Why A Profitable $35,000 Tesla Model E Is A Pipe Dream

| About: Tesla Motors (TSLA)

Tesla (NASDAQ:TSLA) says that its so-called "third generation" Model E (currently due sometime in 2017) will have a base price of $35,000, excluding buyer tax credits and a 200-mile battery range, and will generate an average gross margin of 15% (including upgraded models). This article will explain why I believe this is impossible.

During the just reported 4th quarter of 2013, Tesla's non-GAAP automotive revenue was $761 million. If we subtract from that $15 million of regulatory credits and $13 million of Toyota and Daimler powertrain revenue, we get Model S sales revenue of $733 million divided by 6892 cars = an average selling price (ASP) per car of $106,355.

On that $106,355 ASP, Tesla enjoyed a 25.2% (non-GAAP) gross margin (an average of $26,801 per car), much of which it attributed to extensive options uptake. The most basic Model S with a 60kWh battery starts at approximately $70,000 (excluding the buyer's tax credit). If we were to guess that on all upgrades from there (on average, $36,355 per car above that $70,000 base) the company's gross margin averages 45% (35% on the battery upgrade and 50% on everything else), it would mean that $16,360 of the $26,801 average gross profit per car came from option and battery upgrades. If we then subtract that "upgrade profit" from the total profit, it would imply that the gross profit on the most basic S60 is around $10,441, making its build cost approximately $59,559.

So let's now look at where savings could occur in order to turn a $59,559 (build-cost) basic Model S60 into a $35,000 (retail price) basic Model E...

If Tesla's all-in current battery pack cost is $260/kWh (the most widely rumored number), it would mean that the S60's pack costs the company $15,600. If this were to be shrunk down to a 48kWh pack for the Model E, it would reduce the cost (at today's prices) to $12,480. If the company were able to then further cut that cost by 35% thanks to the gigafactory, it would reduce the 48 kWh Model E battery pack cost to $8112 which would be $7488 cheaper than the S60's battery. Essentially then, if we put the "2017 gigafactory priced Model E48 battery" into today's S60, there would be an estimated savings per car of $7488.

Where can Tesla find additional savings in building the Model E? Without specifying the exact dimensions, Musk has said that it will be smaller than the Model S. If we were to thus guess that the Model E will save 400 pounds of aluminum (vs. the Model S) at .75/pound, it would amount to a savings of $300 per car. If we were to then assume that the Model E saves 100 pounds on various plastics and vinyls at $2 per pound, it would be an additional savings of $200 per car.

Additionally, Tesla would be able to amortize its factory over a higher production rate of cars. However, the company's cost of that plant (excluding tooling) is on the books at only around $60 million and is being depreciated on a 30-year schedule, which amounts to just $2 million/year. If in Q4 that was spread over an annual production rate of 28,000 cars, it would have amounted to just $71 per car, so multiplying that production rate 10x would only save an additional $64 per car. Meanwhile, building the Model E would presumably require a massive amount of new tooling and thus wouldn't be able to take advantage of much of the existing Model S tooling, so the COGS there wouldn't enjoy much improvement. However, let's say there's at least some shared tooling and thus deduct additional amortization costs of $100 per car.

Now we come to the issue of "decontenting" the Model S. However, I find it hard to believe that in 2017 Tesla will be able to offer even a $35,000 car with less equipment than comes standard on today's S60, with the possible exception of the nominal savings from a smaller video screen. As it is, Supercharger use, the air suspension, the tech package, fog lights, a stereo upgrade, leather, premium lighting and a cold weather package are all optional, so what exactly could Tesla get away with removing from what is currently its most basic car? Perhaps because the car will be a bit lighter, the brakes, wheels and tires can be a little smaller; let's call that a $400 cost savings.

Finally, there are the savings the company might enjoy simply by ordering parts in greater quantities. How much will these costs decline by ordering parts for 300,000 cars vs. 30,000? Let's say that's an additional $3000 per car.

Now let's summarize our guesstimate of what it might cost Tesla to build a Model E vs. the current Model S60...

We start with a cost of $59,559 and subtract $7488 (the battery savings) minus $300 (the aluminum savings) minus $200 (the plastics savings) minus $164 (the amortization savings) minus $400 (smaller brakes, wheels and tires) minus $3000 (the "buy in more bulk" savings) = a build cost for the most basic Model E of $48,007. So please tell me how Tesla will sell this car at a base price of $35,000 without losing $13,000 per car.

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.

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