Elon Musk makes great cars, but investors are wondering when his company will turn a profit.
(Bloomberg) — Chris Ziegler presses the pedal of his Tesla Model S. It surges forward silently and instantly — unlike gas-powered cars that roar and gulp for air before accelerating. Driving in the hills north of Los Angeles, he whips through hairpin turns without worrying about flipping over. Thirteen hundred pounds of batteries under the floorboard make that nearly impossible.
Ziegler loves everything about his all-electric, $107,000 Tesla, including that he recharges its batteries using solar panels in the trees above his house. That lessens his contribution to climate change and his dependence on oil from the Persian Gulf — which Ziegler patrolled as a Navy gunnery operator in 1983.
“I’m stunned major automakers haven’t fired back with a product to compete with Tesla,” says Ziegler, 49, a real estate project manager in the L.A. suburb of Monrovia. The license plate on his Model S reads “Waat Gas,” Bloomberg Markets magazine will report in its April issue.
Ziegler is so convinced the Tesla is the car of the future that he and his wife, Barbara, a sales executive for an institutional investment firm, sank 90 percent of their liquid assets in its shares beginning in 2010, when the stock sold for $16. Barbara also earned hundreds of thousands of dollars trading options against investors who thought Tesla would fail, she says.
Tesla, of course, hasn’t failed. Rather, Chief Executive Officer Elon Musk says it’s leading the world into a future without gasoline. Already going toe-to-toe with competitors such as BMW and Mercedes-Benz, he wants to take Tesla cars to the mass market — and push forward the process of freeing the world from its dependence on fossil fuels.
Skeptics Abound
Eventually, “all cars will go electric,” Musk said at a press conference in January
Yet there are plenty of skeptics who question whether Tesla will ever be capable of competing with the Toyotas and General Motors of the world — or get out of the red any time soon. Since its founding in 2003, the company, which went public in 2010, has earned a profit in just one three-month period. In 2014, it lost $294 million on $3.2 billion in revenue.
Some $217 million of that revenue came from the sale to its competitors of zero-emission-vehicle, or ZEV, credits and other pollution allowances.
“You’re talking about a company with no cash flow,” says Matthew Stover, an analyst at Boston-based Susquehanna Financial Group, which in the three months ended on Jan. 31 sold more than half its 1.5 million Tesla shares. “One hundred percent of the value of the shares is associated with some view of the future that has not manifested itself in the past.”
2020 Profits
In a Feb. 11 conference call with investors after releasing Tesla’s fourth-quarter financial statements, Musk, 43, predicted the company would have positive cash flow by the third quarter of this year. He has also forecast that Tesla will be making a full-year profit under generally accepted accounting principles by 2020.
Stover isn’t the only investor skeptical of Tesla’s prospects — and of its stock price, which at $199.6 on March 3 valued the company at $25.1 billion. (That’s almost 40 percent of the market capitalization of Ford, which last year sold 6.3 million vehicles, almost 200 times as many as Tesla.)
As of Feb. 13, 26.8 percent of Tesla’s shares had been sold short, with more investors betting on their decline than for any other company in the Bloomberg Intelligence Global Automobiles Valuation Peers Index.
Musk’s Confidence
The naysayers haven’t dented Musk’s confidence. On the Feb. 11 conference call he said that in 10 years Tesla could match the market cap of Apple, which on March 3 was the world’s most valuable company, worth $753 billion. In a February letter to shareholders, he wrote that vehicle deliveries would increase by 70 percent this year and that there would be a “significant” increase in what he called non-GAAP income, a calculation that takes into account factors such as lease payments and deferred stock options.
Tesla — named for Nikola Tesla, who designed alternating-current power systems in the 19th century — offers buyers just one product, the Model S, of which it sold 31,655 in 2014 at a price that started at $71,000. The company will introduce a gull-wing SUV late this year, also priced at around $70,000, and then target middle-income consumers with a $35,000, 200-mile-range (320-kilometer) car called the Model 3 in 2017.
Musk forecasts he’ll make 500,000 vehicles by 2020 at his Fremont, California, factory, equipping them with batteries from a massive plant dubbed the Gigafactory that he’s building with Panasonic in the Nevada desert.
