Now, mister, the day the lottery I win I ain't ever gonna ride in no used car again -Bruce Springteen
In this day of sky-high P/E ratios and mega-market caps attached to companies yet to achieve profits, investors often get silly about valuations. Certainly, times exist when a company's stock does not deserve the premium buyers have given it. Often, speculators get caught up in an euphoria that's simply gotten ahead of itself.
After a more-than-stunning upgrade from Morgan Stanley's Adam Jones, shares of Tesla Motors (TSLA) exploded. Carter Driscoll of Capstone scoffed: "It's a stock people want to like," while referring to TSLA as "absurdly overpriced." If you're a guy who still calls trades into your broker every morning on a rotary phone, I guess it is. But this is the year 2011, and the old rules no longer apply.
Investing in Tesla today is almost akin to buying shares of Apple (AAPL) in 1984 right after you dropped $10 on the Born in the USA 33 and 1/3. If you bought shares of AAPL in 1984, people like Driscoll might have chided you for buying into some sort of cult-like inanity without a chance of every reaching the mainstream. After years of obscurity, the rest is history. Steve Jobs changed the world. Carter Driscoll has yet to join the rest of us.
Apple could have failed miserably. Investing in it in 1984 was a speculation. Twenty-five years later it remains the same. Unless you want to keep your money in utility stocks or relatively "safe" dividend players like McDonald's (MCD), you engage in speculation, in the mere purchase of a hope and a dream when you invest in a stock. Even the so-called "safe" plays provide for significant potential losses. Unless you strictly adhere to some type of technical analysis and get in and out of your trades in timely fashion, you're guessing that the premium you pay today justifies the performance a company turns in tomorrow.
I obtained a copy of the Morgan Stanley report on Tesla. Due to its proprietary nature, I cannot provide a link to it, but here's an excerpt:
Flipping the chessboard: The confluence of structural industry change, disruptive technology, changing consumer tastes and heightened national security creates an opportunity for significant new entrants in the global auto industry. California dreaming? We don’t think so. In our view, the conditions are ripe for a shake-up of a complacent, century-old industry heavily invested in the status quo of internal combustion. The risks are high. So is the opportunity. Enter Tesla.
xEV market entering higher volume and it’s happening right now: We are convinced electric cars will comprise a significant minority of global light vehicle sales medium-term and the majority longer term. Our global xEV model suggests penetration of 5.5% globally by 2020 and >15% by 2025. Even on our forecasts, the Internal Combustion Engine remains by far the dominant form of propulsion for a very long time.
Tesla moves from rich man’s toy to mass market: We believe Tesla’s long-term independence can only be secured through the commercialization of mass market EVs in the $30k price range. Premium offerings like the Model S and its derivatives are important stepping stones to the company’s full volume potential of 500k units by 2025. We see a path to a company with $9.5bn of sales, >$1.2bn of operating profit and >$1.0bn of FCF by 2020, based on Tesla capturing 3.6% of the global xEV market by that time. The risks of lagging EV adoption, launch delays and balance sheet difficulties make Tesla a highly speculative investment.
$70 PT offers almost 200% upside, on revenue est. roughly 3x consensus in the out years. On our forecasts, Tesla’s biggest financial challenge comes in 2013 when gross liquidity falls to $146mm. As is not uncommon with start-ups, the biggest question is if Tesla can remain solvent long enough to capitalize on the forthcoming technological break-throughs.
I bolded what I see as the especially key points from an overview chock full of them. Tesla naysayers ignore a key point in the company's development: It's growing responsibly. Tesla is not executing a Netflix (NFLX)-like high-wire act of unsustainable hyper growth. While Tesla certainly does not move at a snail's slither, it's taking a very logical approach as it paces itself forward. In the process, it slowly moves toward Morgan's suggested evolution from "rich man's toy to mass market."
Observers, as well as Tesla itself, compare the company to Apple. Tesla CEO Elon Musk positions the company as a tech company, not tied to the bureaucracy of the traditional automakers. Tesla dealerships, by design, look, feel, and function more like an Apple Store than a car dealership. In terms of developing and releasing products, the two companies appear to share similarities.
Apple started with products geared towards its cult and individuals and entities willing and able to spend more for quality and something cool. Wider accessibility and subsequent mass adoption of the iPod started to change all of that. Now, Apple offers a $49 version of its iPod, sells one of the world's most inexpensive tablets, will likely introduce a lower-priced version of the iPhone, and is increasingly putting Mac PCs and laptops into the hands of the masses.
What we have already seen from Tesla, what they report in their most recent annual report as their plans, and what Morgan Stanley's Jones predicts resembles Apple's trajectory in a remarkable way.
Tesla's first electric vehicle (EV), the Roadster, clearly targets the affluent. It's the company's version of a fully-loaded MacBook Pro. With a price tag north of $100,000, not everybody will take the bait. In 2012, however, Tesla will begin to place its Model S in the hands of buyers. According to Tesla's annual report, the company has already taken 3,400 reservations for a vehicle they intend an initial 20,000 per year production run for. A base-level Model S runs $49,900 after accounting for the Federal Government's $7,500 tax credit for EVs. In its report, Tesla hints that the Model X Crossover will come next. It, and future vehicles, will use Model S architecture at their core. As Jone's logically speculates, these future offerings, and even the Model X, should start to penetrate the mainstream. Again, strikingly to similar to Apple's model and evolution.
