Tesla Motors: A Look At Both Sides Of The Battle

| About: Tesla, Inc. (TSLA)
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Two years ago, I authored an article here regarding an innovative company that was beginning to cause a commotion in the auto industry, Tesla Motors Inc (NASDAQ:TSLA). On August 31, 2011, Tesla closed at $24.74, had around 5,600 reservations for the Model S, and was creating strategic partnerships to raise funding. Today, Tesla closed at $120.25, an increase of 386% from almost two years ago. I had no doubt that Tesla would be successful if it made it to the first deliveries of the Model S. The company has made great strides since I first wrote about it years ago, but some barriers could still stand in its way to becoming the automaker that it has the potential to be. Recent reports from multiple analysts have sent the stock price into chaos. In the current market, it does not appear as if there is a clear winner, and many people seem willing to change their bet on Tesla in a matter of moments. Here are a few reasons why I could see Tesla moving either up or down in the next few months and further down the road.

Upside Potential:

Tesla is the Only Well-Established Electric Car Maker

Let's be honest, this is probably one of the largest movers of Tesla's stock to this day. Many investors are putting money into Tesla not because of its valuation, but because of their faith in its product. You really can't blame them for it either. Tesla has an excellent concept, and has been the only company to date to execute an idea and sell thousands of fully-electric vehicles. Most large automakers haven't even tried to create electric cars, and those that have use them as compliance cars so they do not have to buy regulatory credits. Tesla has been able to compete excellently with BMW, Mercedes, and Audi (OTCPK:AUDVF) in the luxury car segment of the industry. The Model S outsold the BMW 7-series, Mercedes S-class, and Audi A8 during the first quarter of this year by thousands of cars. Although some companies have plug-ins or hybrids in the works, none seem to have anything that could come remotely close to the Model S. It will most likely remain uncontested in the electric car segment for the foreseeable future. The Model X is also expected to dominate the luxury crossover market with little competition. The first time Tesla will encounter competition is with its release of the Gen3. However, due to Tesla's proven performance, it's likely that the Gen3 will be a superior contender to whatever enters the marketplace to challenge it.

Excellent Management

Tesla's CEO, Elon Musk, is an excellent businessman. He not only knows how to take risks, but he knows how to succeed when he takes a gamble. He puts plenty of effort into making sure his business is a success and that most of his goals are met. Currently he has put the company on pace to break through original production estimates for this year and he makes sure people know of the company's successes through social media and the internet. He has been the brains behind countless companies that have done excellently. Tesla's investors should feel safe with Elon Musk at the helm.

Increasing Gross Margins

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Over the past couple of quarters, Tesla's gross margins have been increasing. Many have attributed that increase to the regulatory credits which have been sold by the company. I provided this data to give investors a better idea of the gross margin growth in recent quarters. Many people only took out the $67.9M ZEV credits when calculating the gross margin without credits; however the company also made $17.1M in revenue from the sale of other regulatory credits. This reduced the gross margin without credits from 5.7% to 2.3%. Even with this change, margins increased dramatically from three months earlier. Elon Musk has stated that his goal is a 25% gross margin without the inclusion of regulatory credits, and based on these patterns, it appears he should be able to achieve this goal by the end of the year. Expect an 8-12% gross margin excluding credits for Q2.

Production Will Most Likely Beat Expectations

Elon Musk originally stated that he wanted to produce more than 400 vehicles a week in the second quarter, and judging by his recent statements, it appears he has done it. Musk stated that the company passed the 400/week mark and included that the production increase was "not trivial." Now let's look at a scenario. Say Tesla was able to produce around 440 cars a week on average at an average price of $91,000 (I got this number by adjusting the average revenue per vehicle of ~$96,000 in Q1 which was skewed towards Performance and 85kwh models), then revenues would be $520M from vehicle sales alone. Not all of this revenue would be recognized under GAAP earnings due to special accounting for cars purchased under the lease/buyback program which I will explain later. Even though revenue will appear lower, cash flows will not be affected and the company should be around the break-even mark for Q2 2013.

