Seeking Alpha

Tesla And The Coming Automotive Industry Disruption

by: Carmi Turchick
Carmi Turchick
Special situations, Growth, long only, carmakers

Both electric cars and autonomous mobility are sure to disrupt the automotive industry. Disruptions never leave all of the existing companies intact.

The dealership networks are in danger and may take down automakers when they collapse.

Whether Tesla survives or not, we are likely to see new companies rise and take market share from the existing automakers, as happens in every disruption.

The disruptions will affect many industries, including auto parts and even real estate, investors who correctly anticipate the coming changes should be able to profit handsomely.

It will be far more difficult for automakers to transition from ICE car production to EV production than most understand.

Thousands of articles here at Seeking Alpha and elsewhere have examined the challenges facing Tesla (TSLA) moving forward, but the challenges facing other automakers as an industry are rarely examined in any great detail. In this article I will briefly examine a number of potential existential threats that automakers may face in the next decade or so, including a severe shortage of batteries to make EVs, a collapse of their American dealership networks, large losses on leases and loans, the need for large investments when their incomes are plummeting, and a potential for a huge drop in overall demand caused by EVs and autonomous mobility. In my opinion, at least one and probably several of these challenges are likely to be quite serious, serious enough to cause serious financial difficulties in companies unprepared to face them. There is recognition that electric vehicles and autonomous mobility will be forces of disruption in the automotive industry (a team of Credit Suisse analysts did identify autos and oil & gas as "at the epicentre of disruption" over a year ago), but the unexamined general assumption appears to be that all of the existing automakers will survive, which is never how disruptions work. The assumption of automaker invulnerability is surprising, given that we are just a decade past the bankruptcies of GM and Chrysler, which was caused by the financial crises and by the companies delaying "...making alternative energy vehicles. Instead, they focused on reaping the profits from gas-guzzling SUVs...." Lesson not learned. Picking the winners and losers correctly in a period of disruption can be highly profitable, so it is worth trying to get this right.

The road forward for Tesla and other EV startups is straightforward: grow as fast as they can while making the best cars and other vehicles they can and avoiding spending so much on R & D and facilities that they go bankrupt.
The road forward for the other automakers is far less straightforward: correctly guess EV demand as a proportion of total sales four or five years out and convert factories, build battery pack factory capacity, and obtain sufficient battery supply to meet that demand. Then keep their dealerships alive, avoid a potential financing and leasing bloodbath, somehow compete in autonomous mobility, and keep pace in an EV quality and features race that will require programming expertise not currently in their wheelhouse. No one seems to understand just how difficult all of the above will be, so let me try to explain.

The EV Demand Challenge:

This is the central issue for the ICE automakers going forward: no one knows how quickly demand for EVs will grow. I have likely read several thousand assertions in articles, and comments on articles, that the automakers will be easily able to make as many EVs as needed when demand comes, or when battery prices fall enough to make EVs profitable, and this is simply wrong and the automakers know it. First, the amount of batteries needed is vast and there is an enormous difference in the amount of batteries required for an industry wide 15% EV demand or a 25% EV demand, which will cause inevitable battery shortages for reasons I will describe below. Second, to make EVs profitably, in large numbers, and of the best quality, they will have to actually convert assembly lines from ICE production, which means stopping ICE production and doing something with all those union employees for a while. Some automakers plan instead to try a highly questionable tactic of making their EVs on shared platforms, used for both EVs and ICE cars, seeking the advantages of flexibility of production and being able to use their existing assembly lines. These automakers include Daimler Mercedes (OTCMKTS:OTCPK:DMLRY), Volvo (OTCMKTS:OTCPK:VLVLY), and BMW (OTCMKTS:OTCPK:BMWYY), but the EVs that result seem sure to be compromised (for example, Mercedes states that their coming EQC will be “as safe as any other Mercedes,” [around 8.20] but EVs have inherent advantages that should allow them to easily be more safe, not just as safe, and Tesla says they are making the three safest vehicles available), and I doubt this strategy will ever result in top quality EVs.