As Tesla paces out this growth, it continues to nurture another key revenue stream, which could help bridge the gaps in sales Jones alludes to and Tesla speaks of in its annual report:
Prior to the launch of our Model S, we anticipate our automotive sales may decline, potentially significantly. We currently produce the Tesla Roadster gliders, which are partially assembled vehicles that do not contain our electric powertrain, with Lotus Cars Limited (Lotus) in Hethel, England. We currently intend to manufacture gliders with Lotus for our current generation Tesla Roadster until January 2012. We intend to use these gliders in the manufacturing of the Tesla Roadster to both fulfill orders placed in 2011 as well as new orders placed in 2012 until our supply of gliders is exhausted. Through December 31, 2010, we have delivered over 1,500 vehicles. We do not currently plan to begin selling our next generation Tesla Roadster until at least one year after the launch of the Model S, which is expected to be in production in mid-2012. As a result, we anticipate that we will generate limited revenue from selling electric vehicles in 2012 until the launch of our Model S.
Tesla hopes to extend agreements with Toyota (TM) and Daimlerchrysler (DCX) to provide the companies with EV drivetrain components. As Tesla notes in its annual report, these deals can generate significant income:
In May 2009, we entered into a development agreement with Daimler under which we performed specified research and development services for the development of a battery pack and charger for Daimler’s Smart fortwo electric drive. All development work related to the development agreement had been completed as of December 31, 2009. We have been selected by Daimler to supply it with up to 1,800 battery packs and chargers to support a trial of the Smart fortwo electric drive in at least five European cities. We began shipping the first of these battery packs and chargers in November 2009 and started to recognize revenue for these sales in the fourth quarter of 2009.
In the first quarter of 2010, we completed the development and sale of modular battery packs for electric delivery vans for Freightliner Custom Chassis Corporation (Freightliner), an affiliate of Daimler. Freightliner plans to use these electric vans in a limited number of customer trials.
In May 2010, we and Toyota announced our intention to cooperate on the development of electric vehicles, and for us to receive Toyota’s support with sourcing parts and production and engineering expertise for the Model S. In July 2010, we entered into an early phase agreement to develop an electric powertrain for the Toyota RAV4. With an aim by Toyota to market the electric vehicle in the United States in 2012, prototypes would be made by combining the Toyota RAV4 model with a Tesla electric powertrain. We began developing and delivering prototypes to Toyota for evaluation in September 2010.
In connection with the Toyota RAV4 program, in October 2010, we entered into a Phase 1 contract services agreement with Toyota for the development of a validated powertrain system, including a battery, power electronics module, motor, gearbox and associated software, which will be integrated into an electric vehicle version of the Toyota RAV4. Pursuant to our agreements, Toyota will pay us up to $69 million for the anticipated development services to be provided by us over the expected term of our performance.
In the first quarter of 2010, Daimler engaged us to assist with the development and production of a battery pack and charger for a pilot fleet of its A-Class electric vehicles to be introduced in Europe during 2011. A formal agreement for this arrangement was entered into with Daimler in May 2010. In October 2010, we completed the development of the A-Class battery pack and charger and began shipping production components for a demonstration fleet in February 2011.
Clearly, Tesla should work to further these pacts and forge more like them. In fact, the company should strive to supply as many traditional automakers as it can reasonably handle. Tesla actually stands to benefit if the major producers experience growth in their EV sales. Given the obstacles EVs face in terms of adoption, success for one represents success for all.
Tesla does not need to be, nor does it want to be Ford (F) or General Motors (GM). To reach Morgan Stanley's target of $70 or its bull case estimate of $135, it only needs to be the BMW (BAMXY.PK), Mercedes, or the Apple of EV carmakers. There will always be a lucrative market for the most expensive BMWs, Mercedes, and MacBooks just as buyers will always exist willing to plunk down $100K on a Tesla Roadster instead of a Porsche (POAHF.PK). By the same token, a middle of the road BMW 5-Series or a MacBook Air could represent the forthcoming Model S. And, as both BMW and Apple have done (but not Mercedes quite as much, I don't think), future Tesla EVs will likely resemble a 3-Series Beemer or entry level iPad in terms of relative price structure.
If Tesla stakes its claim to this piece of the overall auto market, it will have no problem turning over a billion dollars in profits, while helping the overall EV market grow.
And if you have a look at the Model S, you'll see that it will be more than capable of stealing market share away from, say, a Lexus Hybrid. Given most people's driving habits, the anticipated ranges of 160, 230, and 300 miles will more than suffice. In terms of fuel efficiency, it should be at least as much of a winner as the Roadster. Consider Tesla's figures, from its most recent annual report, using an outdated average price per gallon of gasoline:
For example, assuming a 245 mile range of the Tesla Roadster, an average electricity cost of 11.7 cents per kilowatt-hour and an average gasoline price of $2.86 per gallon, which were the average residential electricity cost and the gasoline price in the United States for November 2010 as reported by the U.S. Energy Information Administration of the U.S. Department of Energy, the cost per mile to fuel the Tesla Roadster is approximately 70% less than the cost to fuel the 2009 Porsche 911 Carrera, which has an EPA mileage rating of 18 miles per gallon city and 25 miles per gallon highway.
As Morgan Stanley's upgrade highlights, Tesla's "disruptive technology" will prove key to its success. One of the biggest roadblocks to adoption and criticism of EVs has centered on how you charge them. You effectively treat a Tesla like your mobile phone, plugging it in to an electrical outlet overnight. With the emergence of fresh EV charging technology, the Model S will be able to charge fully and rapidly -- within 45 minutes -- at commercial locations in the future.
Investors often worry about high P/Es or, in this case, lack of profitability and the uncertainty of the consumer's willingness to move from the status quo. While these worries are reasonable, they can hold investors back from profiting in the stock market. If you intend to hold a stock over the long-term, it's always a gamble. While Tesla might not end up in this category, it took some foresight and serious guts to be one of the people who bought Apple 25 years burnin' down the road.
Disclosure: I am long AAPL.
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