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Summary

  • A chief executive of LG Chem recently stated that they are working on making batteries for a 200-mile range vehicle in the $30k-$35K price range.
  • Tesla maintains competitive advantages such as the currently-in-progress Gigafactory and Supercharger network, which will keep competition away until they develop similar infrastructure.
  • Due to the risk averse nature of large established companies, Tesla will maintain competitive advantages in EVs for the foreseeable future.

When Tesla Motors Inc. (NASDAQ:TSLA) announced that they were going to build a Gigafactory that costs $5 billion in order to reduce battery costs by at least 30% by 2017, Tesla skeptics were all over it. Since then, Tesla has broken ground on at least one site in Reno, Nevada and has an official partnership with Panasonic (OTCPK:PCRFY). However, when LG Chem announced recently that they are "definitely working on making a 200-mile-range battery electric vehicle at around the $30,000-$35,000 price target," those same skeptics didn't even blink an eye. Commencing, instead, to forecast doom and gloom for Tesla because this will, according to them, create huge competition for Tesla's Model 3. But it is important to actually examine these claims and the magnitude of the challenge to Tesla they suggest.

The Gigafactory

With the construction of the Gigafactory already begun, Tesla has created a huge moat between itself and its competitors. The gigafactory's mission is to reduce battery costs by at least 30% and support production of 500,000 EVs annually by 2020. According to Tesla, production of 500,000 cars requires 35 GWh, while the Gigafactory will be producing an estimated total of 50 GWh of battery packs, leaving 15 GWh for other applications. To put this in perspective, the rapidly expanding battery industry produced 34 GWh in 2013, with production growing at 15-20% every year. Even if the rate continues at 20% per year, the battery industry will be producing 100 GWh in 2020. This means that by that point, at 50 GWh per year, Tesla will be producing half the world's battery capacity.

Source (click to enlarge)Source: Tesla Motors PDF

Tesla is building this Gigafactory specifically in order to make possible the production of their Model 3 (200-mile-range $35k vehicle) by reducing battery costs. And Tesla already has about $2.7 billion in cash of which it plans to invest $2 billion into the Gigafactory. During the most recent quarterly call, Elon Musk described the funding of the Gigafactory:

"We see Tesla probably providing 40% to 50% of the total [cost], Panasonic probably about 30% to 40%, the states maybe 10%, and other industrial partners about 10%, maybe 15% to 20%, depending on how vertical [ph] we go with the factory."

LG Chem also set the ambitious goal of being able to support production of a 200-mile-range vehicle in the $30,000 to $35,000 price range. However, with only $1.4 billion in cash, they have no public plans of building anything that is on the same order of magnitude as the Gigafactory. In order to reduce costs enough to support such a vehicle, LG Chem will have to expand their production capacity rapidly in order to reap the benefits of economies of scale and they will have to invest heavily in R&D in order to figure out how to construct batteries in a cheaper way. Clearly, $1.4 billion in cash doesn't really compare with Tesla's $2.7 billion, of which it is deploying $2 billion already. LG Chem is a large, established company that will not dare to spend such large amounts on any one investment due to their risk averse culture. Even if LG Chem manages to produce such a vehicle without a Gigafactory, they will not be able to mass-produce it. Without such a large factory, the increase in their battery capacity production could not outpace the rest of the battery industry.

Due to the risk-averse status of much of the battery industry, there is a low likelihood that any battery company will invest in its own Gigafactory without a partner that is willing to cover a significant portion of the project (which of course is hard to find). An example of this is the Tesla and Panasonic deal itself. Panasonic's risk averse culture translated into them deciding to fund its portion of the Gigafactory in installments (the first of which is $200 million), rather than one lump sum.

In order to reduce costs as quickly as Tesla and be able to mass produce a vehicle in the $35k price range with a 200-mile range, any company will have to expand battery production capacity comparable to Tesla's Gigafactory. So until some company announces either a Gigafactory or huge expansion in battery production in multiple factories, Tesla will remain far ahead of its competitors. As more time passes without such a battery factory being built, Tesla will continue to grow its competitive advantage in terms of time and money spent on such a project.