Cars are a major purchase for the vast majority of buyers; those who set out to buy an EV are unlikely to choose an ICE car instead, just because that is all the automaker has to offer them, so the automakers need to have guessed correctly what demand will be and have the batteries, battery pack factories, assembly lines and so on ready to supply that demand. The issue is that everyone is simply guessing what the demand curve will be for EVs and what the timing of the growth in demand will be, and this is especially a problem for the battery supply.

There are several additional complicating factors here: the advent of autonomous mobility at some still unknown date may result in a rapid drop in overall demand, and there is a possibility of a feedback loop where increasing numbers of EVs make gas stations unprofitable, causing closures, making finding gas less and less convenient and driving still more EV purchases (alternately, a drop in demand may make gas considerably cheaper and this may somewhat slow EV adoption, impossible to say).

The Risk to Battery Manufacturers and the Coming Shortage:

Battery manufacturers face major challenges as they seek to estimate how much demand there will be going forward. The difference between a 15% global demand for EVs in a given year and a 25% demand is approximately 630 Gigawatt-Hours of battery manufacturing capacity industry wide (depending on the size of the battery packs, which is currently unknown), or roughly five times current worldwide lithium battery production. Obviously, this means there is a huge risk of overbuilding and having tens of billions of dollars of factories sitting there unused, with huge contracts for materials needing to be honored. This is a risk we have to expect battery manufacturers to try to avoid: overbuilding can easily result in serious financial distress, while having too few factories to meet demand is something they can readily survive. Keep in mind that building factories and the mines to supply them on this scale is something that requires years of planning and construction; all the industries involved here are trying to figure out what consumers will want five years or more from now. This means the battery manufacturers (and their investors and sources of financing) are incentivized to be cautious, and automakers who want to ensure they have the batteries they will need when they need them will likely have to assume some of the risk, as VW Group (OTCMKTS: VWAGY) has done with their large battery contracts through 2028. But again, it falls then on the automakers to estimate correctly what demand will be in any given year. Again, building five times the current worldwide battery production capacity, and all the mines needed to supply raw materials for those factories, is not something that can be done quickly if demand is 25% of the total market for EVs and not 15% in a given year; that gap cannot be breached in a year or even three, and once battery production capacity falls significantly behind demand it is not likely to catch up for at least five years, if not more, as demand likely will continue to rapidly grow. Just a few months ago, AAA released their poll showing 20% of Americans want to buy an EV next, up from 15% the year before. Demand could easily grow by ten percent of the market or more in a year for EVs; consider that this 20% number and rapid demand growth is coming BEFORE the releases of what we assume will be a good number of great EVs by the major automakers in the next three years.

What about all those charts showing all the planned battery factories we keep seeing? Benedict Evans, included one such chart in a fine recent article here, for example, showing planned battery production of close to 1,000 Gigawatt-Hours by 2028; sure seems like a lot, right? First, such charts have so far been made by those less than thoroughly researching the issue; both this one and the Bloomberg analyst’s similar chart count 40 Gigawatt Hours from Northvolt AB (PRIVATE), for example, when it seems exceedingly dubious to me that the company will ever build their planned factory (so far they appear to be well short of the $4 billion they need), and in any case they are planning to make only batteries for energy storage, not for EVs. But even if we take this number at face value, 1,000 Gigawatt-Hours of batteries is only enough for around 14 million EVs in 2028, only 14% of the current automotive market worldwide, and this is in 2028. Surely with a poll showing 20% desire in 2018 in America, demand will be a LOT higher than 15% of the market in 2028. China alone in 2028 could use well over 500 Gigawatt-Hours of batteries, given the government push for EVs and the enormous size of that market. We should assume that more battery factories will be planned and built between now and 2028 as EV demand grows, but sufficient supply is far from a given, and current plans will fall far short of meeting probable demand.

