Since late February, the buzz in the battery business has focused on Tesla Motors' (NASDAQ:TSLA) audacious plan to build a lithium-ion battery gigafactory somewhere in the southwestern US.
The scale and scope of the project are nothing short of gargantuan: a single factory that will integrate the entire lithium-ion battery supply chain; make more cells in a year than all the world's other lithium-ion battery factories combined; incorporate recycling technologies that don't even exist; and power it all with solar panels and wind turbines.
It's the industrial equivalent of a Cecil B. DeMille epic with a hero of biblical proportions and a cast of thousands - at least until construction is completed and huge sections of the gigafactory commence "lights-out" operation as robots eliminate the need for human involvement.
While Tesla's car factory in Freemont, California boasts the world's second largest footprint with 5.4 million square feet of mostly empty manufacturing space on a 210-acre site, the proposed gigafactory will need about 10 million square feet on a 500- to 1,000-acre site.
If the gigafactory is built, Tesla's combined facilities will rival Ford Motor's (NYSE:F) River Rouge Complex, which took a decade to build and eventually included 16 million square feet of power plants, steel mills and manufacturing facilities on a 1,000-acre site.
You remember River Rouge, the sprawling factory complex in Dearborn, Michigan that gave Mr. Ford the confidence to decree, "Any customer can have a car painted any color that he wants so long as it is black."
While Tesla has estimated a $5 billion cost for the gigafactory, giga-scale projects have a long and colorful history of giga-scale cost overruns. In its initial announcement, Tesla implied that industry partners including Panasonic (OTCPK:PCRFY) would gladly cough up $3 billion for the privilege of participating. Panasonic, however, is backing away from the project like a startled crawdad, which isn't all that surprising when you remember that Panasonic has already absorbed over $6 billion in impairment losses for obsolete lithium-ion battery factories it bought from Sanyo in 2009 and 2010.
Frankly, I'm beginning to wonder whether Mr. Musk has an edifice complex.
In a recent autopsy of $1.4 billion in Federal and State incentives that were awarded to Michigan battery manufacturers in 2009, the Detroit Free Press lamented "Today, Michigan has only a few hundred battery workers in four plants." The reason is simple. Globally, the lithium-ion battery segment has a massive capacity glut.
Tesla wants to transform a massive glut into a gigaglut and pay for it all with borrowed money.
Tesla's plan to cut cell manufacturing costs by 30% through VIMS is theoretically possible, but it will be very difficult because the gigafactory will need to make substantially all of its battery materials and components from scratch instead of buying them from suppliers that have years if not decades of experience making cans, foils, cathode materials, anode materials, separators, electrolytes and other cell components.
While it's not rocket science, the number and variety of technical competences Tesla will need to bring together from around the world and flawlessly coordinate under a single roof in the middle of nowhere is mind-boggling.
To the extent that industry partners contribute technical expertise and capital to the gigafactory, they're certain to expect a fair share of the profits from running that factory. Those future profit participations will sharply reduce the anticipated cost savings.
If the industrial miracle eventually happens, the likely collateral consequences include:
- Adoption of a particular cell size, form factor and chemistry as Tesla's answer to black paint due to the strengths and limitations of VIMS;
- Stagnation of inquiry into other battery chemistries and form factors that aren't used or can't be readily implemented in the gigafactory; and
- Strong institutional resistance to change because modifying a gigafactory to accommodate new, improved or simply different technologies can be prohibitively expensive.
Highly automated factories are a great way to do one thing very well at the lowest possible cost. They're not, however, terribly flexible because the materials, equipment and process flows that work flawlessly for Product A are usually not appropriate for Product B. They're great if you're willing to carve your processes and products in stone for 10 or 20 years like the automakers did for the better part of the last century, but they don't cope well with modest variations like paint colors much less major variations in raw materials, chemistries and cell architectures.
Is Mr. Musk gently telling us that he thinks lithium-ion battery technology has reached the bitter end of its development curve and the only way to significantly reduce future costs is VIMS?
The entire theory of vertical integration presumes that demand will exceed capacity by a wide margin and the factory will always work at an optimal rate. Even minor demand shortfalls can spell the difference between modest profits and catastrophic losses.
Since the electronics industry abandoned the 18650 cell format favored by Tesla because cylindrical cells don't fit inside today's sleeker and flatter devices, there is no reason to believe that Apple or any other electronics manufacturer will launch "iChubby" product designs to save a couple bucks on batteries imported from the US. There is even less reason to believe the auto industry will abandon a wide variety of EV and fuel cell development initiatives to rally behind a competitor that would like to be a sole source provider of essential components. In the final analysis, the only reliable long-term customer for products from the gigafactory will be Tesla itself.
