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Tales From The Future (tftf). I picked my nickname because many advisors and investors claim they can predict the future of the (stock) markets and somehow pick the winners. I don't. I usually do not engage in short-term trading and myopic analysis (quarter by quarter, without looking at the big... More
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  • Cult Stock TSLA And The EV Mass-Market Going Forward - Epilogue (The Porsche Exit) 2 comments
    Sep 24, 2013 6:55 AM | about stocks: TSLA, GM, TOYOF, NSANY

    I asked the following question in the original version of this article:

    Will the upcoming TSLA Gen III car be better rated in 2018 by consumers, the auto press and have higher gross margins than (just mentioning three example cars)...

    • GM Volt + 5 years of refinements
    • Nissan Leaf + 5 years of refinements
    • BMW i3 + 5 years of refinements (maybe also an upcoming i5)?

    (( This question is very important because only then does the current valuation of TSLA at well over $20 billion make the slightest sense. In addition, any revenue numbers from the Gen III car and other potential revenue options (car tech licensing, stationary battery products...) far in the future also have to be adjusted to present value, see here for more details. Damodaran, a noted academic expert on valuation, writes regarding his TSLA valuation for the next years:

    If you revisit my valuation and check the value that I have attributed to Tesla in year 10 (the year that I see them having Audi-like revenues and Porsche-margins), you will see an estimated value of $68.27 billion. To get from that expected value for a business in the future, estimated either using a DCF model like I did or by applying a multiple on earnings as many venture capitalists becomes a value today, you have to take into account the following "drags" on value:

    (click to enlarge)

    Bringing together all of these adjustments into one picture shows the cumulated effect of all of these drags on value, reducing the estimated value of $68.27 billion in year 10 for the business to the $8.15 billion in value for equity today.

    If you read my earlier Instablog entries: I arrived at a similar valuation for TSLA from simpler numbers, resulting in a stock price between 70-85 USD, about half of its current valuation.

    That was quite a long but important insert about equity valuation to present value, on with the regular program below :-) ))

    I won't list all the additional models from these manufacturers or other major car companies introduced between now and 2018. There will likely be dozens of hybrid/EREV (both hybrids and extended range vehicles) and "pure" EV (battery only) car models to choose from in the mass-market (defined at 35k USD or below) price range by 2018-2020.

    In the end, the propulsion system doesn't even matter for many car customers, they just want a car to bring them safely and economically from point A to point B - especially so in the mass-market segment.

    Which brings me to the epilogue's question: Should TSLA even enter this price segment and produce a Gen III car? It may be a strange question to ask, since the Gen III aka "BlueStar" car was the major strategic goal of TSLA from the start: Produce a mass-market EV car at/below 35k USD with acceptable pure battery-only range (200 miles).

    Let's review the revenue options for TSLA in the coming years:*

    • Model S (currently the only model for sale)
    • Model X (and maybe a "baby" Model X, smaller SUV/crossover)
    • Roadster 2.0/sports car (a successor to the original Roadster)
    • Pick-up/Truck (maybe U.S.-only)
    • Gen III (mass-market car at 35k USD)

    Considering what I had written in the first part of this article...

    It would be a mistake to assume TSLA can carry over all the advantages the Model S enjoys (hence the price tag) to the Gen III car - or that competitors couldn't match these features or the vehicle range (rumored to be 150-200 miles) in the mass market by 2017.

    One could even turn the argument around and say GM, Nissan and BMW have a 4-year headstart in the lower-end/mass-market EV and PHEV price segment until the Gen III is available from TSLA [in 2016-2017**].

    (Projecting today's high-end Model S specs onto a future GenIII car sold at half the price will only end in disappointment when that day comes).

    ...it's useful asking whether entering the 30-35k USD price segment makes sense for a new entrant like TSLA.

