Tesla Motors Inc (TSLA) news Tesla An Investment Based On Optionality …

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Tesla: An Investment Based On And The Genius Of Elon Musk

Few have garnered as passionate a of supporters and detractors as Tesla (TSLA ). With a 344% in 2013 it was one of the best performing of the year and recently a very Morgan Stanley analyst’s sent the stock soaring to highs of $258 and a $31 billion capitalization.

Thus, we see that seems to be valued 233x than GM and 37x more than (TM ) (the world’s biggest and valuable car company). However, are 3 reasons why I believe that deserves a premium over more established automakers. reasons are better operating an objectively better product and the that goes along the leadership and innovative genius of co-founder and CEO Elon Musk.

Operating Margins in the Industry

to the last earnings report achieved an operating margin of 25% and the guided to 28% operating margins for In the last investor presentation. the stated that Model X are to begin in Q4 of 2014. The Model X is to be a CUV on the Model S and include double all-wheel drive.

It seems to assume that the price of vehicle will be higher that of the Model S. Since and CUVs are higher margin than sedans let’s a slight improvement in the company’s operating margin to 30% in 2016. the cheaper Model E coming in 2016 will be the last of pure higher margin S and Model X.

30% operating margins be 3x higher than that of and so it seems clear that deserves a premium to Toyota’s

Best Car Ever Made

two that Tesla deserves a over industry leader is that its cars are objectively Toyota has built its empire on much one thing — Toyota’s cars are not the safest, beautiful, best performing or comfortable but Toyota’s are the most

But Tesla’s cars have no parts other than the motor. There are no valve belts to break and no filters or oil to There is essentially no maintenance to be on a Tesla. This means there is a good probability Tesla is now the most reliable car in the world.

We’ll have to see 2014 JD Power and Associates quality study shows but might lose its one advantage.

If can take that crown Toyota; then it will a car that is: more beautiful, comfortable, (no engine means space for storage and passengers), (the Tesla Model S is the car ever tested by the NHTSA) and running costs are much This is not only because is essentially no maintenance to perform on a but because charging your car at is equivalent to filling up your with $.75/gallon gas. this to the average price of $3.44 and you can see that your costs will be 78.2% in a Tesla.

In addition, consider In 2013 the Tesla Model S won 9 including Consumer Reports it the best car they have tested. achieving a score of Take a moment to consider fact. In 2003, Tesla was in Silicon Valley. 10 years it produced what is arguably the car ever made. Imagine if can bring this caliber of and excellence to the Model X, the Model E and all the models they will going forward.

If each model is the most reliable, the comfortable, the safest, the best in its segment then there is no to how successful sales can grow. In situation, the sales will be and market will correctly Tesla a premium to other car such as Toyota. I’ll how large of a premium in a second but I must cover one other I think Tesla deserves.

This premium is the most as it includes all the potential for market that the company brings to the

Optionality and Elon Musk

Fool’s David Gardner the idea of optionality the idea a company can morph into an new company expanding beyond original business model in and profitable new ways. In 1996, Mr. recommended Amazon.com (AMZN ) that CEO and founder Jeff was an innovator and disruptor who could far more than books.

Amazon has expanded to selling from office supplies and to cloud services and soon to be minute drone delivery of packages.

This concept of is what the Morgan Stanley was focusing on when he raised his target on Tesla to $320. I think that analyst on the wrong things, his general was correct.

Investors in Tesla are paying a major premium for Musk, the CEO and co-founder of the company. Mr. is the co-founder of PayPal, SpaceX and on the board of Solarcity (SCTY ). He is an dynamo (and allegedly for Robert Downey Jr.’s of Iron Man ). Mr.

Musk at 42 is still in his with many decades of in front of him.

What the Stanley analyst was talking when he made his admittedly utopian proclamations (he literally that Tesla would in a utopian society within 20 is that Tesla can become far than a simple electric car

Where the analyst went was assuming that autonomous will be the key to Tesla’s future. the most obvious optionality for is two areas.

Optionality One: and Electric Systems

In 2009, bought a 10% stake in Tesla and in Toyota bought $50 million of at Tesla’s IPO. Both have licensing arrangements the company.

The upcoming Mercedes EV, which goes on sale in will feature a Tesla Toyota, meanwhile, gave a $100 million contract to the electric motor, power battery, gearbox and software for the new RAV4 EV.

