Why Tesla?

| About: Tesla Motors (TSLA)

Summary

To understand the market for Tesla Motors shares, one needs to understand what motivates customers of and investors in this unusual company.

Tesla has received 400,000 paid reservations for their Model 3 car, reflecting enthusiasm and customer interest the likes of which legacy automakers can only dream.

Traditional valuations of Tesla are generally lower than the market, while exponential growth models matching Tesla's disruptive prospects produce valuations that are severely discounted by the market.

Looking to future valuations for Tesla shares can only be successful if investor sentiment and factors driving it are taken into account.

Model 3 far exceeding expectations will further boost investor sentiment over coming months, prompting me to adjust my medium-term price target upward from $320 to $355.

Author Somon Sinek explains why (five-minute YouTube at the link) some companies, organizations and leaders are more successful than others. For those trying to understand why Tesla Motors (NASDAQ:TSLA) is valued so highly by the market, Simon Sinek is worth a listen. With "great mysteries," often one need only look in order to see. And, in the case of Tesla, those who don't see Tesla's appeal have yet to appreciate the cause. Since blind investors are like to fare poorly amongst the sighted, lets take a look at what's going on with Tesla.

Tesla has about 400,000 paid reservations for their 200 mile range, $35,000 (before incentives) Model 3 electric car. One hundred and fifteen thousand of those reservations, with deposits, were made in the 24 hours before Tesla's CEO Elon Musk showed Model 3 to the public! Tesla isn't promising delivery for nearly two years, and they have a reputation for being very late. But still the orders poured in.

General Motors (NYSE:GM) has a 200 mile range, $37,500 (before incentives) Bolt electric car which is in some ways similar to Tesla's Model 3. General Motors is a huge, established, well financed carmaker with a century of experience building cars. They make and sell almost 200 times as many cars as Tesla, and have thousands of sales outlets around the world. General Motors CEO Mary Barra introduced the Bolt last year. General motors has zero customer reservations for the Bolt. Zero. (isolated Chevy dealers may have a few.)

Why did Tesla receive in two weeks, more reservations for their electric car that won't be available for years, than all the electric cars ever sold in the US? And, why does GM's Bolt, that will deliver much sooner, have none? If you don't know the answer, then you don't understand why Tesla is valued by the market at $647,000 for every car it sold last year while GM is only worth $4,700 per car sold. GM may have sold 200 times as many cars as Tesla, but Tesla is worth 138 times as much for each car it sold.

It turns out in this case that the answer to, why? is why itself. Take a look at the entire Model 3 introduction. The first thing CEO Elon Musk talks about is why Tesla exists, why what they are trying to do is important. Not everyone thinks global warming and anthropogenic climate change are real. But that doesn't matter. Many people do accept, worry about and want to see action to curb global warming. These folks are among Tesla's customers, fans, and investors.

Does anyone know why General Motors exists? Does GM have a mission beyond next quarter's numbers and staying away from bankruptcy court? Meeting next quarter's numbers and remaining solvent may appeal to some. Judging from the numbers, either reservations or market cap in relation to sales, GM's 'why' is nowhere near so compelling as Tesla's.

Valuing Tesla

Tesla is a different kind of company. It is an automobile company, of course, but it is growing at compound rates far beyond what any legacy carmaker has seen since Ford (NYSE:F) started making the Model T. But Tesla is much more than cars. Tesla is an energy company with an array of grid storage products. Tesla is a tech company leading the way in development of autonomous vehicles. And, Tesla is an electric car fast charging network company with the largest network of truly high speed road-trip chargers deployed across three continents.

In every business area, Tesla is leading a wave of disruption that is just beginning to hit the respective industries - electric cars disrupting cars and oil, grid storage disrupting utilities, autonomous cars disrupting carmakers, car dealers and taxis, road-trip recharging disrupting gas stations. With so many nascent opportunities at such an early stage, valuing the company by conventional approaches has proven problematic. Valuing Tesla on the basis on last quarters numbers, or linear growth models has produced valuations generally lower than the market.

Exponential growth models representative of the leading edge of disruptive ('S' curve market penetration) products predict very high valuations and are consistent with the early-point disruption nature of Tesla's several businesses. But the market consistently applies very high compounded discount rates to such exponential growth projections.

Two months ago I looked at Tesla's market prospects in the US and at a mid-case exponential growth valuation, arriving at an important realization. Not only was the market highly discounting Tesla's long term future prospects, the current price for TSLA is extremely sensitive to that compound discount rate applied by the market. The high sensitivity of TSLA to this discount rate (which serves as a numerical proxy for investor sentiment) explains the observed volatility of Tesla shares.

