On a recent trip to Boulder, CO, I stood outside a
Tesla Motors (Nasdaq: TSLA)
showroom ogling its sports cars with lust in my heart. A few weeks
later, when a Tesla roadster whooshed silently past me on a New
York City street, my heart skipped a beat. Tesla makes the kinds of
cars that auto enthusiasts lust after. Then again, I have a short
attention span. Minutes later, a Porsche 911 zoomed past me with
its inimitable throaty growl, and my lust was re-directed.
My fickle tastes highlight a real problem for Tesla. The company is
aiming to crack two auto market niches, though success looks like a
long shot in each. The car faces heady competition in a crowded
sports car field, and the electric car market is also about to get
Investor message boards are filled with Tesla's vitriolic
detractors and even more rabid supporters. So I won't weigh in as
to whether Tesla builds the world's coolest cars or simply
overpriced go-karts. The truth lies somewhere in between.
Others suggest that Tesla isn't a car company, so much as a
technology development company. Hogwash. This is a car company,
plain and simple, and investors need to focus on the
of the auto industry. In this business, the odds of success are so
overwhelming that it's impossible to see how Tesla will ever reach
Volume is everything
Tesla wisely decided to first focus on a halo car, the Tesla
Roadster. The company established its cred with the
"money-is-no-object" crowd, as nearly 500 consumers paid six figure
sums to be the first in the neighborhood to own an electric sports
car. In the auto world, it's far easier to move down market than up
market. Hyundai is trying to do so after many years of effort.
Volkswagen tried with the Phaeton and failed miserably.
The down-market move: Tesla's niche market roadster will soon be
joined by a more mass market sedan known as the "Model S." And when
it arrives in showrooms, possibly in 2012, it will represent clear
advances over the Roadster in terms of mileage range and broad
market appeal. But by 2012, the Model S may already be late to the
game, as cars from
, GM, Mitsubishi, Nissan, Mini,
and others peddle impressive electric cars as well. The key
distinction is that those auto makers will be able to spread
development costs among more cars and will handily undercut Tesla
Going instead after the Volvo/BMW crowd instead isn't necessarily a
bad thing, but it's simply unclear how Tesla can compete by
building cars in the thousands while its rivals build cars by the
tens or hundreds of thousands. The auto industry is all about
scale, and no auto maker has ever been able to sell cars for less
than $100,000 in volumes below 10,000 and been able to thrive. Just
ask Saab or Hummer about that.
Tesla's supporters argue that its cars will be similar to luxury
sedan rivals in terms of performance, durability and comfort, while
also providing cutting edge electric vehicle technology. The
company believes that power storage and management will be the
game-changer. Tesla has been working on its core propulsion system
for more than five years and expects to squeeze an increasing
number of miles out of every watt that its power pack generates.
That is also the goal of every other auto maker and battery
technology in the world as well. And it's simply unclear how or why
Tesla will end up with the best mouse trap.
Do the math
Once the Model S production lines are at full volume, Tesla
believes it will generate 25% gross margins. To get there, the
company has embarked on a range of cost reduction initiatives, when
compared to the Roadster, which appears to have carried miniscule
or negative gross margins. As a point of reference, Ford hasn't
even cracked 15% gross margins since 2004.
What has happened since then? The auto industry has become awash in
far too much capacity, and auto makers have had to compete much
more aggressively on price. Even BMW hasn't generated 25% gross
margins in a number of years. Porsche's gross margins exceed 40%,
but that's with an average selling price on its cars in excess of
$75,000. The Tesla Model S is expected to be priced closer to
$50,000. And Porsche makes 75,000 to 100,000 cars a year. Tesla
aims to ramp up annual production to just 20,000 units by 2013, so
it will have to spread unit costs over a much smaller base.
Tesla also thinks that operating margins can exceed 10%, as
operating expenses will be well below industry norms. To get there,
the company anticipates fewer repairs and very limited ad spending.
But the company's Roadster model has been dogged by a series of
defects, and even if the new Model S proves quite reliable, that's
a boast that almost any major manufacturer can claim these days.
And word-of-mouth marketing approach may have worked for the
Roadster model, but the Model S sedan will be competing with
similar offerings from other manufacturers -- all of which
anticipate hefty marketing budgets.
More prosaically, you have to wonder about total demand for
electric cars. Many recent reviews for the Nissan leaf and the
Mitsubishi i-Mev focus on "range anxiety," the notion of the fears
of running out of power and being stranded. That's led reviewers to
assume that electric cars will be great second cars, used for
commuting to work and other limited runs. But those second cars,
the ones you see parked at railroad parking lots, are usually
cars. The Tesla Model S will be priced far too high for that.
Action to Take -->
Be wary of bullish Wall Street reports on Tesla. The company is
expected to keep raising more money after this summer's
, as it is unlikely to reach break-even for at least three or four
years, according to optimistic Wall Street
models. I have my doubts that the company will ever move into the
If I'm right, then the end game for Tesla will be to sell itself to
another auto maker that can better capitalize on industry
economics. And that price would likely be far lower than the
company's current $2 billion
-- David Sterman
David Sterman started his career in equity research at Smith
Barney, culminating in a position as Senior Analyst covering
European banks. David has also served as Director of Research at
Individual Investor and a Managing Editor at TheStreet.com. Read
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.
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