Will Tesla's Earnings Exceed Expectations? The Company Won't Match Its Valuation Either Way

| About: Tesla Motors (TSLA)


When investors mistake their own tastes for the tastes of the broader consumer market, they often bid niche companies up far beyond any reasonable valuation.

Tesla seems like a classic example of this phenomenon. While its cars are clearly popular among the investing class, I don't see how it ever justifies its current share price.

Essential shortcomings in its design and strong competition from richer, more established companies make investing in Tesla a highly speculative wager.

In my forthcoming book Dead Companies Walking, I describe six common mistakes that can lead to ruin in both business and investing. I believe many people buying stock in Tesla (NASDAQ:TSLA) are making one of these potentially disastrous errors:

They're confusing what they like with what a company's potential customers want.

For thirty years, I've seen the stock of one company after another rally because its products or services appealed to the tastes of the investor class--mostly urban, educated, and upper-income consumers. But, in almost every case, those same stocks have eventually flamed out when their companies failed to catch on with broader segments of society. I believe Tesla will wind up as another example of this phenomenon.

As I write in the book, an analyst at a prestigious Wall Street brokerage once confidently predicted to me that inline skates (aka: "Rollerblades") would soon vastly outsell bicycles in America. After I picked my jaw up off my desk, I politely ask her if she used inline skates. The answer was yes, she Rollerbladed regularly, and so did many of her friends in the financial industry. I hung up the phone and promptly shorted the stock of one of the largest inline skate manufacturers, which soon dropped over 80 percent.

I don't believe that Tesla is necessarily the automotive equivalent of Rollerblades--that is, a purely overhyped fad product. I am not short the company and I actually think it makes cool looking cars. I've even considered buying one, and I wish Elon Musk the best in his attempts to revolutionize the auto industry. But anyone willing to buy Tesla's stock anywhere near its current price is making a similarly outrageous prediction as the analyst made about Rollerblades and bicycles--that Teslas will soon outsell more established, practical and consumer-friendly alternatives.

The only way Tesla can possibly live up to its astronomical valuation is to broaden its appeal away from rich guys like me (who, let's face it, usually buy Teslas as a second car so that they can show off) and into the wider consumer marketplace. That means the company must convince middle-class consumers to buy huge numbers of the planned Tesla Model 3 as their primary or only vehicles--the cars they use to get to and from work, to run errands, and to take road trips to grandma and grandpa's house for the holidays. But even if everything goes according to plan and Tesla manages to roll out this new, cheaper model by 2017 (which is a big if) for its projected MSRP of $35,000 (big if number two), I'm still extremely skeptical that enough regular people in places like El Paso, Texas or Milwaukee, Wisconsin or Tallahassee, Florida or Spokane, Washington will buy what Elon Musk is selling. Here's why:

"Range Anxiety" Is Real, And It's Not Going Away Anytime Soon

Tesla's website boasts that its "supercharging" stations "provide half a charge in as little as 20 minutes." This might sound impressive on first glance. And again, if all goes according to plan (big if number three), Tesla will eventually install these stations within reach of most drivers. But take a moment to really inspect the meaning of that sentence and then consider how your average working mother will process it as she's deciding which car she should buy. Twenty minutes is an eternity to such a person. Let's say she forgets to charge her car one night because she has to check on her sick father, or she has to drive a long distance for a last-minute meeting. If she then has to get from her office to the supermarket to little Janie's soccer practice or little Jimmy's piano recital all the way across town, do you really think she is going to be willing to sacrifice twenty whole minutes to sit around for her car to charge? Of course not. The fact that all that time will only buy her the equivalent of HALF a tank of electricity makes the idea even more ludicrous. When was the last time anybody in America waited twenty minutes to get half a tank of gasoline? Maybe during the OPEC crisis forty years ago--and people were not happy about it.

Tesla enthusiasts might counter that our hypothetical working mother could plug the car in while she's at work, or while she's eating lunch. (The company's website suggests charging the car "during a quick bathroom or food break.") But expecting busy consumers to alter their normal behavior to accommodate shortcomings in a product's design is rarely a profitable approach. Fans and early adopters of a product--i.e.: the type of people who have already bought Teslas--might be willing to work around its flaws and adapt to new requirements. But, again, those aren't the type of people Tesla is going to need to convince to buy its cars if it wants to justify its current valuation.

