Tesla's Model 3 Mess: The Aftermath

| About: Tesla Motors (TSLA)

Summary

900+ comments later, we want to summarize what Seeking Alpha readers thought about our article claiming that Tesla is in trouble with the Model 3.

Bottom Line: We still believe this car is going to cost more than $35,000, and that Tesla faces stiff competition. And, those making deposits are taking huge risks.

As for the Gigafactory, well, that's a whole 'nother story. We decided to write about it separately.

Well, that was quite a ride. As of the date of this article, we've experienced almost 24,000 page views and received more than 900 comments on our recent effort, Beware Tesla's Model 3 Mess.

The great headline surely helped. We would love to take credit for that, but it's not ours. The one we originally suggested was plodding and soporific. The creative editorial crew at Seeking Alpha axed our effort and substituted its own inspiration. A mercy killing followed by a miraculous birth.

Also beneficial was some lucky timing, as the article was published during the same week that the General Motors (NYSE:GM) Chevrolet division unveiled the Bolt, Panasonic (OTCPK:PCRFY) (OTCPK:PCRFF) commented publicly about the Gigafactory, and equity markets worldwide took a tumble.

And then, too, bull or bear, there's something about Tesla Motors (NASDAQ:TSLA) that really gets the juices flowing. As usual, we learned a lot from the comments and were once again impressed by the astonishing font of experience and expertise that many of the Seeking Alpha members bring to the discussion.

We have other Tesla topics we hope to discuss here soon, including Tesla Energy, Tesla's investment bankers, and the true environmental impact of Tesla's Supercharger network. But, first, let's wrap up where things stand now that the comments on The Model 3 Mess are tapering off.

The comments about the Gigafactory provoked us to more research and reading. The topic became so big that we have devoted a separate article to it, which you can find here.

Source: Wikipedia

So, Gigafactory aside, we'll take the following topics in order:

  • 1. Will Tesla be able to keep its promise that the Model 3 will cost only $35,000?
  • 2. Will the introduction of new EV, PHEV, and other hybrid models squeeze Model 3 margins?
  • 3. In unveiling the Model 3 and inviting reservations, is Tesla obligated to disclose the material risks being taken by those making deposits?

A. $35,000 Model 3 - Realistic or Far-Fetched?

We claimed that Tesla would be unable to keep its promise of a Model 3 with 200 miles of range priced at only $35,000. Making separate estimates of the costs of the battery and of what we called "Everything Else," we suggested that the base price would need to be at least $45,000.

We're not surprised that we received lots of disagreement on this point, but we are surprised at the variety.

First, there are many who agreed that the Model 3 will cost more than Tesla has promised, but say it won't matter because consumers will happily pay $45,000 or more. Commenter doubleE summarized this view: "Tesla could easily miss the $35k price and still sell the [Model 3] in the hundreds of thousands."

Awakeinwa was more colorful in expressing his confidence that Tesla would find many buyers at $45,000. "You make it sound like people are scroogy car buyers these days…Peeps pay 45k for ice cars now. They'll pay that for superior electric."

Both those comments made for an interesting contrast with the view of another Tesla bull, stealthology, who expressed confidence that "Tesla wouldn't dare make the starting price more than 35-40k."

Second, there are those who claimed that we underestimated how much Tesla can save on the "Everything Else." Value Horizon captured this view: "The Model S sells in the same category as the BMW (BAMXY) 7 series, not 5 series. The price differential between a 7 series and a 3 series is $43K not $15K." (Other commenters, most notably Steve Funk, defended our use of the BMW 5 and 3 series in our cost analysis.)

Third, there was a huge disagreement about our view that the battery would cost between $200/kWh and $300/kWh. Some, citing a report that LG Chem is selling battery cells to GM for only $145/kWh, appeared to equate the cost of battery cells with the cost of the fully assembled battery packs.

Others, with perhaps a fuller understanding of all the battery components, were all the same convinced that Tesla can do significantly better than $200/kWh.

