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Will Tesla Drive Into the Mainstream?

By: SeekingAlpha
Posted: 7/7/2010 3:27:00 AM

Last week, the much revered electric car maker Tesla Motors ('Tesla')( TSLA ) saw its initial public offering (( IPO )) on the NASDAQ exchange - the first from an American car company since Ford ( F ) in 1956.

The influx of buyers on the first day alone pushed Tesla's share price 40% higher in what was the second largest first day advance for a US IPO this year (first largest was Financial Engines ( FNGN )).

Tesla sold 15.3 million shares in its IPO last week at $17 per share, including the exercise of an overallotment option (activated due to high levels of demand) totalling around 2 million shares, with 14% of the company now sold to the public. All told, the company raised $226 million in the IPO, which it plans to use to move into production its new line of the more affordable, but very attractive looking 'Model-S' sedan. Before the launch of the Model-S, which is due to start appearing in 2011, Tesla was solely focused on producing the Tesla Roadster, a high end electric sports car which sells for a little over US$100,000.

Tesla benefited from a massive amount of press coverage for the IPO, and in many ways, has been treated more like a technology story, akin to Google's IPO ( GOOG ) rather than a car manufacturer, partially due to its decision to list on the tech laden NASDAQ and undoubtedly boosted by the fact that CEO Elon Musk was a co-founder of PayPal.

Since IPO Tesla's shares have managed to hold onto some of the early impressive gains, rising as high as $30.42 in their second trading day, and generally held steady above the $20 per share mark, closing last Friday at $19.20, valuing the company at US$1.8 billion. Musk, who originally put $70 million of his own money in the company, gained around $24 million from the IPO, with his holdings (28.4%) now estimated to stand at around $510 million.

However, considering the company has to date sold around 1,000 electronic vehicles (EV's) and has losses of $290 million since its inception in 2003, what has investors so revved up about Tesla?

The main selling point for Tesla is the market they are in, which is expected by many to expand exponentially as Western economies move away from fossil fuel powered vehicles to other alternatives. Tesla is hoping its new Model-S car will allow it to tap into this wider expanding market. Taking into account current subsidies for individuals who buy electric in the U.S., the Model-S price tag will be just a smidgeon under US$50,000. As part of this ambition to move toward mass market production Telsa recently acquired a manufacturing facility from Toyota ( TM ) in Fremont, California which is capable of producing half a million vehicles per year.

However, critics of Tesla are quick to note that the company is yet to post a profit, and is not expected to for several more years. Tesla has also faced numerous liquidity and capital raising problems in the past, burning through $230 million of cash since 2003, according to the Reuters news agency, while at the same time generating only $148 million in revenues.

Advocates of Tesla on the other hand see a car expanding from a niche of high end sports cars to a more wider appealing sedan. While the Model-S is certainly lower priced, at US$49,000, it is still very much outside of the low end, low margin part of the market. If Tesla can position itself correctly in the market, it could build a larger, loyal consumer base and push for much wider market share. Ultimately, one has to assume that if the brand is strong and its market share is growing, it will eventually be snapped up by a larger competitor looking to consolidate.

Competition in the EV market is heating up quickly. Toyota has undeniably thrown large amounts of cash at developing its hybrid electric cars, but this year both Nissan ( NSANY.PK ) and General Motors ( GM ) will launch new EV vehicles in the U.S. Both are aimed at the low to mid range of the market. This in itself could be viewed as good news and bad news for Tesla.

The good news is that for Tesla to truly thrive, it requires a supportive and growing sector. For this to happen, all of the big car manufacturers need to be in the race, as this will have a knock on effect to vital support services around the EV industry - from recharging stations to automotive centres that will not only have parts in stock when required, but will be also to carry out work at an acceptable cost. The bad news is Telsa will undeniably find it difficult to compete on economies of scale with the big boys. This will act as a major barrier to becoming a truly mass market car manufacturer.

The strength of Tesla therefore, depends largely on the broader outlook for the electric car market, and its own brand positioning, which at the moment certainly appears to be targeting individuals who want to buy electric, but are probably currently driving a premium brand, like BMW ( BAMXY.PK ), Honda's ( HMC ) Acura or Toyota's Lexus.

Can EVs become widespread?

To date, and despite the wide media blitz they have received, electric cars (including hybrid cars) have seen comparatively little demand compared with their gasoline counterparts. There are several issues that currently face the electric car market, which one could argue will need to be fully addressed before the use of EV's becomes truly widespread.

Firstly, while the production costs of electronic cars will continue to fall as market uptake increases, it is still relatively expensive for auto manufacturers to produce them. Until this issue is resolved, mainstream demand for EV's is never likely to match the demand for gasoline powered vehicles no matter what the other benefits may be. This is a self fulfilling prophecy. As demand slowly ticks upwards, economies of scale will improve and costs will fall, which will in-turn improve margins and boost appetite from big automotives to increase demand. The big question is not if EV will replace combustion engines, but when.

The other problem facing the market are issues surrounding the limitations of the vehicle's battery. Although, for example, EV's can generally be charged using a standard household outlet, fully charging the battery typically takes up to 12 hours. This is an inconvenience that many would-be buyers may not be able to swallow. Secondly, while the distance a car can drive on a fully charged battery is improving; even Telsa's sedan will be limited to around 300 miles before requiring a boost. Many electric vehicles are claiming distances much lower than this. For car owners driving predominantly in their local area, this wouldn't be much of an issue, but what if you want to drive from Boston to Philadelphia (320 miles)? At the moment you would have to stop and charge the battery along the way, and that would take a lot longer than filling the tank up with gas.

There are 'fast chargers' available for electronic cars that owners can have in their homes, which speeds up charging of EV's significantly, however, they come at an additional cost. Several groups are also working on a system where a car could simply pull into a station and have a depleted battery replaced with a fully charged one, but even this concept is many years away from any sort of national rollout. The question again seems to be a matter of when will EV technology catch up with many decades of research and development into internal combustion engines.

Even charging a car as one would do at home, which at first may seem quite trivial, isn't necessarily straight forward. What do individuals who live in apartments or similar high rise developments do, for example? Are property developers going to install plugs in every parking bay?

So then, with these factors to overcome, one could certainly suggest that Tesla faces an incredibly challenging market in the foreseeable future. The large uptake of their float last week has many asking if the company's valuation is already too high. Investors would be wise to remember that Telsa isn't Google. It is burning cash at a fair clip and is years away from profitability.

There is certainly potential in Tesla to deliver exceptional returns, and massive credit is due to the company for getting this far, but the risks still appear very high. Timing is everything in investing, but the jury is out on whether Tesla's time has come.

Disclosure: No position

See also Nissan and the Electric Vehicle Battery Conundrum on