What Is Wrong With Tesla Motors?

| About: Tesla, Inc. (TSLA)
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It's difficult to argue that the U.S. automotive industry is in great shape. Yes, it is doing okay. We are a little better than we were in 2008 because a majority of the nation isn't defaulting on their mortgages but I'm pretty sure a newer and cooler car still isn't on the top of everyone's next purchase priorities. Talks of a spectacular recovery were prominent in recent news but there are few definitive signs that the economy will recover in the near and immediate future. Of all industries it is the automotive industry that is a main key player in the United States' economy.

However, today producing cars in the states is expensive and the only way that these huge car companies have adapted in the midst of a changing marketplace is by obtaining subsidized loans from the government in order to meet a sudden market demand that's also been subsidized by, you guessed it, the government. With all of this being given I decided to look into the SEC filings for my one ray of hope. That hope? Tesla Motors (TSLA), proclaimed to be the car company of the future by many.

With a cool disruptive technology the execution could be beautiful, allowing Tesla to dominate the market in the years to come by beating out its aged and slowly adapting competitors. Unfortunately what I found is not enlightening. However, I don't think that the market place truly cares. Tesla is a growth story, not a value play. And the fundamentals of the growth to come are artificial.

Tesla seems to be a golden chariot in the auto industry for me because of one thing - it's EV technology. It's the only company out there to serve as an incubator for developing the electric car and from a business perspective this is exactly what needs to be done. This technology is one of the most accepted technologies to be labeled as 'disruptive' and consumers have been aware of this since the early 90s. It's such a staple for b-school students to analyze that it was included in the book titled The Innovator's Dilemma as a case study in the second-to-last chapter.

My attraction to Tesla is that it could shake things up a bit by going for General Motors Company (GM) and Ford Motor Company's (F) lower end, low-margin market share and really change things when it has an engineering team devoted to building an all-electric vehicle. Yes, it was the first company to produce a fully-street legal, full-production EV, so maybe I was a little late in jumping on this infatuation bandwagon. I decided to give it a go and do some research.

Unfortunately, it is here that the opportunity to develop my feelings for Tesla ends. My love affair with Tesla came to an end just like when you realize the pretty girl you're on a date with is simply agreeing with everything you are saying and doesn't have anything that makes her tick. First impressions are great, but that is where the romance ends. Tesla's first production vehicle, the roadster, was not a financial success as much as it was a technological surprise. Executed as an extremely expensive novelty item with a limited production run makes managerial sense—you don't jump into the deep sea filled with sharks unless you've been scuba diving before. But the fact that this small run was not profitable is a sign that something is amiss.

Evidently the technology was impressive but still not cost competitive with gas-powered vehicles. It shows that the application of this technology may not be timed correctly, or that there simply isn't as much of a green demand as predicted. This was my first disappointment with a company that many call the Apple of the automotive world. Apple Inc. (AAPL) shook things up by entering the computer industry at the lower-margin consumer end, like many successful disruptive businesses have. Tesla is attempting to enter from the top where there is intense technological competition with proven market-competitive technology. From an academic perspective this is alarming - and stupid.

Additionally, Tesla is attacking the EV like it is just another car. In a pre-crisis world it would have a viable strategy because it is marketing its car to a select group of people—the upper-middle class—and is attempting to enter the automotive industry, where companies are profitable and successful with their business models, in a classical way. Interestingly enough its costs are lower than international companies because of their financing—from the government. Unfortunately, this shows that a company that has massive lines of credit, but a cool green story, can be artificially supported by its country's government even if genuine demand for the product and market competitiveness isn't present.

Since it'll be able to reach profitability sooner than most would normally expect it seems that Tesla is the righteous future of car making, for soon it will all be electric and it is the only one to see 'it.' I believe that for most this is where the public investor's connection and understanding ends and this is where my love affair ends as well.

Jump post-crisis and forget the beauty of the 'idea' of an all electric vehicle, let's get down to the facts. For a growth company Tesla has an enormous amount of debt. It is the only one to market a car to the people who can really afford paying any sort of premium right now (after all, on the low end who would pay $40K for a thing that looks like the Volt when you can get a fast Mustang for the same price?) and since it's a luxury sedan it may sell, especially when it beats it's competition with a $7,500 tax credit in your name after purchase. However, as the Volt and Leaf have both proven, the technology still isn't quite there to be fully price competitive with the general gasoline-powered automotive market. Additionally, consumers who can afford a $50,000 car probably isn't as concerned about the cost of fuel as they should be. Their marketing premise suddenly seems somewhat flawed as well.

From a fundamental perspective it suddenly seems that Tesla's only lifeline is its low cost of debt that it got from the government. Financed at a draw rate between .9% and 3.4%, it seems that as long as it doesn't literally burn the money that can draw, it should be okay. It's possible to make an argument that Tesla is great just because of this argument.

There's another issue with Tesla that is more of a b-school and managerial issue than one found by simply studying their fundamentals and it has to do with their value network. A value network is a series of customers that defines a company and because these customers drive the profits of the company they also drive what a company can and cannot do without risking their current income. Tesla has generated about a third of its overall revenue from technological development for outside automotive companies, and these revenues have risen more quickly and grown in margin more quickly than the sales of their proprietary EVs.

In a proper resource allocation model Tesla's management should be noticing that devoting their attention to the development side of things, rather than the automotive-consumer side of things, will begin to net them more money. (After all, if you were an investor wouldn't you want them to do this?) Quite the contrary, it doesn't seem that they care. With so much capital available at such a low rate, you don't need a high ROI in order to justify expanding into whatever you want - like buying a manufacturing plant in one of the most expensive countries in the world. Even worse, this is committing Tesla to a trap.

As the company continues to devote resources to develop electric technology gradually for established automakers, it removes itself from the consumer value network needed to tap a market at a low margin and float upstream as the technology develops. Instead, it is placing itsas a developmental company for established automakers, using its technology for sustaining purposes rather than disruptive ones. And all the while, it can try to support its own cars with technology designed for all the others with a flawed manufacturing strategy.

With all of this being said, I can't justify buying into Tesla from a growth investment perspective. The market will continue to behave in the way it always has though, looking for the next best thing with the fastest growth and the coolest story. Thousands of investors will be attracted to Tesla because hey, the technology will work eventually, right? And eventually the runs could be huge.

So this market will continue to incorrectly price Tesla Motors by looking at the lowest common denominator of logical reasoning - the electric car finally exists! - rather than seeing the lack of competitiveness the company has, what's driving it's current performance, and if the future growth the market currently projects for the company is even partially warranted in today's sideways market. Buying this stock is not a way to make much money as much as it is a way to attempt to preserve capital with a growth company due to government intervention in the market.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.