Looking at the sensitivity of TSLA to the applied discount rate and what back in February were sagging expectations for the company, I reckoned a target price of $320 for TSLA based on a belief that news flow going forward would be more positive.

Introduction of Model 3 and the vast number of would-be customers putting in $1,000 reservation deposits far exceeded my expectations for good Tesla news. As the full import of Tesla's avalanche of reservations sinks in, I believe investor sentiment will be even more bullish and in consideration of this happy state of affairs have raised my target price for TSLA from $320 to $355.

New TSLA Price Target - Sensitivity of TSLA to long-term appreciation expectations Click to enlarge

Many Tesla investors look to the company's long term future and extreme returns by 2025. As a result, the price is very sensitive to expected compound rate of appreciation (discount rate) that investors associate with the less than certain likelihood Tesla will succeed. - Author

Is Tesla Winning?

Back in September of last year I predicted that Tesla would be the first automaker to introduce an electric car that crossed the threshold where lower cost, higher performing batteries make a long range electric car less costly to manufacture than a similar size and performance ICE car. Comments made by Tesla executives about battery chemistry improvements, together with the non-showing of Model 3 at the 2015 Detroit Autoshow, the suspension of work on the GigaFactory contingency section in early 2015 and its subsequent removal, the new Model 3 introduction date, all pointed to Tesla getting lighter, smaller, high performance batteries from the GigaFactory.

Based on estimates of the performance of new-design cells from the GigaFactory, which appear to be confirmed by Tesla's abandoning construction of the 'contingency section' of the initial factory, I predicted some Model 3 specifications and was pleasantly surprised to see how closely these predictions matched Model 3 cars shown at the end of March.

Since Tesla didn't disclose either the weight or the battery capacity of Model 3, we cannot yet confirm how good are the batteries. (Tesla probably doesn't have exact numbers yet anyway.) Close agreement with other design predictions is encouraging of Tesla winning the race to a disruptive electric car. If the base Model 3 weighs less than 3,300 pounds (1,500kg) or has a battery less than 50kWh we will know Tesla has won on technology.

Two Model 3 cars - Tesla Motors Click to enlarge

Model 3 is a beautiful car and has attracted phenomenal response from customers world wide. It closely matches predictions made earlier on the basis of anticipated advanced battery performance, suggesting Tesla has reached the BEV vs. ICE cost tipping point. - image Tesla Motors

If we are not yet certain Model 3 is a technology disruptor, we absolutely know it is a market disruptor. Model 3 is a gorgeous car and competitors like BMW (BAMXY) with its 3 Series, Volkswagen (OTCPK:VLKAY) with its Audi A3/A4, Daimler (OTCPK:DDAIF) with its Mercedes C Class, and Toyota (NYSE:TM) with its Lexus IS are surely thinking about what Tesla has done to them with Model S and worrying mightily about Model 3.

US Luxury car market 2015 vs. 2014 sales growth. Click to enlarge

Tesla's Model S is the dominant car in the US luxury segment, and Tesla's growth has come entirely at the expense of competing ICE luxury cars. If Model 3 dominates 'D' Segment the way Model S has dominated luxury cars Tesla will sell all the Model 3s they can make while competitors feel lots of pain. - Author (data from 4Q2015 Tesla shareholder letter)

Why Model 3 Will Boost TSLA

All the technology and engineering speculation, all the market analysis, all the pretty pictures cannot make Tesla a winner or make their shareholders rich. Only a large, loyal base of customers buying Tesla cars can do that. The 400,000 reservation deposits booked by Tesla suggest customers will be there for Model 3. But the number of customers is just part of the story.

It isn't just the number of reservations, it is the enthusiasm and commitment these largely new customers exhibit toward Tesla. Even in Minnesota where it gets really cold in winter, hundreds stood in the rain (FOX news video) to reserve a Model 3. They made $1,000 deposits realizing they would wait years for delivery. People who are not millionaires and not from California have bought Tesla's 'why' as much as they have bought Tesla's car. And this is very important for Tesla and their investors, long or short.

The question facing investors either long or short TSLA is what market sentiment will do to the stock going forward. TSLA is valued by the market on the basis of highly discounted, long term growth at exponential rates. Even modest changes in market sentiment and hence in the discount rate investors collectively apply to Tesla's future prospects have disproportionately large effect on the price.

At this point, it isn't earnings, cash flow, or even the prospect of Tesla raising new capital to accelerate Model 3 production that drives the price. What matters is sentiment - the degree of belief the market collectively has that Tesla will realize their potentially vast future. To paraphrase Simon Sineck, investors don't buy what Tesla does, they buy why Tesla does it.

Like so many Model 3 reservation holders, investors are buying Tesla's 'why', not just Tesla's financials. And that is why Tesla.

Disclosure: I am/we are long TSLA.

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.