Innovation Leader
Even supporters question whether Musk can meet his targets. Morgan Stanley auto analyst Adam Jonas is a Tesla enthusiast yet predicts the average Model 3 will cost $60,000 and that Tesla will sell 319,000 cars a year by 2020. He thinks that even at the lower number Tesla can make money and lead innovation in the global auto industry.
Jonas has an overweight rating on the shares.
Susquehanna’s Stover says that the Tesla share price — it peaked at $291 in September before falling in tandem with oil prices — suggests investors already regard the Model 3 as a hit.
“Since nothing can happen for two years to validate that view, the market will simply be guessing,” Stover says.
Tesla’s debt is no less popular than its shares. In February 2014, investors bought $2.3 billion of Tesla convertible notes with coupons of 1.25 percent or less — a smaller return than U.S. inflation. The bonds won’t convert to shares — and provide a bigger return to investors — unless the stock reaches $359.87.
Model X
If the past is prologue, the Model 3 will be late; it’s already about two years past its original launch date, as is the SUV, dubbed Model X. And analysts say there is no guarantee that Musk’s battery factory — which he predicts will dramatically reduce the cost of the Tesla’s most crucial component — will live up to expectations. The plant will supply batteries for two businesses that are in their infancy: electric vehicles and solar power systems being built by another company he founded, SolarCity.
Tesla doubters point out that once the Model 3 comes to market, it will face a tsunami of competition. Virtually every major carmaker is producing or is on the verge of producing a ZEV, in part to meet rising emission standards of the federal government and the state of California.
No one doubts that, in the Model S, which Tesla introduced in 2012, Musk has created a vehicle that’s hard to hate. The appeal is based on its ferocious performance and 265-mile driving range — the highest among electric cars. In October, Tesla launched a dual-motor version that goes from zero to 60 miles per hour in 3.2 seconds, half a second faster than a gasoline-powered Corvette.
Dashboard Touchscreen
The Model S also has cozier features, like a 17-inch (43-centimeter) dashboard touchscreen. Drivers control nearly every function by swiping their fingers — just like on their iPhones. (It’s no coincidence that several high-level Tesla employees were hired away from Apple, which is also researching automotive technology.)
The communication system enables Tesla owners to regularly download new capabilities, like a navigation system introduced in September that plans alternate routes based on traffic.
Among U.S. buyers, 96 percent say they love their Tesla’s technology, according to a December survey by marketing consultant Strategic Vision, compared with 62 percent for Porsche and 55 percent for BMW.
Entrepreneur Musk
Wall Street’s love affair with Tesla is really a romance with the charismatic Musk, a South African–born entrepreneur who pronounces his company’s name TEZ-la. He earned bachelor’s degrees in economics and physics at the University of Pennsylvania and then dropped out of the Stanford University Ph.D. program in physics to join the Internet boom.
Musk helped create PayPal in the 1990s and pocketed $165 million when EBay bought the company in 2002. By the time he joined Tesla in 2004, he had already launched rocket manufacturer Space Exploration Technologies, or SpaceX.
A decade later, he’s got a near-mythic reputation.
“Elon Musk is our generation’s Thomas Edison,” says Joseph Fath, a fund manager at Baltimore-based T. Rowe Price Group.
“He’s the greatest inventor of all time,” says Gwynne Shotwell, chief operating officer of SpaceX.
“Elon will be the richest man who ever lived,” says Scott Painter, CEO of TrueCar, a Santa Monica, California–based online auto-buying service.
Disruptive Technology
T. Rowe Price started buying Tesla at $20, and the firm now owns 6 million shares scattered in half a dozen funds. Fath, who runs the Growth Stock Fund, says the shares will do OK even if the Model 3 is only a moderate success and could double if the car is a hit.
“You don’t often see large-cap stocks with this kind of significant disruptive potential,” he says.
Max Warburton, a Sanford C. Bernstein & Co. analyst in Singapore, says Tesla’s shares are priced less on the company’s own financials and more on how it’s forcing competitors to boost spending on electric cars.
“Tesla is massively disruptive,” Warburton says. “Its valuation reflects the $30 billion problem it’s created for the rest of the car industry” — a reference to the amount he says other automakers will spend chasing Tesla.
Reusable Rockets
Musk is even disrupting outer space. SpaceX has promised NASA, with which it has $4.2 billion in contracts, and satellite makers that the reusable rockets he’s developing can deliver their payloads at a much lower cost than other companies.
