Objective analysis is currently losing the competition against human emotion in the case of Tesla Motors (NASDAQ:TSLA). One far extreme is cemented in their position that Tesla is destined to fail while the other extreme believes so deeply in Tesla that they are deaf to any valuation concerns. All the while, "pot-stirrers" are happy to stoke the emotional flames.
The conversation about Tesla is exposing a nasty human flaw, confirmation bias. One extreme will end up claiming "victory" in the debate, but can the "winner" credit it to objective analysis?
The good news is the Tesla talk is not devoid of objectivity. The goal of this article is to add to the objective analysis.
The Car and The Business Model
The Model S is an exceptional car, both in performance and safety. Sufficient evidence can be found by looking at awards the car has received or by taking it for a test drive.
Beyond the car, TSLA has ventured away from the traditional auto manufacturer business model. The traditional "push" approach is - manufacturers wholesale vehicles to dealerships. The dealers sell vehicles at slim margins while most profits come from their service centers. TSLA uses a "pull" approach to sell cars. They by-pass dealerships by fulfilling customer orders directly. TSLA operates service centers at cost.
The "old" model has manufacturers sacrifice margins - estimated at 3-5% - to focus on their strength, manufacturing, while letting dealerships handle the direct sales. The TSLA approach captures the margins lost via wholesale while limiting inventory levels needed. The trade-off is TSLA has to take on the OPEX of Tesla stores and service centers.
TSLA has gross margins of 25%+ while General Motors (NYSE:GM) margins are ~11%. This is a positive signal for the TSLA model, but a great deal remains to be seen. TSLA has yet to generate a positive EBIT, thus, making it hard to compare the complete picture. The other uncertainty with the TSLA model is how it will work as demand fluctuates. Current demand exceeds production, but this may not always be the case.
It is important to understand large R&D investments - roughly 13% of revenue - create potential for high future return, but are a primary reason TSLA not generating an operating profit.
Note the incentives for dealerships. They need to sell cars that require maintenance or break-down in order to generate a profit. TSLA, on the other hand, has better aligned incentives with customers. A Model S breaking down harms the TSLA reputation, offers no financial gains, and potentially harms future demand.
The TSLA supercharger network is a point of further differentiation. The expanding network only charges TSLA vehicles and is miles ahead in scale and re-charging time. This ecosystem creates barriers for anyone looking to enter the long-range EV market.
Is Tesla Motors angling to be more than an auto manufacturer?
Elon Musk wrote a "secret master plan" in 2006. One excerpt from Musk's post stands out:
This is because the overarching purpose of Tesla Motors (and the reason I am funding the company) is to help expedite the move from a mine-and-burn hydrocarbon economy towards a solar electric economy, which I believe to be the primary, but not exclusive, sustainable solution."
This does not sound like the overarching purpose of a just an auto manufacturer, especially one ran by a guy sitting on the board of Solar City (SCTY). This one post from eight years ago is absolutely not enough to go on so I'll provide some more evidence.
Exhibit 2 - Gigafactory: The battery production facility is expected to supply more batteries in 2020 than were produced globally in 2013.
An additional note: The cost per kWh is expected to drop 30% conservatively. TSLA has proven superiority over other EVs in terms of range, thus, better battery packs. Those who think all batteries are created equal should watch this video.
Exhibit 3 - "Opening" of patents: This is not an act of charity. TSLA has clearly stated their goal of being the catalyst for EV adoption. How would one benefit from broad EV adoption? Perhaps a massive battery production facility. Read Musk's comments here.
Any one of these actions in isolation may not signal much, but the sum of the parts is building towards a business revolving around much more than a car.
Tesla Motors Growth and Valuation:
Production is continually improving with guidance of 35K vehicles shipped in 2014 and a run-rate of 100K in late 2015. The long term growth outlook is largely dependent on successful deployment of the Gen. III - the Tesla EV aimed at mass markets.
Valuing TSLA is near impossible to do on a comparative basis. Trading at 14x trailing sales and strong top-line growth, TSLA is drastically different than traditional auto manufacturers - industry average P/S ratio under 1. Despite this limited context, most agree that TSLA has huge future expectations priced in.
One viable way to approximate TSLA's value is a DCF model. Jonathan Weber wrote an article objectively examining multiple outcomes for TSLA and a DCF valuation for each.
Tesla Motors' biggest risks revolve around demand
How big is the EV market?
Short-term: Will potential buyers be turned off by the long wait times?
Long-term: Does the Tesla "pull" model work under changing demand climates?
Another risk is in competition, but TSLA is currently winning the EV race by a wide margin. While I have my opinions on competitors' reluctance and/or inability to truly address TSLA, I will keep those to myself as they are difficult to prove - and I'm not angling to be a conspiracy theorist today.
TSLA success is predicated on EV acceptance, not competition. One extreme is mass acceptance of EVs which, if the case, TSLA has strong upside. The other extreme is the EV market is currently near saturation which means TSLA investors are in trouble.
Pin-pointing where TSLA, and the EV market, falls in between these two extremes is the real challenge. The bold and the biased can place their bets, but I recommend looking elsewhere for sound investments.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.