    In my view, the company could retain the current lower volume, higher margin business and its brand positioning (important in the car industry) by "only" selling cars in the first three categories:

    • high-end EV sedan (Model S)
    • high-end EV SUV (Model X)
    • high-end EV sports car (Roadster 2.0)

    ...with maybe an EV truck/pick-up added for the U.S. market. In this scenario, TSLA could become the Porsche equivalent of EVs with sales of about 75-250k cars/year (assuming an optimistic scenario).

    Looking at Porsche's margins, this niche strategy worked very well in the ICE market for the German company. Porsche is set to sell "only" 200-250k cars by 2015, yet it enjoys the highest operating margins as well as an prestigious brand value in the car industry.

    Using a similar strategy in EVs and (only) selling cars above a base of $50k Tesla could maintain its current exclusivity and offerings better:

    • Proprietary Supercharger network (maybe with battery swaps and couriers in the future? So far, swaps are a technology demo)
    • Direct sales model (showrooms in urban areas, no car dealers)
    • High level of service/after-sales quality

    TSLA can't have it all - either high margins or a (much) higher volume.

    Most people long TSLA dreaming of even higher share prices will disagree of course and favor the high risk strategy pursued by the company: Ramp up production and introduce a mass-market car, yet somehow magically retaining the current brand appeal and operating margins?

    (There's a reason Harley Davidson and other cult brands don't offer cheap products for the mass market - it would generate more money for a few years, but dilute the brand value over time and backfire.)

    Granted, some elements of the Gen III car release plan may still be tweaked - since the reality of the car market with huge up-front investments may make the original strategy goals and deadlines very hard to follow. I can see the following roadblocks, for example:

    • Price increase into 40-50k US range for the Gen III car instead of the proposed 30-35k USD, no "true" mass-market car any longer?
    • Delay in Gen III car release (eg. 2018 instead of 2016-2017) because of slower battery price drops or (battery) supplier issues?
    • Outsourcing the Gen III production to a partner (eg. Toyota or Daimler, since both of them are TSLA investors)? ***

    More generally, I view the original strategy (introduction of a sub-35k USD EV and selling hundreds of thousands of vehicles a year, adding factories in Europe and Asia) as a high-risk approach which may ultimately backfire for the young company and its shareholders.

    Almost all European, Asian and US car companies are deeply entrenched in the mass-market price range. According to studies, most new car buyers in the mass-market segment have a psychological "price barrier" around 30-35k USD. Margins are very low and high rebates are the norm in this segment:

    With a Gen III car at the promised $35k (or even lower), TSLA will likely enter a fight over operating margins and have trouble extending and maintaining its current go-to-market model (free supercharger network and only direct sales, service) worldwide at current quality levels.

    TSLA longs should not under-estimate the competition in a few years:

    While many car execs may have laughed at or at least underestimated TSLA (or in general all EVs as a segment) up to now, they won't do so in the future. This year's 20-30k unit sales of Model S do not bother them a lot**** (except for a few of their dealers in California), an upcoming Gen III car selling well over 100k units per year (according to Tesla's plans) certainly will.

    With billions in R&D money, plants and global distribution in place, most major car companies can flip the switch and start making more EVs fast - should their mass-market customers demand them in the future (eg. see the September 2013 news from VW, announcing up to 40 hybrid and EV car models over the next few years depending on demand). In addition, they can hedge their bets with a broad portfolio of PHEV, CNG or ICE models - something TSLA is not willing to sell.

    Asian car companies in particular will probably churn out EVs and hybrids in this price range cheaper and faster - there is little doubt they will once again be the worldwide leaders in terms of build quality and speed (for example, look at the constant refinements and price reductions of the Toyota Prius since 1997). In addition, new entrants such as Chinese (NYSE:EV) car and battery companies will likely get massive "infant industry" protection at home, similar to earlier ICE car industry support by South Korea and Japan in the late 20th century. China already has EV companies such as BYD. Japan, South Korea and China already are world leaders in battery technology manufacturing.