Elon Musk Might Be Smart, But His Competition Is Not Dumb

Worse still for Tesla, there are plenty of other, more practical and economical options out there for consumers like our hypothetical working mother. Why would she buy a Tesla and risk having to waste twenty minutes of her day or more for half a charge when she could buy a perfectly good hybrid that she would hardly ever have to fill up, and would be able to refuel in minutes when needed? Moreover, Tesla's competitors are now offering plug-in hybrids, which allow their cars to run in all-electric mode most of the time. That essentially makes them the same as Teslas, only better, as they feature a gasoline-powered engine as a reassuring backup.

Worrying about getting from work to your kid's soccer practice on time and then making sure you can get to the store to buy ingredients for dinner afterwards are not abstract issues for prospective car buyers. These are real life problems that regular people deal with day in and day out. If your car doesn't help solve them, most consumers not going to buy it, no matter how cool it looks or how technologically disruptive its propulsion system is. That's a simple fact--especially when bigger, richer car companies like Toyota are already producing highly efficient vehicles that do solve these problems.

In May, Toyota announced that it was ending a partnership with Tesla and focusing on hybrids and fuel cell technologies. Toyota is not a dumb company. It's not GM in the 1970s. It's one of the smartest, most proactive corporations on the planet. If it believed it could make significant profits from all-electric vehicles, it would have been all-in on the technology. Instead, after a three-year trial period collaborating with Tesla, it pulled out. That should give prospective Tesla investors serious pause. But, amazingly, in the days following Toyota's decision, Tesla's stock continued to rally.

Surprise! EVs Can Still Be Bad For The Environment

I went to my local Tesla store a little while back and asked the salesperson there why I should buy one. He proudly declared that, because they run on electricity, Teslas are "100 percent environmentally clean." I couldn't believe what I was hearing. "Did you know 40 percent of the US electric grid is still powered by coal?" I asked him. "Or that another 25-30 percent of our electricity is generated by natural gas or other fossil fuels?"

I'm not recounting this interaction to mock the salesman. He was just doing his job and trying to make a commission. The point is, I don't think most people understand that when you plug a Tesla into an electrical socket, you're not automatically charging it with green energy. In large areas of the country, there's a good chance you're running it on the dirtiest power source around, coal. Many Tesla bulls have been hyping the company's planned expansion into China. If Tesla manages to take market share in that country (big if number four), that will only mean more cars being powered with Dickensian energy. China consumes half the world's coal and 70 percent of its electricity comes from the filthy black stuff.

Of course, if you install solar panels on your house, you can be sure the juice going into your Tesla is 100 percent renewable. But, again, Tesla must appeal to a broader segment of middle-class consumers if it ever hopes to live up to its current valuation, and many of those people aren't able to afford solar arrays on their roofs. Moreover, the company is going to have to sell cars in a wider swath of the country, not just in coastal and urban enclaves like the Bay Area (where it seems like every third car on the road is a Tesla Model S). That will inevitably mean even more coal-powered Teslas.

Even If Tesla Is A Smashing Success, Its Stock Could Easily Fall

Like I said, I think Teslas are neat. Who knows, I might actually wind up buying one. But when you consider these issues, the car's main selling point--being greener than hybrids or bad old internal combustion cars--gets awfully, well, murky. Throw in the fact that alternatives like plug-in hybrids from powerful competitors like Toyota are more practical and economical for middle-class consumers, and it gets even more difficult to see how Tesla meets its 500,000-cars-a-year sales projections.

Tesla will probably not go the way of Rollerblades (or other niche carmakers like Delorean, Bricklin, or Fisker). I hope it succeeds, and I believe there is a good chance it will beat Wall Street estimates this week and in the quarters to come. Elon Musk is a bold and capable executive. I toured Tesla's factory in Fremont, California and was impressed by its systems, and how cheaply Musk was able to take control of it. But Musk's positive qualities aside, we're talking about a barely cash-positive company with a very uncertain future and a market cap fast approaching half that of Ford Motor Company. I don't know how any investor can be a buyer at that valuation.

Even if I'm completely wrong about the Model 3 and all of Tesla's many big ifs pan out (including big ifs numbers five, six, and seven: that its much-ballyhooed Gigafactory gets off the ground; that it is able to produce enough batteries to meet projected demand; and that it winds up producing batteries that fill needs beyond the automotive industry), I still can't see how Tesla's stock does anything but trend down over the long term. Given its enormous run-up, the company could meet or exceed all of its (extremely ambitious) goals and still see its share price lose half its value or more.

Then again, if you like highly speculative stocks with a lot of upside already priced in, TSLA is for you.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.