Tesla Motors: Buy the Car, Avoid the Stock

Tesla Motors (TSLA) makes a cool car, there’s no question about it. The high-performance all electric vehicle is the toast of eco-sensitive millionaires and talk show hosts. Unfortunately, according to our stock value screening test, Tesla is one of the worst investments we can imagine making. Just because you love the product, does not mean you should love the stock.

Tesla Motors designs, develops and manufactures high-performance, fully electric vehicles (EVs) and electric vehicle power-train components. The company was incorporated in 2003, and introduced their first vehicle, the Tesla Roadster in early 2008. As of 2009, the company has sold approximately 1,650 Roadsters. To broaden beyond the $110,000+ Roadster, the company is designing its second platform, the Model S, for a lower, but still luxury priced market, with a broader customer base and higher volumes. Production of the Model S is not expected until mid 2012, and as of March 31st, the company has approximately 4,300 reservations for which customers have paid a reserve payment.

The company is very much in the development phase. Revenues for the quarter ending March 31, 2011 were $49 million, with R&D costs of $41 million, Sales and Admin costs of $24 million and a loss from operations of $47.3 million. Capital expenditures alone for 2011 are expected to be in the range of $190 to $215 million.

Vehicle sales in the quarter were $20.4 million in the 1st quarter, up 13% from the same quarter in 2010.

Tesla is partly owned by Toyota (TM) and Daimler Corp. (DDAIF.PK) and has been supported by both of these companies. For example, Tesla has provided some development services for the Toyota RAV4 EV, and for Daimler they supplied battery packs and chargers for a trial of Smart ForTwo electric cars.

Financing Development

On March 31st the company had $100.7 million in cash and cash amounts totalling $405 million available from (low interest) DOE loan facilities. The company anticipates that the cash will fund operation through the anticipated initial deliveries of the Model S.

Risks Related to Business

Frequently, investors ignore or gloss over the risks identified in a company’s 10-Q and 10-K filings. Many of the risks are related to getting a new and more complicated platform into production on time, and although some extra time can fix most production problems, the implication will be more time with high expenditures and limited revenue

The risks to Tesla are stated in great detail in the sec filings. As is typical with these types of reports, there are almost too many risks to comprehend, which we think is the point in most of these reports. They list so many risks, in extremely scary language, to the point that the average reader won’t even bother to read them.

However, in this case, we think it is worth a few minutes to consider what Tesla is trying to do: create a new car company, in a completely new category of product, using unproven technology, with unknown consumer demand. This is a tiny car company trying to launch an all-new car to compete at a time when plug-in Toyota Hybrids, Nissan ((NSANF.PK)) Leafs, and Chevy Volts will be in the market. In addition, they need to build some serious manufacturing capacity, and expand a sales and service network. It would be one thing if Tesla was doing this with 1 or 2 % of their company resources, like their big competitors, but this will be Tesla’s only vehicle.

Additional risks, largely outside of Tesla’s control, are the long term availability and costs of lithium and lithium batteries, the availability of a charging infrastructure, the development of alternative technologies, the cost of electricity for charging, the health of the economy, and the actions of competitors.

We can’t think of another company trying to do so many difficult and new things, all in such a short time, with (relatively) so few resources.

On the positive side, Tesla has a lot of support from the government in the form of low interest loans and subsidization of EV purchases. It has also had some uniquely supportive investors, including car companies like Toyota and Daimler, who can be customers and partners, as well as investors.

Valuing the Investment

Almost everyone likes the karma of electric vehicles. It’s almost unpatriotic not to support the concept. However, investment is a financial decision, and for valuation analysis we take into account the level of risk that we are assuming. In our valuation model, if the risk is high, we discount the value of future earnings accordingly to allow for the uncertainty.

For early stage technology companies, (and we view Tesla as a tech company at this point in their history), we have a fairly simple valuation model that screens the good investments from the bad ones. Essentially, we make assumptions about future revenue growth and about the after tax net profits. We do a present value calculation to put a value on those future earnings, and from that we estimate how much we should pay for a share of those earnings.

With Tesla, nobody knows what future revenue growth and earnings will look, but that doesn’t stop us from testing a few scenarios.

Here’s one: let’s assume (optimistically) that they start shipping Model S in mid 2012. Year 1 revenue growth without the Model S would be minimal. For Year 2 we assume they can build and sell 5,000 Model S’ for $60,000 each (revenue $300 million). Let’s assume they build and sell enough cars to grow revenue by 50% every year for another ten years. Let’s assume they can finance all that growth cost effectively. Let’s assume that after a couple of years of losses, they can quickly grow earnings to the 8% net profit after tax range (very good for a car company).

For the above scenario, our model calculates that the discounted value of those earnings would be approximately $1 billion. For early stage tech companies we don’t put a value on what happens after 12 years. Maybe that is where we will differ from you. Our standard assumption for early tech companies is that the uncertainty of revenue and earnings streams are so high after 12 years that we don’t put any value on it. (If we were valuing toll highways or hydro electric stations, we would use a very different model.)

A billion dollars in earnings pretty much assumes that none of the many risks listed by the company become a problem. Less optimistically, if Tesla is late by one year in getting to volume shipments of the Model S, or if one of two of those risk items identified in Tesla SEC filings were to happen, then most of the $1 billion disappears. Such is the unforgiving financial reality of paying out for development costs in present dollars, but collecting the benefits in heavily discounted dollars.

I can hear the howls of protest already – we are being too hard on Tesla by discounting the value of its future earnings. Our argument for not doing that is that we would have to discount the value of those future earnings so heavily (to allow for the uncertainty about Tesla’s world will look like after 2023), that the present value of those distant earnings would be near zero anyway.

We value all early stage tech businesses this way, and we don’t see a reason to make an exception for Tesla, no matter how good the karma. In round numbers, a billion dollars, if shared by some 130,000,000 diluted shares, is worth about $8 a share. Granted, it’s a quick and dirty test, but we’ll be passing up on this investment.

Conclusion: Buy the car, sell the stock. Check back in a couple of years.

Disclosure: I am long ABAT, XIDE.