    Is this a market segment TSLA wants to compete in? Can it compete as a young company in a segment where...

    • buyers value features/$ over styling, demand constant rebates
    • buyers are more conservative (fewer early EV adopters, more expensive and constant advertising needed, hurts margins)
    • buyers are less likely to own a house or a garage (thus no easy recharging their EV overnight, making EVs a harder proposition)
    • current car companies will cross-subsidize nascent EVs (already happening, see recent lease price cuts on GM Volt/Nissan LEAF)
    • competitors will produce in lower-cost locations (than California)?

    I may be one of the lonely voices saying no.

    As a result in this scenario a more modest valuation of TSLA with smaller risks may result - let's call it "the Porsche Exit not taken":

    In my view, a "Porsche of EVs" strategy could work out better for TSLA and its shareholders:

    Target only the higher-end markets above $50k (base prices). In short Tesla would become the EV equivalent of Porsche in the ICE world with a similar (simplied comparison) small palette of models:

    Model S <-> Porsche Panamera
    Model X <-> Porsche Cayenne/Macan
    Roadster 2.0 <-> Porsche 911 and derivatives

    A successful execution would likely result in a less volatile share price of "only" 50-85 USD longer term (obviously less than most TSLA bulls want or hope for today) - but enable stable dividends over time.

    This scenario of course runs contrary to the dream of TSLA's founder and CEO, namely bringing personal EV transportation to the masses...

    $30k in 2013 $ (ie + inflation) w 200+ mile range w some really cool tech that we can't talk about yet.


    ...so it obviously is just an academic argument - Tesla will introduce a mass-market EV. Nevertheless, the question is important even if just to highlight the massive add-on risks with Tesla's future Gen III strategy.

    As Porsche showed in recent years, taking on massive bets (Porsche was at one time trying to take over the entire VW Group using financial engineering before the financial crisis hit) may not always be the best option - even disrupters like Tesla have limits in the real world.

    If Tesla or in general EVs as a car category are successful, they are likely to disrupt...

    • parts of the traditional car service (oil checks, other ICE services)
    • parts of the traditional distribution channels (car dealers)

    ...in the car sector - but not most***** of the established car manufacturers: Car companies will simply produce more EV cars in the future should customers demand them. There is nothing magical to building a fine EV longer-term - or a CNG, EREV/PHEV or fuel-cell powered car - should customers demand them one day. The car market is slow-moving, people only shop for a new car every 7 to 11 years.

    All car executives are well aware of Tesla by now, it's not like the company is not generating headlines disproportionate to its current sales in both the automotive and the mainstream media with Model S.

    However, the "disruption" process may be much slower than TSLA bulls hoped for given the nature of the car industry compared to other sectors (e.g. IT/Internet where disrupters have a more level-playing field and shorter time frames) - remember it took all the Japanese car companies combined decades to take on Detroit with superior products.

    Speaking of Japanese companies, Nissan-Renault today is the market leader in EV sales and intends to remain at the top. Many people forget (over the TSA hoopla) that the mass-market EV vehicle market is already in play today - years before Tesla can enter it with Gen III.

    Again, shareholders should ask themselves: Should Tesla enter at all?

    I'm saying no.

    With that, I'm ending on a thoughtful quote from the linked Damodaran article from above:

    A Tesla for all its' worth is a well executed electric car - it is not a car that runs on energy from free air or water. It's the Lexus of this decade - nothing more.


    * As long as basically all revenue is derived from cars, I see TSLA as a car manufacturer, not a technology company; their current revenue from contract work/licensing is very small compared to their car sales.

    ** Assuming there are no delays. For example, the Model X car was pushed out by one year to late 2014 and the Gen III car could also be delayed considering slower reductions in battery pricing than predicted. Tesla is also changing the price estimates, mentioning "below 40k", "35k" or "$30k (2013 plus CPI until the introduction date)".