Orders Appear to Remain High

In the Q1 2013 earnings report, it was stated that orders were coming in at a rate of 20,000 per year with most of these orders being domestic. Most of Tesla's competition sells less than 10,000 comparable cars per year. If it is in fact able to sell 20,000 or more cars in a year then this shows large market appreciation for Tesla and electric vehicles which could continue.

Revenue Estimates Seem Low

The revenue estimates for Q2 seem low because of lease-accounting associated with Tesla's lease/buyback program. Under GAAP, the company cannot count the transaction as a sale and further restrictions arise due to its buyback promise. GAAP allow for 57% of the payment to be paid out proportionally over 39 months and then the other 43% will be added at the end of the lease period if the purchaser decides not to sell back their Model S to Tesla. Technically, this is not much of a problem for the company as they will still be receiving the money for the car up front, and cash flows will reflect this even if the company is making a GAAP earnings loss.

Infrastructure Establishment

With more stores around the United States, Tesla will be in a better position to drive sales for the Model S. These stores offer people the ability to view and experience the Model S before buying. Most are in high traffic areas and will grab the attention of a passerby that may not know about Tesla or be interested in buying a car from them. These stores are critical to Tesla's direct sales model and an increase in stores should help to increase sales. Also important to Tesla's infrastructure are service centers and supercharging stations which the company has been working to increase. Having a larger supercharger network will help to win over potential customers that were formerly concerned with range issues. If they have the ability to refuel during their trip, they will be more inclined to purchase a Model S, X, or Gen3.An increase in service centers should have a similar effect as the increase in supercharger stations, although the supercharger stations are more important as people's main concern still lies with the range of Tesla's vehicles.

Another Short Squeeze is Possible

Although short interest was down significantly to 19,815,686, this is still a large percentage of float at 25.8% making Tesla a candidate for another short squeeze. More good news about production and earnings numbers could send the stock price on another run. The last short interest report was on June 28th, but short interest is probably still high.

Insider Buying

On May 30th, Elon Musk purchased 1,084,129 shares of TSLA at $92.24, with a total transaction value of slightly over $100M. Peter Lynch once said that "Insiders might sell their shares for any number of reasons, but they buy them for only one: they think the price will rise." It is usually a better indication of future price increases when multiple insiders buy shares, but in this case I believe Elon Musk is sure that he will be able to deliver on his promises. Although insider buying is not the best metric for determining future price action, I see this as being a bid of confidence in the future of the company. So far, almost all of Elon Musk's gambles have paid off and I don't see this as being much different.

Downside Potential:

Tesla's Q1 2013 earnings and ZEV credits

Many of you who actively follow Tesla should be aware by now that a decent portion of its revenue was generated by the sale of ZEV (zero-emission vehicle) credits. For those of you not familiar with ZEV credits; a number of states (California and 10 others) require automakers to fulfill certain regulatory requirements by earning ZEV credits through the sale of electric or partially electric vehicles. The states allow companies who cannot meet the regulatory requirements to buy ZEV credits from companies who are doing more than their fair share, such as Tesla. During Q1 2013, Tesla earned $67.9M from its sales of ZEV credits. Each Model S earns between 4 and 5 credits depending on its range and could be eligible for extra credits if Tesla's battery swap stations are considered "fast refueling." These ZEV credits usually sell for around $5000 because that is the fine an automaker will face for each credit it does not have at the end of the year. In addition to the ZEV credits, Tesla is also able to sell GHG (greenhouse gas emission) and CAFE (corporate average fuel economy) credits to other auto-manufacturers and did so in the first quarter which earned the company $17.1M. These allowed Tesla to make a profit in the first quarter but they do indicate a potential problem down the road. Tesla announced in its earnings report that "we have sold substantially all of the ZEV credits saleable under our existing ZEV credit sale agreements" and "While we continue our efforts to sign agreements with a limited pool of automakers to sell them ZEV, GHG and other regulatory credits, we may not be able to enter into new agreements to sell any or all our available regulatory credits related to Model S, Model X or our other future vehicles, which would negatively impact our revenues and margins." I think this could indicate that the credit market has already become saturated which would leave Tesla with little revenue from credit sales in Q2 to Q4 of this year. Without credit sales of $85M in Q1, losses would have been around $70M. Elon Musk stated in the Q1 conference call that Tesla expects less credits in Q2, decreasing to little in Q3 and none in Q4. Earnings in Q1 were also skewed because of a higher number of 85kwh and performance versions delivered than normal. Both of these issues will lower the average revenue per vehicle significantly in later quarters. With credits included, the average revenue generated from a Model S in Q1 2013 was ~ $113,000. Without credits, it was ~$96,000.

