Tesla - Reality Is Beginning To Set In

Nov.12.13 | About: Tesla Motors (TSLA)

In a previous article I disclosed that I'm short Tesla (NASDAQ:TSLA) and gave as one significant reason the idea that in its early stages, Tesla owners and commentators were giving the car - and the company - a pass on any problems or negatives it might exhibit. This attitude, which I thought could not and would not last as the car made its way out to a more general audience, led to the stock being priced for perfection (and beyond). Now there are signs that process is starting to unravel.

Following are three important manifestations of the bloom coming off the Tesla rose:

Safety, Design and Insurability

As we were told repeatedly by longs, the company deserved stratospheric valuations because it had built a car with a 200 mile range, a top safety rating, and great handling. These are all facts and are indeed all positive. The problem was only that no one ever spoke of the design choices and compromises that were made to achieve these results. Let's look at a few of these, which the media and general public are just now beginning to appreciate.

First off, the car is a tank. And by that I mean it's very heavy, weighing in at almost 4,700 lbs due mostly to the huge battery needed to achieve its relatively long range. (For comparison a Nissan Leaf weighs about 3,300 lbs, a BMW 528i about 3,800 lbs, and a Cadillac Escalade almost 5,800 lbs.) Second, its heaviest component, the battery pack, is placed very close to the road in order to create a low center of gravity. Third, the car's ground clearance, 6" nominally but as low as 5.2" when active air suspension lowers it for highway driving, is also deliberately low in order to improve aerodynamics and handling. (The ground clearance for the comparison cars listed above are 6.3", 5.6" and 9.3" respectively.) Fourth, the company uses high energy density batteries which afford it its range, but also mean that more precautions must be taken to avoid fires.

All of these choices are required to achieve the positives listed above. But there are (unmentioned) negatives associated with each as well. First, when a heavy performance car is driven to take advantage of its acceleration and speed, it carries a lot of momentum with it. This momentum is bad not only for any other car, pedestrian or bicycle it might hit; it is also bad when hitting stationary objects such as road debris or a wall. (The impaling force of road debris is higher due to the car's momentum when it strikes it.) Second, by having the whole underside of the car carry a high energy, flammable chemical pack close to the ground, the odds of it being hit and ruptured go up relative to a small gasoline tank which can be more readily shielded from the consequences of a car hitting road debris. Indeed, the same relative argument is true when comparing the Model S against a Nissan Leaf, since the Leaf is lighter and not a race car (thus carries less momentum), has a smaller battery pack (and hence is less of a target), has lower energy density batteries and rides slightly higher above the ground.

Now with all this said, I don't personally see a big problem with the car in terms of safety; after all, in the two battery pack road-debris fires so far, the car has warned the passengers and contained the fires outside of the passenger compartment. My question is simply how will the car's vulnerability to catastrophic damage to its most important - and most expensive - component affect insurability (not to mention demand from new buyers)? This is perhaps a moot point with the current first-adopter customer base, as these buyers were quite willing to fork over $100K for an as yet unproven vehicle and probably wouldn't care about insurance rates either. But going forward, as the company tries to entice non-first adopters, as well as trying to put forth (a somewhat dubious in my opinion) value proposition, these issues may become more and more important.

Batteries

One of the innovative ideas that Tesla implemented going all the way back to the Roadster was to use a common laptop battery form-factor (albeit with proprietary chemistry changes) as the basis for its battery pack. Doing so allowed it to use a proven mass-production component and thereby get a head start on vehicle production and deliveries. Moreover, at the time the company decided to use this form factor, there was an excess of worldwide battery production capacity of this form factor, and as a result the company could procure its batteries very cheaply. Again these are all positives.

But the as-yet unasked question is: what compromises were made in making this decision? Was this form factor the technically best choice, or the short-term best choice? Remember that other EV manufacturers have chosen to implement "large-capacity, purpose-built lithium-ion cells in their car's battery packs". Tesla aficionados will say that's because no other car manufacturer knows what it's doing. But given the company's pointing to battery supply limitations, and the prospect of the company having to build its own giga-factory (and/or pay full price for batteries from suppliers like Panasonic), the question that will soon be answered is: "Is the 18650 form factor the cheapest way to go when there is no longer a glut of worldwide supply?" My guess is that it will turn out that making batteries from very small cells won't be the most economical or technologically best solution in the long run (and that other car companies aren't completely incompetent), but it's a still unanswered question that we'll all be following closely. For what it's worth, in two separate articles SA contributor John Petersen has interesting observations which are relevant to this discussion.

First:

If Bloomberg's revenue estimate for Panasonic is accurate, Tesla's 2-billion cell battery supply treat includes a nasty hidden trick in the form of a 40% to 75% cell cost increase that will have to be passed along to customers. It probably won't make a difference to Model S and Model X buyers who seem to be willing to pay any price for eco-bling, but it could be showstopper for Tesla's plan to build a $35,000 to $50,000 Gen3 model that will need $18,000 of battery cells.

And second:

Battery factories are designed and built for a specific form factor and chemistry and they can't easily adapt to changes in either set of specifications, which means that once Tesla builds a giga-factory it will be locked into a particular form factor and battery chemistry for many years and it will be unable to respond quickly to future technological change.

Deliveries, Service and Overall Demand

Recently I argued that the aging of the Model S fleet would begin to reveal new issues and costs which would also cause investors and consumers to become more realistic about the company's valuation. In my article I estimated monthly (and quarterly) delivery numbers to then establish average fleet age over time. It turns out that my numbers for new deliveries were optimistic, which has two implications. First, more cars were needed for service loaners than anyone previously thought (which fits in with the idea that problems like motor hum, pano roof leaks, etc. are causing more service time, and thus more loaner car use, than expected). Second, since new car deliveries are less robust than estimated, fleet aging is happening more quickly than expected. As I discussed previously, this means that there is less money from vehicle gross margins available to support warranty repairs, at-cost servicing and supercharger network costs for the existing fleet.

Now of course Tesla and its proponents maintain that the slower than widely-expected ramp up in sales is due solely to supply constraints. But as a bit of a skeptic, I have to wonder if Tesla's not content with this "supply-limited" scenario, because were it to be rectified, analysts and commentators might learn that their bullish demand numbers aren't realistic. Indeed, I suspect that domestic demand has peaked, if it's not already waning. Certainly the buzz in the media and the public in general was already leveling off by the end of the last quarter, and the recent fires have accelerated that trend. Indeed some Tesla car owners have recently related that where they'd once been admired for their purchase, now people are making them the butt of their barbeque jokes. As I mentioned earlier, I'm not particularly concerned about a safety issue per se, but it's certainly interesting to see how quickly public perception can turn. (My tracking of Model S's for sale on eBay also supports the idea that domestic demand may already be waning.)

Conclusion

None of the items discussed above would be big deals if TSLA weren't priced for perfection. But even now the stock is valued at almost twice the market cap of Fiat (FIATY) when by any standard valuation measure even a half or a quarter would be extremely optimistic (admittedly the enterprise values are commensurate, but still those too should be an order of magnitude different on a valuation basis). It's an accepted truism that if a stock lives (rises) by momentum, it will die (fall) by momentum. Only time will tell of course, but I personally don't see TSLA being exempt from this rule - and have placed my bets accordingly.

Disclosure: I am short TSLA. 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.