One of the main arguments skeptic’s use against the company is larger OEMs such as GM and Volkswagen will easily the fledging upstart once proves the viability of electric

There are three problems this argument.

The Prius

In 1993, Toyota was concerned higher fuel prices cause consumers to demand mileage cars. So it launched a $1 RD program and in 1995 revealed the Prius at the Tokyo auto and launched the vehicle in 1997 in In 2000, sales went and today the company has sold 4 million units and total hybrid sales of 6 million .

in the 1990’s, Detroit’s big three given $1 billion in taxpayer to come up with their own mileage hybrids through the For A New Generation Of Vehicles .

The results a trio of hybrids: the GM Precept, Prodigy and Chrysler ESX3 who got 82, 72 and 72 respectively. None of the Detroit big brought any of these cars to arguing that hybrids too expensive and that there was no demand for them.

When the Prius, by 2005, had a major success, with surpassing 1 million units, recorded that GM (GM ), Ford (F ) and dusted off these 3 amazing (with mileage far superior to the and crushed the young, fledging with their far superior Today, the Toyota Prius is a footnote in history while the GM rules supreme among

Oh wait, that didn’t Despite the amazing success of the neither GM, Ford nor Chrysler able to effectively compete Toyota’s first-mover advantage. (HMC ) tried to compete the Insight but recently announced it was discontinuing the brand due to low sales.

To no company has been able to challenge the dominance of Toyota’s Synergy Drive (Prius up 40% of global hybrid sales ). The first move advantage out of far sighted innovation and risk means that the Toyota will remain triumphant it comes to hybrids.

Just as we saw bet big and win huge with the Prius, represents a potentially as big, if not opportunity. The benefits of electric vs regular cars are undeniable:

cars are 90% efficient vs 20% for regular

Maintenance on an electric car is non-existent. the maintenance on the now defunct GM EV-1. stating that they in the electric cars in every miles, rotate the tires, the windshield wiper tank and them out again.

Cost to according to the EPA. a model S drives 24,000 miles/year just $700 in annual bills.

Environmental benefits: cars can be run off of clean energy, as the Tesla Super Charger many of which are solar .

Performance: Electric motors instant maximum torque allows for amazing acceleration.

As seen in the Tesla S, when a car designs the car without an engine and the and motor in the floor of the vehicle, the of space available for passengers and is amazing. The Tesla S has 31.3 feet with all seats up and cubic feet with seats folded.

Safety: all the added room for crumple (no engine, just a front to collapse and absorb energy) the Model S is the safest car ever by the National Highway Traffic Administration.

What this is that at some point in the nearly all cars will be and right now Tesla is the undisputed of electric cars. It has the most technology that big competitors, as Toyota and Daimler) are choosing to and buy from Tesla rather pour billions in RD into a system.

Competing RD

Let’s about RD for a second. This is how Tesla’s competitors are spending to competing models.

Toyota $1 billion

GM/Ford/Chrysler hybrids: $1 tax payer funded

As one can see, spends the least on RD yet develops the product. Not convinced? Consider the battery costs for today’s EVs .

average per kWh: $650

Leaf: $375


Tesla after Gigaplant online in 2020: $182 or (Elon Musk is quoted as at least 30% savings in battery

Meanwhile, big traditional automakers Toyota and Hyundai (OTC:HYMTF ) are hundreds of millions of dollars fuel cell vehicles a goal of being able to 5,000-10,000 in the US, in 2015 at a cost of With a range of 310 miles is close to 300) and requiring 3 to refuel the car is going to likely money for Toyota and waste its RD

This is because fuel vehicles are already inferior to vehicles and they haven’t arrived yet. Tesla has the Model S’s battery to be switched out in 90 seconds for a cost of which is the cost of a tank of Meanwhile hydrogen stations, are rare, cost $3/gallon for hydrogen and take 3-5 minutes to up.

Fuel Cells, Main EV Have No Future

The only that fuel cells had electric cars was in their time.

FCV: 3-5 minutes to at $3/gallon equivalent

Tesla S: 90 to refuel at $3.43/gallon equivalent

A hydrogen economy requires infrastructure buildup of special hydrogen producing stations and facilities. The estimate cost of infrastructure is $200 Trillion .

is everywhere. The aging electric will have to be rebuilt and in to keep the lights on and economy A smart grid will $338-$476 billion over 20 but will deliver $1.4-$2 in economic benefits.