Q2 Results Could Vary Greatly

Next quarter's results could vary greatly based on two aspects: new GAAP compliance and credit sales. Tesla has not given a large amount of guidance on how many credits they intend to sell during Q2, although they did mention it would be significantly lower than the first quarter. Because sales of cars with the new financing will not be immediately counted as revenue, it creates a large unknown for GAAP earnings coming into the next quarter. Tesla has not released the amount of cars they plan to sell under the lease/buyback program. If this number is high, then revenue will be low, but if it is low, then revenue could be higher than expected. The Q2 results could also suffer greatly if Tesla does not sell a large portion of credits and also fails to increase gross margins.

Economic Concerns

The United States is looking at GDP growth of 1.1% for the current year which is dangerously close to contraction and an indication that consumer spending has decreased. In addition to this, Europe has also been suffering from continued economic problems. If these problems persist, Tesla could face difficulty acquiring new customers in the United States and breaking into the European market.

Production Could Outpace Demand

The Q1 earnings report indicated that Tesla was receiving orders at a pace of 20,000 vehicles per year. If Elon Musk is able to reach his goals of production, which include producing more than 20,000 vehicles per year, then it's possible for Tesla to start taking on inventory that they are not able to sell. As of now, most of Tesla's customers are lined up waiting to purchase a Model S or have been considering it for some time, indicating pent up demand for the product. If these original buyers were to run out, then Tesla would have to increase its marketing costs and the cost to acquire customers would increase.

Tesla Could Lose the Battle Against Dealers

A few months ago, car dealers voiced their displeasure with Tesla selling cars directly to the consumer. Although the problem is not new, it is starting to make headlines as it represents a potential problem facing Tesla's profit margins in the future. With current laws, it is illegal in 48 states for car manufacturers to sell directly to consumers without the use of a dealer. Some states have allowed Tesla to sell its cars through retail shops in the state, while others such as Texas, Virginia, North Carolina, New York, and Minnesota have made it difficult for Tesla to sell its product by creating multiple restrictions. According to a statement from Elon Musk in April, he intends to "fight one federal battle" instead of dealing with each state. If Tesla were to lose this battle with the federal government and was forced to sell through dealerships, gross margins would be reduced by a decent amount, risking Tesla's profitability. This would hurt Tesla's unique sales model which is currently effective in cutting out the middleman by selling directly to consumers. Regardless of whether or not the company is successful in its legal quest, it will still be required to pay millions in legal fees.


As you can see, the situation surrounding Tesla is filled with many variables and is not as simple as it may look. Although it appears that the company will not have a problem selling cars or making a profit in the future, it is still hard to place a price on it at this point. Valuations at this stage are wild guesses on production numbers years down the road which may or may not come true. I hope I have been able to enrich those who are not following Tesla by the minute to come to a better understanding of the company and where the company could be going in the next few months. In the long run, I see Tesla overcoming most problems highlighted on the downside. It has the potential to become a great automaker and I believe it will succeed and become highly profitable. For now, Tesla remains at the mercy of analyst reports, CEO updates, and quarterly earnings reports; a risky play.

Disclosure: I 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.