138 million last year and it's stable from quarter to quarter even though the company ramped up its production in the recent months. Then again, keep in mind that customer deposits include the deposits Tesla collects for its Model X vehicle, which won't even hit the markets for at least another year. Currently, the deposit for those looking to buy a Model S is $2,500, the deposit to reserve a Model X is 5,000 and the deposit to reserve signature version of Model X is $40,000. Tesla doesn't tell us how many of each car was reserved, so it's difficult to determine the exact size of the backlog or the ongoing demand.

Of course, some people will raise some fair questions like "if Tesla is supply constrained, why did it start taking orders in China?" or "why does Tesla offer a lease option if it is supply constrained?" but we will not find answer to those questions anytime soon.

Meanwhile a third Model S caught fire in Tennessee, and it was photographed by another driver who shared the photo on his Twitter account. If more of these fires happen, a lot of people will start questioning Tesla's ability to build safe cars. I understand that all cars can catch fire, ICE cars kill far more people than electric cars and no one ever died in a Tesla car, however, the media will not approach these events like that. The media will deliver these stories in a way that will scare people away because the media loves hype and all the emotions that go with it.

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When a company trades on hype but not fundamentals, things can turn around so quickly and catch many people off guard. I don't expect Tesla to fall much further because there is a lot of support at the current prices. The Fed's free-money policy will keep many stocks strong for the foreseeable future. In the short term, the only way I see Tesla falling below $110-120 levels is if the Fed suddenly decides to end its quantitative easing. We already know that it won't happen anytime soon.

Nevertheless, this is a very risky stock and investors should be very cautious when putting their money in stocks like this. I usually try to protect my long positions by either selling covered calls or buying puts and I suggest investors to do something like that, especially in highly volatile stocks like this. If Tesla has another quarter where it talks about supply problems, the investors might run out of patience very quickly.

Going back to the main question, will Tesla solve its battery problem? In the short term, the deal with Panasonic will provide Tesla with enough batteries; however, the company has to act quickly if it wants to increase its volume substantially in the future. Currently, many investors expect Tesla to launch a $35,000 Tesla within 5 years and this will become an impossible task without Tesla solving its battery problem. Since Tesla can't force other companies to increase their battery production, it may have to get its hands dirty and produce its own batteries. This will not be easy but this may be the only way out for the company. Considering how Tesla is priced for perfection, the investors will not have a lot of patience if things start going in the wrong direction.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

Additional disclosure: I'm long TSLA calls and puts simultaneously.