Seeking Alpha Contributor Randy Carlson, who may properly be referred to as the Dean of the Tesla Bull Case at Seeking Alpha, referred to articles he has published here, here, and here in setting forth this view:

My battery pack analysis estimates $158/kWh for the pack ready to be installed in the car (i.e. including the structural battery pack casing as seen in Model S / X). Dan Dolev at Jefferies has used a different and independent analysis to estimate an even lower battery cost ($86/kWh cell level; $125/kWh assembled pack).

Carlson's claims were met with skepticism by MRTFF, who describes himself as a Ph.D. chemist working in research and development for a domestic Lithium-ion battery manufacturer. He wrote that he guessed Tesla's cell costs are "close to" $200/kWh. However, "[p]acks are only (on average) 60 to 80% cells. When you add in the material and labor costs of pack assembly, plus any margin tacked on, the price creeps up significantly."

Fourth, at least one commenter, cashchain, thought the Model 3 would price out higher not because, as we had suggested, Tesla would shrink down the Model S to come up with the Model 3, but because Tesla was starting from scratch with a new design,leading cashchain to conclude that Tesla badly needs "a global manufacturing partner who can scale a product."

This view was elaborated upon by xonkd:

I think, and have stated a few times before, that the Model 3 is an engineering and production challenge vastly more difficult that the S or the X as they are constrained in terms of price and have the critical need to build in truly mass production volumes. They need to have Fremont put out as many or more cars as Toyota ever did and they are not even close to that level of management, just-in-time supply system, assembly technique, tooling, etc. They are still an entrepreneurial company (bless them) but at junctures like this, organizational maturity and experience probably win the day. I truly hope they make it but they need a strong management team with a hands-on leader right now who is all over that company 24/7.

Where do we come out on Model 3 cost?

We lack the technical background and industry knowledge to know whether Randy Carlson or MRTFF has the better end of the argument. We do note that, less than a year ago, one Tesla owner reported that the list price for an 85kWh battery pack was $44,000, which works out to $518 per kWh.

Yeah, sure, that price no doubt includes some current mark-up, excludes some future cost savings, and all that. But, all that said, it's a long way from Tesla's list price of $518/kWh to Randy Carlson's $158/kWh.

When we try to figure out what the Model 3 will cost Tesla, we hearken back to the wisdom of Daniel Kahneman, who in Chapter 23 of his seminal and path-breaking book "Thinking Fast and Slow," identifies what he calls the "Planning Fallacy," by which plans and forecasts by those embarking on complex projects are often "unrealistically close to best-case scenarios."

Stated simply, Kahneman urges that planners make their baseline forecasts by identifying an appropriate "reference class" that is similar to the project they are examining, and then adjust the baseline forecast in view of other relevant factors.

So, we begin by asking whether anyone else has tried to build a car resembling the Model 3. And, indeed, someone has. Just now. General Motors unveiled its Bolt two days after we published our Model 3 article, announcing that it will be priced at close to $38,000 and available later this year.

Seeking Alpha member CoverDrive does a better job than we could hope to in identifying both the reference class case and the appropriate adjustments:

From the comments [to the Model 3 article] that I've read, it appears that the Bolt is not an adequate competitor to the Model 3. Most people believe that the Model 3 will be equipped at a class above the Bolt. And many people believe the Model 3 will be base priced at $35,000. Yet the Bolt is the best barometer for estimating the future cost of the Model 3.

Here's the situation: In today's economics, $35,000 will buy you a Bolt. Tesla cannot produce cars more efficiently than GM. GM is delighted to sell Bolts at $0 profit. Tesla needs to generate enough profit from the Model 3 to repay billions in debt. There is no battery technology on the horizon that will shave $10,000 from a battery pack by 2020, let alone by 2017. Maybe it's just me, but even a $45,000 base price would seem optimistic.

