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EV Manufacturers And Batteries: Siamese Twins - Part II

|Includes:NSANY, Tesla Motors (TSLA)

As promised, here's part II of my article since the news on Tesla's "gigafactory" (see Tesla's official blog entry and PDF here) and its financing (see FT article quoted below) are now public.

Between part I and part II of my article, a rather "curious" analyst upgrade (Morgan Stanley doubling the TSLA price target to $320) took place. I already discussed the timing and the stipulated market potential (autonomous cars, grid/residential storage...) for TSLA in a separate article.

The result from this financing round? Investors and intermediaries from Wall Street hand over up to $2.3 billion to TSLA:

Tesla sold $800m in five-year notes and $1.2bn in seven-year notes as part of the deal on Thursday, according to a person familiar with the matter. The five-year notes will carry a coupon payment of 25 basis points and the seven-year notes will pay 125 basis points. Both bonds have an equity conversion premium of 42.5 per cent.

The company had originally sought to raise $1.6bn, but the deal was increased due to heavy demand from investors, according to a person familiar with the matter.

If underwriters, including Goldman Sachs and Morgan Stanley, elect to exercise an overallotment provision, the size of the offering could reach $2.3bn.

A reader comment on SA saves me a few lines to discuss the technical aspects of this factory plan:

This all comes down to the belief that if you build a factory so big that you quadruple the world's lithium ion battery manufacturing capacity, then you will also be able to reduce costs by 30%.

Given that Tesla has no experience in making lithium ion batteries, and will be reliant on its unspecified battery partners (presumably Panasonic), I don't think it is unreasonable to be skeptical.

The battery industry is already large, has had large amounts of capital intensive investment made in it for years, so you have to ask yourself, why do they think they can continue to drive down the costs along a learning curve, at least in this magnitude (30%).*

Technological improvement has been more in the magnitude of 2-5% per year in terms of power output vs cost. And if the costs don't come down, then the fundamental premise for the Version III (an affordable price point for a mass market car) is in jeopardy. So it's not unreasonable to be skeptical.

(emphasis mine)

Assuming the 30% number (TSLA execs even mentioned up to 40% on a recent European tour in early 2014) is correct we will also have to think about competitor's reaction.

There are three other important numbers besides this 30-40% cost reduction plan:

- Quality control (error rates per cell and battery pack, this rate will obviously only be known once mass-production started in 2017)

- Number of employees (aka automation rate. That number is already known: up to 6500 people, see TSLA blog linked above)

- Total output in GWh (estimated at 35 GWh in cells and 50 GWh in completed battery packs at capacity, see TSLA blog linked above).

As for the last number, the difference could be explained by additional cells from external sources (Panasonic ?):

Though the plant will be making 35 gigawatt-hours worth of cells by 2020, it will be making 50 gigawatt-hours worth of battery packs. Panasonic currently makes a total of only about 6-7 gigawatt-hours worth of batteries elsewhere. While previous deals between the two companies have called for that to increase significantly, it's clear that Tesla is expecting the Gigafactory to receive finished cells from other sources for conversion into packs. This means pack production will be centralized into one location, regardless of the source of the battery cells.

It is important to note that these external cells probably will be more expensive to make/buy (since TSLA is touting a 30-40% cost reduction on in-house cells).

The 6500 employee number also demonstrates not everything can be automated in this new plant. As for quality control, we will see how these 6500 newly hired people can produce with near-zero defects from day one in 2017**.

I'm again using Nissan-Renault as a market comparable since it was the first car company to produce its own in-house batteries for EVs:

- Quality control: There were no major battery-related incidents reported with LEAF cars since they went on sale in late 2010. That's an achievement in itself given the issues other EV/PHEV makers with much smaller production runs (A123/Fisker Karma and GS Yuasa/Mitsubishi Outlander PHEV battery issues).

- Number of employees: Nissan has about 300 (at the moment, below capacity) people with a plan for up to 1000 (at full capacity) to produce up to 200-250k battery packs/year at its US battery plant.

- Total output: LEAF batteries are of course smaller, only 24 kWh in at the moment. Total production estimates for the LEAF and other EVs can be found here: (it's hard to estimate the exact percentage of the US plant since Nissan has two additional battery plants in Japan and in the UK).

Tesla's battery plan outlook versus its competitors will come down to two main assumptions TSLA bulls are making:

- They compare today's mass-market EVs and their short ranges with a future TSLA car (Gen III) and range announced/promised for 2017.
An important point about car prices and range: TSLA indirectly sells a car in this lower price range soon: The Mercedes B EV (on sale later in 2014, details and specs in the link). This car is equipped with TSLA batteries (Daimler is a TSLA investor). According to the link and other test runs, the B EV does NOT seem to offer a better range than a Nissan LEAF or a BMW i3 at similar price points. Conclusion? Maybe TSLA isn't so far ahead ("pre" giga-factory) in battery tech/cost reductions at similar car price ranges as many bullish analysts claim? Or Mercedes must achieve incredibly high profit margins on that car (I doubt that).

- They assume only TSLA can bring battery prices down 30-40% by 2017-2020 thanks to its economies of scale. I assume Nissan didn't stand still since 2010 when it introduced the LEAF and the LEAf battery in its current form. Same for other battery vendors and research efforts all over the world.

In my opinion, the EV race is far from over. Even with the giga-factory running at full capacity in 2020, TSLA will have a sub-1% car marketshare. It will take more than a decade for battery-only vehicles to gain significant marketshare.

The challenges are huge and stakes are high for TSLA and all its competitors in my opinion - the EV market is still in its infancy, battery technology is yet to be truly disrupted in the future:

"Nanowires", Li-Air, Li-Sulfur, Supercapacitors and many other very interesting technologies are still in R&D stages and not ready for use in mass-production cars.

However, once these advances are ready one day, the multi-billion investments in existing battery factories and related assets will have to be written down or are at least are heavily impaired in value.

Perma-bulls who think TSLA is "poised" to soon dominate several trillion-dollar markets (that's looking very far into the future in early 2014 !) should again note that Tony Stark is a fictional character from a Hollywood movie. ***

PS: This article concludes my discussion of TSLA for the time being.

* Addition to the quote: Notable battery and EV competitors include the following companies:

SE Asia: Amperex (NYSEMKT:ATL), BYD, Samsung SDI, LG Chem, Lishen, Hitachi/Maxell, Nissan-AESC, Mitsubishi, Panasonic, Sony...

Europa/USA: A123 (new owner: Wanxiang), Bollore, Bosch, BASF, Johnson Controls, Nissan-AESC, Saft...

Since many Western readers may underestimate "unkown" (outside of Asia) companies like BYD and Wanxiang: Note that these two companies employ a lot of people and have considerable resources. BYD employs about 150k people and Wanxiang employs about 50k people (!). Wanxiang recently acquired the remains of bankrupt Fisker Automotive in the US and BYD is looking to export its EVs.

** Given the complexity and size of the project, I maintain my cautious approach that the Gen III car may be postponed into 2018.

*** Hollywood likes utopia. So do some bullish TSLA analysts apparently. That at least raises a few questions, especially regarding the timing of analyst reports ahead of capital/debt increases:

Morgan Stanley's ties to Tesla set tongues wagging

Disclosure: I am short TSLA.

Additional disclosure: I may add to my short position in the near future (existing small short position at $198).