If there is a battery shortage, it will be a case of the haves and have nots when it comes to batteries. Those automakers who put money into long terms contracts, as VW Group has, and predicted right, will have, and many less fortunate automakers will have not. These later will have few options, large losses seem inevitable for them.

The Danger of Dealership Bankruptcies:

This is an extreme hazard facing the automakers, I believe, and I have seen not one mention of it so far. Instead, I have seen articles like the one here recently that assert the reverse, that a lack of dealerships is a potential “achiles’ heel” for Tesla. If an automaker faces a shortage of batteries, this means a guaranteed loss of sales for their dealerships. New car sales and associated finance and insurance products are 30% of profits at dealerships. Further, as many do note, EVs need fewer repairs (at least those from major automakers can be expected to, and Tesla quality is also rapidly improving), and repairs are a major income source for dealerships (accounting for 44% of profits). This loss of repair income could be greatly increased by the advent of autonomous mobility, which may be cost competitive per mile with private ownership, and which is likely to be a popular alternative for those faced with sudden large repair bills on their ICE cars. Together, EV demand and autonomous mobility may slaughter demand for used ICE cars, further reducing dealership incomes (24% of profits come from used car sales), potentially causing significant losses on used car inventories, and affecting the trade-in system and leases, as I will discuss further below.

Larry Burns, formerly at GM (GM) and now at Waymo (GOOGL), and the author of a book (“Autonomy: The Quest to Build the Driverless Car—And How It Will Reshape Our World”), states several important things in an Autoline interview. First, he states that autonomous mobility will be electric due to lower per mile costs. Second, he states that his 2010 study showed 18,000 autonomous mobility cars could replace 120,000 of the 200,000 private cars in Ann Arbor. Lastly, he states that he expects EVs to last an average of 300,000 miles, which is double the 150,000 average of an ICE car (Tesla’s objective is for their future batteries and motors to last a million miles). Taken together, these claims, if correct, point to a potential contraction of the automotive industry over time to just 25% of its current size, something that clearly threatens the solvency of the dealerships (and, obviously, automakers directly). Just how rapid that contraction is, if it happens, will make a huge difference in how well automakers and dealerships survive it, but there simply would not be a need for nearly as many dealerships as now exist.

The big problem is that the automakers have no alternative for distribution in America if their dealerships go belly up. The laws they have, ironically, been vigorously defending recently state that automakers who have had dealerships cannot then engage in direct sales. If their dealership networks die, the automakers will have no distribution options in America at all; the loss of their service network will be the least of their problems. Even if we just look at the dealerships in California, where they have very expensive land requirements and are therefore more vulnerable, it is clear that some automakers could be in danger from their dealerships in California alone going under, as that is of course a huge market.

It is impossible to see how most automakers dealing with a rapid loss of distribution in America would avoid serious financial distress, or how anyone would think to try to bail them out. And I believe that it is inevitable that this will happen to more than one automaker over the next decade. Faced with other challenges as I expect them to be, it is impossible for me to confidently state that any specific legacy automaker is sure to weather this storm. Disruptions often eliminate most of the previous companies in an industry, and there is no reason to expect that the automotive industry will fare better while facing two major disruptions at once.

The Finance and Lease Bubble:

Depending on the speed of the growth of EV demand, and when autonomous mobility arrives and reaches a sufficient level of market penetration, there may well be a cliff here for automakers to drop off of. Demand for used ICE cars, and therefore their resale value, could easily drop rapidly during a three year lease period, leaving the automakers facing a large loss on their off-lease sales. Buyers with payments on loans from automakers may also find themselves way underwater on those loans, or facing large repair bills, and, having a nice alternative in autonomous mobility, simply walk away like homeowners did during the crash of 2008. Financing is a huge source of income for most automakers, and for dealerships, and if it turns into a source of losses instead some automakers may face serious financial distress on that account alone. A drop in value for used ICE cars will also mean buyers get less for their trade-ins, making new car purchases more difficult.

