Tesla: What Investors Should Look For At Model 3 Event

| About: Tesla Motors (TSLA)


Press invitations to Tesla's Model 3 event indicate that a working prototype will be available for test drives.

The prototype may still be a far cry from the final production model.

Investors may nevertheless glean insights into Model 3 production readiness, the Gigafactory, and the Model X production ramp.

At Tesla's (NASDAQ:TSLA) March 31 event, a working, drivable prototype of the Model 3 is expected to be available for brief test drives by the media. Although Tesla will have fulfilled its promise to show the Model 3, the devil is in the details, and the details of the prototype will reveal much about the true state of Model 3 development. Here's what investors should look for.

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Source: 2016 Best Cars

From the Parts Bin

Bloomberg actually has a good set of high probability guesses about the event, representing a rational synthesis of various hints and statements made by Tesla personnel, especially Elon Musk. Some of the more negative Tesla bears have questioned in article comments whether there would even be a working prototype on display. Bloomberg points out that invitations sent by Tesla to the media make clear that a working prototype will be available for a "quick spin."

Having a working prototype is not all that much of an accomplishment. Automakers build working prototypes all the time, which they shop around to various auto shows in order to gauge consumer reaction. The important fact that investors should focus on is that the existence of a prototype does not by itself say much about the production readiness of the vehicle.

Prototypes are generally hand built and cost several million dollars. Prototypes often use parts from the automaker's parts bins to substitute for specialized parts that will be newly designed if the vehicle enters production. As such, they may not look exactly like the production model, especially on the inside.

This was true of the Model X prototype, which was shown in 2012 having a nose treatment very similar (probably close to identical, using Model S parts) to the Model S. By the time of the Model X roll out last year, that treatment had been replaced. Doubtless, many other components, including the Falcon Wing doors went through a similar metamorphosis.

Depending on how similar the Model 3 is to the Model S, there's an opportunity for Tesla to raid the Model S parts bin for basic components: battery pack, suspension gear, and drive train are likely to be borrowed from the Model S, even though they may not be used unmodified in the final production Model 3. This will allow Tesla to provide a working prototype at minimal cost, even as it continues with detail design of the Model 3.

Outside Looking In

It will be difficult for investors viewing the highly choreographed unveiling to discern much about the production readiness of the Model 3 from the prototype. Almost certainly, what the world will see will at least superficially be close to identical to the final Model 3.

We will, however, probably be afforded glimpses of the interior of the vehicle. If seats appear to be lifted from the Model S rather than custom designed to fit the reduced volume of the prototype, well, they probably are.

However, the media representatives that get to test drive the prototype will get a much closer look, especially at the interior, and they'll have the benefit of driving impressions of the prototype compared to finished production cars such as the Model S and X. Hopefully, the media will give the world the benefit of their insights, unvarnished by sales hype. So, first and foremost, investors should pay careful attention as I will, to what the media has to say.

Even oblique references to lack of interior "fit and finish," excessive drive train noise, performance issues, issues with software, even bugs in the center console display will be revealing. In short, I have pretty low expectations for the level of design completion of the prototype. We'll see roughly what the car looks like inside and out, and we'll get some idea of how the car drives, and that's about it.

Signs of Lessons Learned

Is the limited information that will come out of the Model 3 event going to be useful for investors? I expect it to be. Mainly what investors should look for is evidence that Tesla has learned the lessons of the Model S and X. More than anything else, that means simplification and design for manufacturability.

Almost everything not involved with Autopilot (which Model 3 is expected to support) should be manually operated, especially things like door handles and latches. So many people are having problems with simple things like door handle deployment on the Model S and X. And of course, auto opening/closing doors should be avoided.

In addition to what we can see, Tesla will likely reveal important design details such as the size and weight of the car, the size and capacity of the battery pack, even the nature of materials used. These details will all aid us analysts in assessing the viability of the Model 3 as a lower cost Tesla that can be built profitably.

This is the central question of the Model 3. So far, Tesla has shown that it can design and build wonderful, state of the art electric vehicles, at a considerable loss. Tesla hasn't shown that it can build anything at a profit. There's hope for the Model 3, but I wouldn't consider profitability to be a done deal.

Q1 Tidbits

In addition to information that Tesla might divulge about the Model 3, investors should be on the alert for any informational tidbits that Tesla (Musk) might drop that have a bearing on Q1 results. Specifically, how the Model X production ramp is going and the state of the Gigafactory.

Fellow SA contributor Montana Skeptic has allowed that Tesla would probably meet its Q1 delivery guidance of 16,000 vehicles, including close to 3500 Model X cars. I find that rather encouraging, as I've pointed to Model X production as a significant gate to pass for the company in its quest for profitability.

That's still far less than the objective of 1000 Model X cars per week that Tesla set for Q2 in the February 10 letter to investors, but it's good progress nevertheless. Hopefully, we'll hear some confirmation of Model X production at the event.

The Gigafactory also is critical to the future financial health of Tesla. Given its relevance to Model 3 production and affordability, I would be surprised if we don't hear some additional information about the state of the factory. Tesla Energy Powerwalls were transitioned to production at the Gigafactory at the end of last year. What's the current production output of the Powerwalls from the Gigafactory? It'd be nice to hear a round number. The lack of a number might indicate problems with the production ramp of cells and battery packs at the Gigafactory.

Investor Takeaway

One key difference in my views compared to the Tesla bears is that I don't see an issue with demand for Tesla cars. Continually, the bears have assumed that demand would drop off rapidly for Tesla cars once orders from early adopters have been filled. This has become almost an article of faith among the bears, and it has to be faith, since it has never been substantiated by fact. Tesla has been able to sell every car it could produce.

The question of demand, especially ongoing demand for the Model X, is really critical to the question of Tesla's capital needs going forward. Tesla has claimed that it wouldn't need to raise capital this year, and I think that was really contingent upon Tesla meeting its overall production goal of 80,000-90,000 vehicles in 2016. I personally believe that there is plenty of unmet demand for Tesla vehicles, especially the Model X, and that Tesla can sell that many cars if it can ramp up production of the Model X.

But I agree there's room for disagreement on this point. This is the most fundamental issue facing Tesla investors. After initial orders for the Model X are filled, will there be sustained demand sufficient to support the 2016 production goal? If there is, then Tesla has a pretty good (better than 50%) chance of meeting its financial goal of achieving non-GAAP profitability in 2016. I continue to rate Tesla a hold.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.