As the owner of the gigafactory, Tesla must put its own needs first. Second place on the priority list will probably go to Tesla's stepsister SolarCity (SCTY), although the inherent conflict of interest issues in material related party transactions will be daunting. While SolarCity will probably absorb some of Tesla's surplus capacity as it tries to develop consumer and small business markets for stationary energy storage products, that reliance is likely to be transitory because SolarCity won't be able to build a sustainable business without a reliable independent supply chain. All other potential customers will either have to wait in line and hope, or select an independent battery manufacturer that isn't a supply chain competitor in its own right.
I know Tesla is the poster child for the utopian vision of an electric car in every solar powered garage, but its current business is selling irrational and expensive cars to emotionally engaged buyers who compare the Model S to other emotional, irrational and expensive cars from Porsche, Mercedes and BMW. That's the genius of the Model S. Emotionally engaged status seekers don't conduct any cost-benefit analysis. They simply say, "I want one!" Presumably the same dynamic will hold for the long-delayed Model X, a comparably priced SUV that's been available for pre-order since 2012 and is currently scheduled for launch in 2015.
Tesla doesn't need a gigafactory for the Model S or the Model X. At this point in time, its wildly hyped Model E is a couple steps shy of vaporware. The Model E is an abstraction in the purest sense of the word and it doesn't exist outside the fertile imaginations of Mr. Musk, sell-side analysts and true believers who haven't seen an artist's conception, much less a prototype.
The reality is Tesla will never need a gigafactory unless its masters of reification can design, engineer, test and successfully launch a mass-market EV that offers a reasonable total cost of ownership to normal consumers who worry about trivialities like transportation costs, monthly payments and household budgets.
Consensus among research firms that focus on the battery industry is that Tesla pays about $300 per kWh for the 18650 cells it buys from Panasonic. According to Bernstein Research, Tesla can't make an electric car that will be marginally competitive on a TCO basis unless it can drive battery costs below $200 per kWh at the pack level. Even if the gigafactory drives cell prices to $200 per kWh, pack level costs are likely to remain above $300 per kWh. Bottom line; the Model E is far from a slam-dunk.
Most Tesla aficionados pay no attention to pesky financial details because they believe vision and a quality ride are all that matters. In my experience, however, companies that don't have a solid and well-structured financial foundation don't survive long enough to give their vision substance. In my view, Tesla's financial foundation is slowly sinking into Wall Street quicksand.
- At December 31, 2013 Tesla reported $667 million of equity, $1,749 million in debt and a book value of $5.42 per common share.
- In connection with last month's sale of $2,300 million in convertible notes due 2019 and 2021, Tesla squandered $214 million of its limited stockholders equity to pay the costs of a hedge transaction with its underwriters.
- The stated purpose of the hedge is to protect stockholders from potential dilution if Tesla's stock price is between $360 and $560 when the notes mature.
- After an estimated Q1 loss of $50 million, Tesla will probably report about $430 million of equity, $3,700 million in debt and a book value of $3.50 per share at March 31st.
- After giving pro-forma effect to the overallotment option closing on April 2nd, net equity will fall to about $400 million, debt will increase to about $4,000 million and book value per share will fall to about $3.27.
- Tesla's pro forma price-to-book ratio of 63 is unsustainable for a debt free company and beyond absurdity for a niche automaker with a pro forma debt-to-equity ratio of 10.
With Monday's close of $207.52, Tesla's 10-day volume weighted moving average price has fallen sharply through the 50-day average. I don't see solid support until it hits the 200-day average and either bounces back up or continues a dizzying plunge to pre-bubble levels. Do you feel lucky?
As a child, I was daydreamer with an overactive imagination. Mom always told me I shouldn't count my chickens before they hatch. As an adult, I have a very hard time understanding how the planned gigafactory can be good for the battery industry, good for Tesla or good for its creditors and stockholders. Tesla's recent announcements and corporate finance activities go way beyond counting chickens before they hatch. To produce this gigafarce Tesla is mortgaging its chickens before it has eggs. I'm too timid to short Tesla's stock, but I wouldn't even think about holding an unprotected long position.
This article is an investor-focused rewrite of an industry-focused column I wrote for the Spring 2014 issue of Batteries International Magazine. I'd like to thank editor Mike Halls and cartoonist Jan Darasz for their contributions.
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.