Superchargers

Tesla is also building out a large network of Superchargers. It is free to use for customers who purchase the 85 kWh Model S, and costs $2,000 as an option for customers of the 60 kWh Model S. According to reports, it costs Tesla between $100,000 and $175,000 to build each supercharger station and takes between 12 and 20 weeks to build. Currently, there are 164 superchargers in the world, of which 105 in North America, 54 in Europe and 9 in Asia. The Supercharger network is also set to rapidly expand, with 2015 maps looking like this:

Source (click to enlarge)Source: Teslamotors.com/supercharger

Assuming that the average cost of a Supercharging station is currently $150,000, then Tesla's total investment for all the Superchargers amounts to $24.6 million thus far. In order for any company to compete with Tesla on a 200-mile range car that costs $35k, they would need to have a similar charging infrastructure that allows customers to charge their cars quickly and for "free." Other companies who build charging stations charge customers money in order to refuel. Therefore, any manufacturer that wants to compete with Tesla directly must build out their own network and not rely on other companies for infrastructure. And because of the relatively risk averse culture of established companies, none of them will start investing $24.6 million in such a network before they have a car that can use them. The only car that can handle such fast charging speeds currently is Tesla's Model S. So car manufacturers could either play catch up with Tesla when they have a car that can use such fast charging networks, or partner with Tesla and thus entrench Tesla as a successful company in the automotive industry.

'Compliance' Cars?

So far, many car companies have built 'compliance' cars that only sell in certain states that require a percentage of EV sales, such as California. Examples of this include the Chevy Spark, Toyota's (NYSE:TM) RAV4 electric and their FCV. Who's to say that the cars that LG Chem will provide batteries for in 2017 won't be low-volume 'compliance' cars? And if they will be 'compliance' cars, then by definition they won't present serious competition to Tesla's Model 3. This means that the Model 3 will not lose any substantial market share to such cars, and will therefore remain as an industry leader.

What About Hydrogen Fuel Cell Vehicles?

Hydrogen fuel cell vehicles do not need a battery Gigafactory in order to be mass produced. However, their cost still needs to come down. The only hydrogen fuel cell vehicles that are sold or will be sold soon in the US are Toyota's FCV, Honda's (NYSE:HMC) FCX Clarity, and the Hyundai Tucson. All of which are costly ($70,000 for Toyota's FCV, $600/month lease for Honda's FCX Clarity, and $499/month lease with $2,999 due at signing for Hyundai Tucson). Moreover, hydrogen cars lack refueling infrastructure, as there are currently only 100 stations in the world (compared with over 20,000 electric car charging stations), with each costing around $4 million to build. These companies plan to mass produce only about 1000 FCVs each in 2015, and then eventually ramp up to tens of thousands by 2020. This is already much later than Tesla's planned roll out of Model 3 in 2017, and by 2020, Tesla will be producing hundreds of thousands. So even if these FCVs achieve their ambitious production targets, they still will not be serious competition to Tesla until at least a few years past 2020. Also, if hydrogen station costs are not significantly reduced, there will not be a rapid build out of these stations; making these FCVs impractical to the consumer. This is yet another reason that hydrogen fuel cell vehicles will not provide substantial competition for Tesla's Model 3 until at least a few years after 2020 (in the most optimistic conditions). And, since Tesla plans to churn out 500,000 cars and an additional 15 GWh of battery capacity, by that time Tesla will already be an established company.

Conclusion

Any company trying to compete with Tesla's Model 3, set to come out in 2017, faces an immense challenge. Given the Gigafactory and Superchargers, Tesla has a huge competitive advantage over other companies who want to compete with them on clean vehicles in the $35k price range. Of course there are risks that the Gigafactory might not be completed in time, or Superchargers expand more slowly than desired, but the same risks apply to other auto manufacturers. Due to these competitive advantages, Tesla seems poised to leave its competition in the dust.

Editor's Note: This article discusses one or more securities that do not trade on a major exchange. Please be aware of the risks associated with these stocks.

Source: Why Tesla Is Poised To Leave Its Competition In The Dust