In other the hydrogen economy is an economically fairytale while a smart grid is inevitable.

The point of the presentation is to show that the Goliaths that Tesla is going to be crushed by are not as mighty or as initially presumed. Toyota, and GM are spending billions of dollars on systems that are more less efficient or in the case of cells, economically not viable. Tesla is focused like a on the final automotive end game, cars.

Hybrids are great and make Toyota lots of but plug-in hybrids offer better fuel economy. Hybrids are great but electric are the end state of automotive technology. The that perfects EVs will own the future.

In ten years, when has proven the superiority of not just vehicles but their electric in particular what is more That big OEMs such as and GM will spend billions of on RD and will take 5-10 to bring a decent competing EV to market? Alternatively, these seeing that Tesla’s packs and electric control offer the highest performance at the price could simply them from Tesla (as and Daimler have already

Here is the first major for Tesla — the licensing of its systems to other OEMs to use in electric cars. 10-20 from now if Tesla keeps on in this space its technological in batteries and electrical management could remain strong. Tesla will primarily be an systems supplier. The recently Gigafactory. which is to be completed by at a cost of $4-$5 billion, be capable of producing enough Branded battery packs for cars.

To put this in perspective the output of this single (to be built in the US and provide 6500 will be greater than all the production in the world today. kind of audacious long-term is what Mr. Musk is known for and why trades at a well-deserved premium to such as Toyota.

Optionality 2: Electrical Infrastructure for EVs

Tesla is a network of superchargers along busiest highways that are of recharging a Tesla S to 80% within 40 and full within 75 minutes. of these will be able to out the battery pack in just 90 at a cost of $60-$80. As of early the network covers 80% of the US population.

The will be complete, covering 98% of the by the end of 2015. This charger is several times faster any competing system. What’s is for owners of the Model S with an 85 kWh back the superchargers are free of for the life of the vehicle. This is amazing technology made so by the fact that Tesla soon have all supercharger powered by solar energy of Solarcity (another Musk The benefit of being solar is not purely for environmental reasons.

In the event of a large scale like the ones that hit the in 1965 and 2003 the Tesla stations would still In fact, Elon Musk mused, even if there’s a apocalypse, you’ll still be to travel the country on the Tesla network.

This brings us to the large optionality for Tesla, up the supercharger network to all compatible Remember that Toyota and are buying their EV components Tesla. Imagine the monetization if these vehicles could (for a nominal fee) at supercharger stations (with free from the sun).

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It be the equivalent of a network of high gas stations. If Tesla succeeds in the main supplier of battery and components to future EV makers, the networking effects become

What I mean by networking is that initially competing car would buy Tesla sourced and electrical systems because are cheaper and better than their own. However, these non-Tesla EVs are compatible the supercharger network, customers of and GM EVs would be delighted to learn could benefit from impressive system.

The supercharger and its compatibility with non Tesla EVs become a major selling for Tesla’s competitors. Suddenly, automakers, such as Honda, that customers would not buy an EV them unless it’s compatible. That requires Honda either build out own supercharger network, a redundant and expensive affair, or just buy EV components from Tesla, are cheaper and better performing the components they could themselves.

Suddenly, Tesla’s become its partners. This suddenly that expensive network (that would to be expanded massively to accommodate more non Tesla EVs) a huge asset. The sheer and scope of the infrastructure cost to with Tesla (once have a 5+ year head becomes economically nonviable.

It within every automakers interest to save money and sales by sourcing Tesla EV This creates not just a economic moat around but creates enormous residual Suddenly Tesla is the world’s one automotive equipment supplier and the largest high margin gas station operator.

It could far more sales and profits these two optionalities than could selling cars, they will undoubtedly strong market share in the space as well.

These are the two most obvious optionalities and are the that Mr. Musk has talked himself. Part of the premium is trading at today is because of that reside within Mr.

head that he is patiently on and has yet to reveal.

Despite the optimistic I have painted thus Tesla is a company that face risks both as a and an investment.

1. Market Valuation/Momentum The stock has been one of the best investments of the past year and all its movement has been a momentum The general market’s 30% return in (one of the strongest ever ) helped with this In the event of a market correction stock may fall fast and far of the fundamental performance of the company.

2. risk: The recent spate of Model S fires and the investigation by the NHTSA, could give the wrong impression about the of Tesla Electric Cars. conventional cars are far more given they carry gallons of explosive fuel media hysteria over fires could hurt Thus far it hasn’t but future coverage may turn against in this area.