    *** I doubt these car giants would swallow their pride and produce a car for their junior partner. A JV may be a way-out for Toyota and/or Daimler to save face. In any case, margins for TSLA would be much lower in this JV/outsourcing scenario, but at least save them liquidity.

    **** GM and Toyota currently produce about 10 million cars per year, VW Group's stated ambition is to surpass both of them by 2018. They also have billions in R&D money ready to spend on battery technology should a third-party project like IBM "Battery 500" or a similar breakthrough become ready for mass adoption in EVs one day.

    ***** Laggards like Fiat Group, Toyota or Honda (currently opposed to pure EVs) may obviously suffer market share in this "pure EV" scenario.

    Disclosure: I am short TSLA.

    Stocks: TSLA, GM, TOYOF, NSANY
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  • Tales From The Future
    , contributor
    Comments (7645) | Send Message
    Author’s reply » Since the article was already getting too long, here are the Porsche 2012 numbers as benchmarks for Tesla.


    It's easy to see Porsche's performance currently outshines all competitors on a profitability level. Porsche is the car company with the highest operating margins in the industry:


    "The healthy cost structure and the sustainably high earnings power of the group are also re- flected in the key performance indicators. The Porsche AG group achieved an operating return on sales of 18 percent in the past fiscal year (prior year: 19 percent). The return on sales before tax was 19 percent (prior year: 19 percent). The re- turn on capital, defined as the ratio of operating result after tax to average invested assets of the automotive division, was 33 percent (prior year: 32 percent). The return on equity after tax was 25 percent (prior year: 21 percent)."




    Straight from the 2012 annual report, see link for details (PDF).


    Porsche produced about 150k cars that year and is expected to produce 200-250k untes soon (introduction of the Macan SUV in 2014 as a smaller Cayenne alternative, the Macan is set to become Porsche's best-selling model).
    26 Sep 2013, 07:08 PM Reply Like
  • Tales From The Future
    , contributor
    Comments (7645) | Send Message
    Author’s reply » Update: Summary with an updated article link on EV battery supply challenges, written as a recent comment.


    Two reasons given why entering the EV mass market is a high-risk strategy and taking the "Porsche exit" could be a safer way out.


    Selling fewer high-end cars (without a Gen III model) would also not require TSLA and/or JV partners to build gigantic battery supply capabilities as outlined in 2. below:


    1. Competition from established car makers by around 2017-2020 in the mass market


    The car mass-market at $30-40k ASP is about thin margins and heavy incentives as well as massive advertising, often directly involving the large dealer networks (let's remember TSLA sells direct with fewer retail outlets, push vs pull).


    Marketing and sale efforts will need to be very different and costly compared to the current high-end (ASP often above $ 100k) niches TSLA operates in with the S and X car models.


    2. Battery Supply/Ramp-Up. I have written a longer entry here on battery supply challenges for all EV makers (November 2013):




    I invite everyone to review the numbers in the link, the amounts in terms of GWh needed are simply staggering.


    Linked in the article is a video from JB Straubel, CTO of TSLA. He is talking about 40 GWh needed by 2019, this is assuming 700k vehicles and on average 5000 cells/car.


    These are just the numbers for TSLA.


    Other EV car makers and companies like AAPL and Samsung will of course still need batteries by 2020 (probably even more so than today).


    40 GWh just for TSLA batteries by 2020 !


    Let that number sink in. Currently, the total global capacity is around 25-30 GWh for all these battery types (!), most buyers are not even in the automotive space today.


    Exception: TSLA already is one of the largest buyers of Li-Ion cells with just 25k cars produced in 2013.


    Now run the resulting numbers:


    How many NEW battery plants would be needed before 2020 to solve this?


    We better start construction (which is of course risky, because mass-market EV demand uptake is still largely unproven) today.


    Between now and 2017 people will finally wake up how much investment is required. It looks like many TSLA bulls and analysts are still in deep sleep...
    25 Nov 2013, 11:35 PM Reply Like
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