And that, my friends, is precisely how we see it, as well.

Imagine for a moment that General Motors decided to make California the first focus its Bolt sales efforts. It could sell every Bolt possible there for zero profit, and save itself many millions on the ZEV credits (part of that state's Zero Emissions Vehicle mandate) that it would no longer need to purchase from Tesla.

GM could do the same thing in the several other states with similar mandates. Who knows, perhaps in 2017, Ford (NYSE:F) will be buying its ZEV credits from GM?

Meanwhile, reading the many thoughtful comments, we wonder: Does Tesla wish to emulate GM as a mass-market car? Or is it aiming to make its Model 3 attractive to the BMW target market?

There's a huge difference. GM knows better than to compete with BMW, and vice versa. Perhaps Tesla needs to make up its mind?

B. Will Competition Squeeze Model 3 Margins?

Whilst many agreed that the large number of emerging competitors we listed would create competition for Tesla's Model 3, there was plenty of dissent from that view.

One school of thought held that the Model 3 will be better than any other competitor because Tesla designs and builds cars better than anyone else. Tiderip, who has driven a Model S for more than two years, sums up this view: "Tesla will eat the ICE market's lunch and the Prius… and all the rest. Go drive, then post your moronic guessing." (Ouch. But we appreciate your views all the same, Tiderip.)

PVGO had a variation on this theme, positing that the Model 3 will have full autonomous driving capabilities, whereas "[t]he Bolt will not even be equipped with the necessary sensors, all they have is a Mickey Mouse touch-screen system that controls AC and Radio and has a backup camera, which incidentally, is mandated by law!"

A second school of thought, whose views were captured by samma, is convinced that Tesla's Supercharger network will give it an insuperable edge: "Tesla's charging network is unmatched. The Bolt will come out (maybe) with nowhere to charge except Level 2 junk chargers in parking garages."

A third view, enunciated by Value Horizon, is that Tesla competes with all cars, not just the "kiddy pool" of EV's and hybrids, and that it therefore would be easy for Tesla to capture the tiny market share it needs to achieve 500,000 sales per year.

Finally, there were those who doubted the either the Model 3 or its competitors would achieve great success. In the words of riverside1993:

As I have stated more than once, electric cars are an outmoded idea that was voted out of the marketplace about 100 years ago. They will not be a success today for the same reasons they lost out before. The major automobile manufacturers will only be producing them to appease the Greenies and the current US administration.

A different take on this theme came from Andreas Hopf, who predicted that, outside of California, all-electric vehicles won't make sense until electricity costs less and is produced more sustainably, and until charging a car battery becomes as quick and easy as filling a gas tank.

So, what do we think?

On its face, the Supercharger network would seem to be a significant Tesla advantage. That said, much depends on how many potential buyers of the Bolt or Model 3 intend to use their car for long-distance trips. Much also depends on whether Tesla will offer free Supercharger use to Model 3 buyers, or will charge for it.

And, much depends on whether Tesla will have the capital to significantly expand its Supercharger network in order to accommodate the flood of new Tesla vehicles that would enter the highways with the Model 3's introduction.

Will Model 3 shoppers worry whether they will be able to use the Superchargers if the day comes when Tesla can pay the electricity or rent bills?

Exit question: Should they?

C. Does Tesla Owe Disclosures to Those Making Deposits?

We wrote that people placing deposits on a Model 3 are taking serious risks, including the risk that Tesla will become insolvent before their car can be delivered, and suggested some disclosures we thought were in order.

The reaction was fascinating. Very few commenters disagreed that the disclosures were necessary.

A few commenters saw no risk because the deposit is refundable. For instance, nnnnnoway was confident that "[y]ou can always get your deposit back until you actually configure your car." Besides, people will be making deposits "because they want to support Tesla."

Others, such as Dave_M, felt that "giving a refundable deposit to a multi-billion dollar company doesn't represent any significant risk." (Dave_M acknowledged, however, that others may feel differently.)