3. Execution risk: Thus far has executed very well on its strategy. It has been able to put up results beating its guidance and time it does the stock In the future, raised expectations result in great results but disappointment.

Also, the supercharger mentioned as one of Tesla’s key assets is a challenge to build out. The is not just targeting the network to 98% of the US population by 2015, but is also similar networks in Europe and The logistics and costs involved in a network of superchargers is formidable and any in execution could hurt in management’s ability to execute on Mr.

grand vision.

4. Timing The long-term dominance of electric is certain (fossil fuels eventually run out making gasoline impossible) but the exact timing of electric cars achieve market adoption is not. now Tesla is supply constrained and for 35,000-40,000 sales in 2014. its possible that end demand for the S might peak at 40,000-50,000/year. the general car buying public isn’t ready for mass EV and Tesla’s future will be as a niche player. After according to Elon Musk, won’t be able to offer a 500 range in its cars until

Range anxiety will as EV ranges increase but some will demand that EVs range superior to regular before they purchase

Valuation and Future Returns

brings me to my original point. deserves a premium to traditional companies such as Toyota. how much of a premium? How can we value a whose potential for profit limitless but so hypothetical and far into the

Let’s use Toyota to see if we can model current fair value.

trades at 1.15x sales and has an margin of 9.8%. Since will have a 30% operating in 2016 (due to maximized out of Model S and Model X production let’s give Tesla a P/S of which is proportional to its massive

Next, we need to account for superiority of products over its I feel that a 25% premium is given that Tesla’s are so superlative (the most the safest, the most comfortable, the beautiful, and the best performing). premium gives us a P/S of 4.31.

how do we value the incredible innovative of a man who seems to be bent on solving all the greatest problems within his Again, I think a 25% premium is Applying this to our previously P/S ratio we get a total P/S of 5.4.

is down from the current P/S at which Tesla trades.

is the premium I think Tesla to trade at in 2016. In 2017 be the introduction of the more mainstream E which will come a lower price and lower To determine the value of the company in we need to model how many S and Model X cars Tesla can

According to the company’s 2013 end investor presentation, Tesla is a 55% increase in sales in 2014 to 35,000 vehicles. These almost be all Model S’s the Model X will just be production. Currently, the Model S is constrained which means we do not the true demand for the vehicle Tesla sells all it makes.

However, it seems reasonable to that by 2016 at least model S’s/year will be and I’ll model the same for the Model X SUV. I base assumption on the fact that the popular Porsche (another performance brand) model is the SUV .

This gives us a base of vehicles sold. However, strong growth of stores in where gas is $8/gallon and the cost to a Tesla is 12x less than a gas car might prove conservative. The has just now started to focus on sales which could a sufficient kick to sell Model S and 75,000 Model in 2016.

This is my high-end and represents a doubling of Model S in 2 years off of the increased 2014

To model total revenues we the estimated 100-150K units to the 35,000 expected sold in Using this and the estimated billion in sales in 2014, I $10.4-$15.6 billion in sales in Then, applying my P/S multiple I get a cap of $56.2-$85.8 billion.

This an 81-169% potential upside by the end of and gives us a 3 year price of $468-$693/share with a mean price of $581/share.

To determine the present value of this growth, I discount by the stock long-term, (1871-2013) compound growth rate, of 9% .

This us a present day fair value of which is an average of $410/share. represents a 41.8% potential in 3 years — an equivalent to CAGR. That is 37% better the market’s historical return.

with recent technical this gives a strong buy

Technical Analysis

The technical on Tesla are as clear as they The signals are bullish across the with a recent Bullish candlestick pattern and absolutely no above the current price. there is only moderate at $177; meaning that, unexpected bad news hit or the market a general correction the stock take a pretty strong

However, that would give long-term investors a to acquire more shares at a better price.

Despite its one year run, I strongly that the fundamental strength of (which lies in its award products and best in class warrants a strong buy, at these record levels. I a short-term (3 years) CAGR of from the current price. the introduction of the more mass Model E, I anticipate even 15 year performance (a topic for article).

Disclosure: I have no in any stocks mentioned, and no plans to any positions within the next 72 I wrote this article and it expresses my own opinions. I am not receiving for it (other than from Alpha). I have no business with any company whose is mentioned in this article. )

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