Gigafactory Will Cost Tesla $5 Billion But Offers Significant Cost Reductions

Mar.10.14 | About: Tesla Motors (TSLA)

Tesla Motors (NASDAQ:TSLA) unveiled details of its much talked about "gigafactory." During the earnings release, Elon Musk announced that Tesla would build a gigafactory for the production of electric batteries. The gigafactory will cost Tesla up to $5 billion to build, but once complete, will be able to churn out enough batteries for 500,000 vehicles. To facilitate the set up of the factory, Tesla plans to raise $1.6 billion through the issuance of bonds. [1]

In addition, there are also reports that Panasonic could invest up to $1 billion in order to strengthen its ties with Tesla. [2] The ambitious project will also see the automaker adding 6,500 employees and acquiring a whopping 1,000 acres of land. Since the start of 2013, Tesla's shares have now gained more than 600%.

Demand For Tesla Vehicles Will Grow

Tesla recently announced its fourth quarter and full year earnings, during which it stated that it expects to sell 35,000 Model S sedans this year, up 55% from the 2013 figure. However, demand for Tesla's vehicles could grow multifold once the lower priced Gen III model is launched in 2017.

As of now, demand for Model S exceeds the supply. Acquiring the desired number of batteries is one of the main reasons why supply trails the demand. Currently, Tesla buys its batteries from Panasonic. With the new factory, the automaker will no longer be reliant on its supplier to ramp up production.

Significant Reduction In Battery Costs

The gigafactory will help slash battery costs by 30% in the very first year of production. [3] As production rises, there could be further cost savings. The factory would begin production in 2017 and would reach full production in 2020. At its peak production, the factory would produce 50 gigawatt-hours of battery units in a year - more than the entire world's current production. In 2012, 27 gigawatt-hours of battery were consumed globally.

The inception of the factory coincides with the launch of the Gen III in 2017. The automaker needs to drastically reduce the cost of batteries if it needs to launch the Gen III at a price point of $35-40,000. Currently, the cost of production comes out to be ~$400 per kilowatt hour of battery. But with the economies of scale and advancements in technologies, Tesla intends to push down the figure to $200 eventually. [1]

It's not clear how many Gen III cars will be available to the public in 2017. Based on our conservative assumptions, we expect it to be in the region of 20-25,000 units. However, this could easily cross 200,000 units, once the factory peaks production.

Investors are not only bullish about Tesla's future launches but believe the gigafactory could even revolutionize the dynamics of the power industry. With 50 gigawatts of batteries, Tesla could even provide surplus batteries to the electronic industry. In fact, Tesla could become a leader and low-cost producer of energy storage. The potential impact of such a move remains huge and is one of the reasons why investors are excited about the company's long-term prospects.

Disclosure: No positions.