The Danger of Autonomous Mobility:

Everyone seems to miss the critical issue with autonomous mobility: it does not matter much who gets there first unless they get there first with sufficient numbers of autonomous EVs to meet a significant portion of demand. Mobility by its nature is going to be dominated by vehicles with the lowest cost per mile, and that will obviously be EVs. Sure, Waymo is going to buy 20,000 I-Pace from Jaguar in 2020, but this is a teensy number of vehicles, sufficient for the market of Ann Arbor, and Jaguar is only planning a production capacity of 20,000 a year, so Waymo will not be getting more from that source that year. This is where the huge battery supply available for Tesla now, and the huge number of EVs they already have with hardware for autonomous driving installed, may prove to be an enormous advantage: if Tesla can achieve full autonomous with their cameras and radar system by even 2023 or so they might suddenly have orders of magnitude more EVs in their Tesla Network autonomous mobility system than any other competitor, and customers will naturally favor whoever can quickly and reliably meet their needs. Potentially, this could become a huge first mover advantage for Tesla, with a huge moat against other companies moving in, because the other automakers will not have the batteries to make enough EVs to compete for some years (depending when full autonomous is achieved). Tesla is also the only company that currently claims to have cars on the road with the hardware for autonomous, potentially allowing Tesla to take most of the market and keep it.

Most experts say that it is impossible for Tesla to achieve level five autonomous without having LIDAR on their cars, as I believe all of their competitors do. I am not an expert on that technology, you the reader are not an expert on that technology, so none of us should have an opinion based on the science. What I do look at is the fact that Elon Musk is something like 25-0 lifetime versus the majority of the experts when it comes to achieving things the experts said could not be achieved. Elon Musk is a brilliant man who rather habitually is wildly over optimistic when it comes to how fast and how easily his goals can be reached, and yet appears to always eventually reach those goals. At some point as an investor you have to give some credit to those who consistently prove they were right and everyone else was wrong, in fact identifying those rare individuals is a great way to profit. If Elon Musk is right and the hardware on Tesla cars is sufficient for level five autonomous, it means that Tesla right now is undervalued by tens of billions of dollars.

Even if Tesla utterly fails to deliver full autonomy, autonomous mobility likely means falling sales for automakers, declining demand for used ICE cars, and possibly some other company like Waymo taking a cut of their mobility income, or dominating mobility themselves. Silicon Valley companies that profit from data and advertising have a huge interest in autonomous mobility because the customer will have time to surf the web or watch shows while riding to their destination. The car will be a second living room in effect, so those companies should have a competitive advantage when it comes to autonomous mobility, over automakers, because they will have two income streams from the service instead of just one.

Keeping Up With Tesla and other Startups:

It is often assumed that other automakers will have advantages over startup companies like Tesla when they do start making EVs; that they will be able to make higher quality cars more affordably in greater quantities due to their decades more of experience and greater resources. Maybe. Yes, lots of robots are used by other automakers besides Tesla too, and lots of smart people work at all the automakers. But, inherently, using robots better than the other guy is a question of programming, and the performance and features of an electric car are far more a question of software than is the case with ICE cars. We have to expect Silicon Valley to have an advantage over Detroit and Berlin and Tokyo when it comes to things that depend on software engineering. Again, the other automakers will also have to find the batteries to use if they are going to make greater quantities of cars than Tesla and the other pure EV startups.

Most are missing the speed that Tesla is moving at too, which is Silicon Valley speed and not traditional automaker speed. For example, Porsche (OTCMKTS: POAHY) revealed their Mission-e concept on September 15th 2015. It is now going to be called the Taycan, expected to be available the end of 2019. Meanwhile, Tesla showed us the prototype Model 3 on March 31st 2016, six and a half months after the Mission-e reveal, and Tesla started delivering Model 3s July 28th 2017, just under 16 months after showing the prototype and about three years faster than Porsche will be from reveal to launch. One reason there are frequent delays and missed production targets at Tesla is because the planned launch and production ramp speeds are so fast that most experts say they are impossible. Love or hate the lack of all the usual buttons and knobs, the lack of the usual dashboard, still one has to give credit where due that Tesla is also not just quickly throwing together cars that are typical except for the drivetrain like, for example, GM arguably did with the Bolt.