In person, Musk is relaxed and soft-spoken, with blue-green eyes that dart around the room as he talks. He works long days at his various California offices — Tesla’s headquarters is in Palo Alto; SpaceX’s in a Los Angeles suburb — and spends as much time as possible with his five sons in L.A. He’s twice divorced.
In speeches and interviews, Musk shows little immediate concern for investors who’ve watched shares of alternative energy and related companies plunge with the price of oil. He says his priority is popularizing electric cars.
“We’ve certainly chosen high growth over profitability,” he told reporters in September in Tokyo. “If the shareholders don’t like me, they can just fire me.”
‘Fantastic Vehicle’
If Musk’s competitors don’t always share his zeal for fighting climate change, they appreciate the cachet Tesla gives to the ZEV category.
“The Tesla is a fantastic vehicle,” says Raj Nair, head of global product development at Ford. “It’s made the public more open to this type of propulsion.”
At the Detroit auto show in January, Porsche said it was considering a plug-in electric version of its 911 flagship. Honda’s Acura division unveiled an NSX supercar with three battery-powered motors and a gasoline engine. Audi, General Motors, Honda, Hyundai, Mercedes-Benz, and Nissan all spun out plans for battery-powered cars to compete with Tesla.
GM, Ford, and Renault buy their batteries from LG Chem Power, a unit of South Korea’s biggest chemical company. CEO Prabhakar Patil says his company doesn’t need a Gigafactory to compete with Tesla on costs. And he says Musk may be placing too big a bet on electric cars.
No one knows, he says, whether fuel cells, plug-in hybrids, or battery-only cars will prevail.
Cautionary Tale
Electric-car makers already have a cautionary tale to study. Nissan and its partner Renault committed $6 billion to their all-electric Leaf compact, including plans to manufacture 500,000 cars a year. In 2014, they sold 82,602. One factor in the car’s disappointing sales is that it travels just 84 miles between charges. Tesla’s Model S has helped reset the standard at 200 miles, auto executives say.
“The batteries are getting lighter, cheaper, and smaller,” Carlos Ghosn, CEO of Nissan and Renault, told reporters at the Detroit auto show. “This is totally normal with the amount of investment we are all doing. And we will be competing with the 200-mile car.”
As Musk strives to create a viable company for the long term, his most formidable challenger could be Toyota. The Japanese company swears by hydrogen fuel cells — batterylike devices that produce power through an electrochemical reaction of hydrogen and air, with water vapor as the only byproduct.
Fuel Cells or Fool Cells
The company started marketing its Mirai fuel-cell car for $61,000 in Japan in December and hopes eventually to be selling hundreds of thousands a year, says Yoshimi Inaba, chairman of North American sales. The Mirai travels 300 miles with a hydrogen tank that can be refilled in five minutes. With high-volume manufacturing, Toyota has cut the cost of handbuilt fuel-cell components by 95 percent since 2008, says Satoshi Ogiso, a Toyota executive who helped develop the hybrid Prius. During the next decade, he says, Toyota expects to cut today’s production costs of the Mirai by two-thirds.
Toyota and Tesla once had a close relationship — and Khobi Brooklyn, a Tesla spokeswoman, says they still do. In 2010, Toyota sold Tesla its abandoned Fremont factory for $42 million. A new plant could have cost $1 billion, says Ron Harbour, a partner at New York consulting company Oliver Wyman Group. Toyota then bought electric motors from Tesla for two years.
Today, in Toyota’s view, the companies are drifting apart. “Our relationship with Tesla is not going upward; it’s going stagnant at best,” Inaba says.
‘Fool Cells’?
Toyota didn’t learn much from Musk’s technology and doesn’t expect Tesla to ever sell 500,000 electric cars a year, he adds.
Musk says most commercial hydrogen to run fuel cells is made from natural gas in a process that consumes energy and emits carbon. Hydrogen is also dangerous to store and transport, he says.
“Fuel cells should be renamed ‘fool cells,’” Musk said in a 2013 Bloomberg News interview.
“I think this is not classy,” Inaba says of the remark.
Of course, much of the electricity for recharging Teslas comes from coal. Yet Musk says electric motors are so much more efficient than those that run on gasoline that they are cleaner even if all the electricity comes from hydrocarbons.