Yet others, such as molli, understood there were risks, but said they would happily assume them: "I will be glad to give Tesla an interest free unsecured loan for the Model 3 and I couldn't care less if you think that is right or wrong. I am grown up and it is a deal between me and Tesla and none of your business."

A variation on this idea was that all deposit makers would be sophisticated. RetiredEngineer01 summed up this view:

Certainly the people putting down advanced deposits for the Model 3 will be one-percenters who wish the company well, know perfectly well what they are doing and can afford to risk their money. I think your confusing the average Model 3 *deposit maker* with the average Model 3 *buyer* is a serious oversight, while your benevolent/paternal instinct to protect these poor unsophisticated buyers with a list of fantasy disclosures is... well... ludicrous.

And there was one commenter (NiceWhileItLasted) who is certain that even if Tesla were to become insolvent, "Elon would give me a refund out of his own personal fortune, compared to which the deposits are chump change."

It won't surprise you to learn that our view is unchanged. Contrary to what nnnnnoway believes, there will be no easy or certain way to retrieve one's deposit if the company enters insolvency proceedings.

And, while it is fine for a sophisticated investor such as molli, Dave_M, or RetiredEngineer01 to knowingly undertake the risks, it is evident that many potential Tesla buyers - including some who now own Teslas - are unaware of those risks.

(As a side note, we were struck that with more than 900 comments, no one challenged our assertion that Tesla faces an enormous conflict of interest in choosing between reservation holders of the Model S, Model X, and Model 3 as its exhaustion of the $7,500 federal tax credit draws near. This is certainly a huge disclosure issue.)

There are obvious ways in which Tesla could eliminate the largest risk - that of being unable to recover a deposit. As we suggested in the article, it could secure the obligation to return deposits with its existing letter of credit facility.

Or, as commenter Bill Cunningham suggested, it could create an escrow fund administered by a third party: "I'm sure Tesla could find a bank willing to "pay up" for these deposits and pay interest on them, making the deposit more of a "no brainer" for a lot of prospective purchasers."

A Final Note - Do You Seek Information or Affirmation?

Not everyone enjoyed our articles. Some of the commenters at Seeking Alpha, and some who commented elsewhere, accused us of being purveyors of "FUD" - fear, uncertainty, and doubt.

We plead guilty. We confess that we are filled with fear, uncertainty, and doubt each time we make an investment, whether it's something as "safe" as Treasury Notes or as risky as venture capital. Every investment has risk, and every investor should want to understand the risk.

So, if you seek information, welcome to our world. If you seek affirmation, there are other Tesla enthusiast sites that will make you happier.

A Note About Predictions

We are fond of invoking the wisdom of the late, great Yogi Berra, who appreciated that "It's tough to make predictions, especially about the future."

As usual, the only prediction we are fully confident to make is that our predictions about the Model 3 pricing and production will prove off target. However, with only a slightly smaller degree of confidence, we predict we'll be closer to reality than, say, the predictions of Elon Musk. (Or Adam Jonas of Morgan Stanley. Or Patrick Archambault of Goldman Sachs & Co.)

A Note About the Other Contributors to this Article

I have used the first person plural here because I have shaped so much of my analysis from other thoughtful Seeking Alpha members, especially those calling themselves xonkd and investor.gator. I have also relied heavily on the insights of some knowledgeable posters at the Yahoo Tesla message board, most especially temagami and n0m0renancy.

And a Final Note About How To Reach Me

At long last, I have a twitter account -- Montana Skeptic@montanasketic1. Also, Montana.Skeptic@gmail.com is my email address.

Feel free to follow me on twitter to keep abreast of anything I publish by way of Seeking Alpha article or instablog. And, if what you want to say to me just can't be said in public, well, just blast me via email. I have thick skin.

Disclosure: I am/we are short TSLA BY MEANS OF LONG-DATED PUTS.

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.

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