Even worse off, in my opinion, are the shared platform strategy automakers, who are going to use the same platforms for their ICE cars, hybrids, and EVs, as we have just started to see with the Mercedes EQC launch. The EQC is a car of compromises; an EV with the hump in the floor of an ICE car, no frunk, poor range for the battery size, and average acceleration. Many automakers seem to have missed the memo that a big part of what drives buyers to SUVs is greater safety, and as mentioned above, Mercedes has failed to use the available advantages of an EV to make the EQC safer than their other cars. It is hard to see there being much interest in the EQC in 2020 in the face of competition from multiple EVs with no compromise being offered by others, including the Jaguar I-Pace which seems like a great EV. Yes, it saves Mercedes on converting their production lines, saves by sharing parts too, and makes it easier to respond to unknown demand levels for EVs moving forward. But it also appears to guarantee close to no demand for Mercedes (and Volvo and BMW) EVs going forward into a future with ever increasing EV demand and competition. Mercedes claims to be “all in” on EVs (and they have announced an $11 billion dollar investment in EV production and development), but they appear to be holding a losing hand and refusing to draw.

Automakers who keep moving so much slower than Tesla, or who fail to commit to unique platform EVs, seem sure to always be bringing inferior cars to market. It seems likely that other new EV startups will follow Tesla's example of constantly improving their cars via production changes and over the air updates too, and yet the dealership model makes it very hard for the other automakers to do so.

Why ICE Car Demand May Drop Rapidly and Soon:

Quieter, more reliable, roomier, more convenient with at-home recharging, instant acceleration, safer, these are things people are willing to pay MORE for. The popular hypothesis that EVs must cost the same as “equivalent” ICE cars before demand spikes is not correct because ICE cars are inferior, not equivalent, to EVs. The top five cars traded in for a Model 3 Long Range, which starts at $49,000, are the Toyota (TM) Prius, BMW 3 Series, Honda (HMC) Accord, Honda Civic, and Nissan (OTCMKTS: NSANY) Leaf. Four of the five top trade-ins cost $19,000 less than the Model 3 or more, three cost less than half the Model 3 price new. EVs have other huge advantages very few talk about, like the ability to keep climate control on safely with the vehicle off. Want to leave your dog or sleeping baby in the car while you run into the store in Phoenix during the summer, or in Minneapolis in the winter? Go right ahead. Want to run off to a camp site in the mountains on the spur of the moment with no tent or sleeping bags and sleep comfortably in the back of the car? Go ahead. Got stuck on the road for hours in a huge blizzard? Enjoy some tunes (or a movie, or play some video games, in a Tesla) in climate controlled comfort while everyone else suffers.

The pace of improvement is also just far faster with EVs; as batteries improve the range will keep going up, cost and weight will come down, speed of charging will increase, acceleration will get faster (and it is already very fast), and many more improvements are just a matter of programming. If the other automakers are going to compete with Tesla, and Lucid Motors (PRIVATE) and so on, they will be making EVs that their own ICE cars simply cannot compete with. A car is a huge purchase for most people, and they don’t want to regret their choice or come home with a car that was very much not the EV they wanted and is an ICE car instead. Talking someone into an ICE car who wants an EV will be like trying to sell a rare bloody steak to a vegetarian. The Jaguar (OTCMKTS: JGFCF) I-Pace looks like a great car, for example, why would I instead buy the F-Pace if I could afford the I-Pace? Go drive each one and try to convince yourself that buyers will settle for the F-Pace if they drive both.