Whatever the merits of fuel cells, all automakers are rushing to electrify. By 2023, battery-powered-car deliveries, including gas-electric hybrids, could triple to 6.1 million worldwide, says Sam Jaffe, a Navigant Consulting analyst in Boulder, Colorado.
ZEV Requirements
A big motivator is California’s air pollution control regulations, which require the six biggest automakers to derive 4 percent of sales from zero-emission cars this year. Nine other states, including New York and Oregon, have similar laws.
By the 2018 model year, the ZEV requirement in all those states will jump to 15.4 percent and include smaller companies such as BMW.
The new rules are a great boon to Tesla. Electric-car buyers receive $7,500 in federal tax credits and, if they live in California, $2,500 from that state, where Tesla sold 6,110 Model S’s last year.
In addition, the 10 ZEV states distribute credits that companies can buy and sell to meet emissions targets. Companies that fall short of the targets can buy credits from companies that don’t to avoid fines.
At 2015 prices, these credits earn Tesla $14,000 for every Model S sold in the 10 states, people familiar with the situation say. (Details of the transactions aren’t public.)
Battery Swaps
Tesla can earn another $17,500 in credits every time a Model S swaps its battery pack for a fully charged new one at an experimental station north of Los Angeles.
Each car is allowed 25 swaps, with total credit-eligible visits capped at the number of cars Tesla sells each year in the state.
Dan Sperling, an environmental engineering professor at the University of California at Davis and a member of the state’s Air Resources Board, defends the ZEV program as a way to promote technologies California needs to cut carbon emissions. Still, he expects the Air Resources Board to reduce credits for battery swaps.
“We want to be generous in supporting these technologies, not obscene,” he says.
If nothing changes, Tesla could make enough money selling credits — as much as $500 million a year — to fund a quarter of its capital expenses, says Morgan Stanley’s Jonas.
Cheaper Batteries
When he was designing the Model S, Musk chose lithium-ion battery packs that in 2009 cost $1,200 per kilowatt hour, Jaffe says. The Gigafactory, by consolidating an extensive global supply chain, could help reduce the cost to as little as $250 by 2020 — low enough to make batteries competitive with gasoline engines, he says.
To build a $35,000 car, Tesla will need more than cheaper batteries. Tesla executives say it will have to make optional some of the equipment that’s now standard on the Model S and buy more generic components, such as shock absorbers, from high-volume suppliers.
And the company will need higher productivity. The Fremont plant today boasts some cutting-edge technologies, such as a device that uses air under high pressure to twist hot aluminum sheets into complex shapes. But the production process also includes labor-intensive operations incompatible with mass production.
Labor Intensive
For instance, just after body panels leave the stamping presses, workers use files and rasps to smooth out their surfaces. Other workers assemble bundles of wires that connect hundreds of components — a job usually outsourced to a cheap-labor foreign country.
Tesla does such jobs in-house in part because it’s making design improvements to the Model S “20 times a week,” says Greg Reichow, Tesla’s manufacturing vice president. He says Tesla is rapidly deploying more automation. Producing a new electric motor for the dual-motor Model S requires one-sixth of the manpower devoted to prior designs, he says.
Musk says he’s determined to conquer the mass market because the world needs electric cars, even though, for the moment, hydraulic fracturing has lowered gasoline prices dramatically and made driving gas-powered cars cheaper.
“Fracking probably increases the accessible oil and gas in the world by a factor of 10,” Musk said in Detroit in January. “We’re really going to regret the amount of carbon we’re putting into the oceans and atmosphere.”
Loading Up
Rolling through fire-scarred canyons above Los Angeles on a hazy afternoon, Chris Ziegler says he’s confident Tesla will make the world a better place. Meanwhile, he’s loading up. In addition to his Model S, he owns a $109,000 Roadster that Tesla discontinued in 2012, and he’s one of 20,000 people on the waiting list for a gull-wing SUV.
He never tires of driving his Model S. After showing off its speed and agility, he apologizes for resuming normal driving.
“I’ll get motion sickness,” he says.
Praise from owners such as Ziegler, together with the long waiting list, underscores Musk’s success as an auto designer and manufacturer. The question for investors is, will the entrepreneur ever be as proficient at making money as he is at making cars?
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