I predict this transition will be far faster than most are expecting. The wave of EVs coming over the next three years or so from many major automakers and the flood of Model 3s being made by Tesla will rapidly demonstrate all the advantages EVs have, and demand is already far higher than EV sales. It appears to be impossible that the ICE car automakers will be able to make the transition as rapidly as consumer demand grows; even if they converted all their factories the batteries simply would not exist, nor would the mines for the raw materials for the batteries. For companies like Tesla it will simply be situation normal; still cannot produce enough to meet demand. For most other automakers it will be an enormous crisis as income craters and losses mount just when they need lots of capital to convert to EV production as fast as possible. Even if the swing in demand takes longer than I expect, it is hard to see most of the automakers that exist today being able to make that transition without serious financial distress or spinning off their EV production as separate companies that can survive, letting the rest die. Disruptions have never left all of the existing companies in an industry still in business, and two major disruptions at roughly the same time is extremely unlikely to.

Implications for Investing:

Obviously, when evaluating the value of a stock for long term investment, we need to look at not just the prospects and details of the company in question, but also at the prospects of their competition. Whether one thinks Tesla is doomed or not, I think it is clear that the other automakers face a lot more risk of serious financial distress due to the EV and autonomous disruptions ahead than is being discussed. The early leaders of disruptions don’t always come out the ultimate winners, but the old guard is still typically swept away or at least reduced in size, and new companies do come to dominate the industry. Ultimately this may include Apple (AAPL), Nio (NIO), Lucid Motors, BYD (OTCMKTS: BYDDF), some companies we don’t even know exists yet, or Tesla may maintain their lead all the way. Often it is easier to pick the losers than the winners, but remember that a lot of money can be made by knowing who will be the losers. My estimate is that about 80% of ICE automakers will be losers here, and the rest will have a hard time for a while, and those are good shorting odds.

Looking beyond the automakers themselves, it is clear that some battery companies will be winners, but it is hard to pick which, and some may lose big if they fail to keep pace with innovations or overbuild. But automotive parts companies like O’Reilly Automotive Inc (ORLY), to pick a random example, should pretty reliably be doomed as people stop needing the vast majority of those parts for their cars, so that seems like another great opportunity for shorting as their industry is likely to inevitably go the way of typewriter repair shops and video rental stores. Oil companies are likely to have huge amounts of “stranded assets” of oil reserves that will never come out of the ground, and should be another great short opportunity. As the drive for more affordable batteries for EVs is also making energy storage more viable and economical, and therefore making solar and wind power more capable of replacing coal and natural gas and nuclear both at the industrial and at the home or business level, the non-renewables may also be opportunities for shorting along with some utilities. Unless some new breakthrough battery chemistry arrives, lithium mining companies look like a sure thing here.

Even less direct investment opportunities may be predictable because of the coming dual disruptions of EVs and autonomous mobility. For example, real estate in towns now too far away from major cities may go up in value because the cost of driving will drop and we will be able to sleep or work or entertain ourselves on the journey. One might not consider a commute of an hour and a half if one was driving and paying for gas, but a nice nap before work and a much smaller cost for electricity could make that cute affordable house in a little town very attractive.

Tesla is a compelling story, and there is a vigorous debate about its future prospects and proper valuation, but the changes Tesla has helped trigger will be far reaching and will provide many opportunities for an investor who looks at the bigger picture at the industry scale, at the effects on other industries, and at the effects on how we live and where we live, no matter what happens to Tesla. There seem to be opportunities to make a fortune on the coming disruptions without buying Tesla, shorting Tesla, or even playing any automotive stocks at all.

Disclosure: I am/we are long TSLA. 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.

Additional disclosure: I work for Tesla, I also have stock options at Tesla. I have signed a NDA with Tesla which I believe this article does not violate. My opinions here are my own and do not in any way reflect those of Tesla, nor has any person at Tesla discussed this article with me or requested that I write this article. I have no other investments in any other stocks mentioned here and have no plans to initiate positions in those stocks within the next 72 hours.

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