TODAY’S STUDY: The Boldness Of Tesla (And Elon Musk)
Tesla and Elon Musk’s moment of truth with first mass-market car; Ambitious bet that Model 3 will set company on a path to profitability
Richard Walters, July 23, 2017 (Financial Times)
For Dom Larose, there was an obvious next step to shrinking his carbon footprint after he had switched his home in the UK to a renewable source of electricity: buying an electric car. When the Vodafone sales executive first made the move four years ago, however, it did not come cheap. Prices for the Tesla Model S, the car he bought, start at £62,000.
“You drive into the car park at work — the Audis and BMWs — it’s something different,” he says. And, like many Tesla fans, he admits to being inspired by the Californian carmaker’s irrepressible chief executive: Elon Musk “is a bit of a risk-taker, putting his money where his mouth is”.
Mr Musk’s army of fans is marching again. Mr Larose was one of thousands to register their interest last year in buying the company’s forthcoming Model 3. The first handful of the cars is about to hit the roads, with deliveries scheduled to begin at the end of this week, though the early customers will all be Tesla employees, as the company keeps the first cars close to home so that it can identify any quality problems.
It will be more than just another car launch. If Mr Musk is right, the Model 3 will become the world’s first mass-market electric vehicle, transforming the automotive industry forever.
And if sales meet the company’s hopes, it will finally set the chronically money-losing Tesla on the path to becoming a sustainable business that justifies, at least in part, its heady stock market valuation.
In a sign that Mr Musk may be on to something, would-be customers have put down deposits on more than 400,000 Model 3s. True, buying an option on the vehicle, which will cost from $35,000, has not represented much of a risk: the deposits are only $1,000 and are fully refundable. Many reservations may fail to turn into orders. But the sight last year of customers lining up outside Tesla showrooms to register their interest drew comparisons with the rush to buy the iPhone and reinforced Mr Musk’s reputation as the car industry’s most effective showman.
Boosted by its new, lower-priced model, Tesla hopes to produce 500,000 vehicles next year, before reaching a target of 1m in 2020 — almost as many as the total number of electric vehicles sold worldwide as recently as 2015.
Mr Musk has already gone much further than his many doubters in the car industry predicted. The launch, six years ago, of the Model S turned heads across the luxury car world.
“It is beautifully designed. I think it is one of the best sedans in the world,” says Bob Lutz, who served as a senior executive at each of the big three US carmakers. He credits Mr Musk with being a “brilliant salesman” who made the canny decision to start at the luxury end of the car market before turning to the mass market, giving him a high-end brand. The success of the Model S scared other luxury carmakers and has contributed to the spate of electric cars from other companies, he says.
Yet Mr Lutz counts himself among Tesla’s biggest doubters. With the attempt to build a company based entirely on electric cars, Mr Musk is taking extreme market and business risks, the industry veteran says.
Tesla’s spotty performance has provided ammunition for the sceptics. News this month of the latest shortfall in deliveries of its existing two models, the S and the X, took some of the shine off its shares, leaving them 16 per cent below their June record. Periodic lapses like this have left Wall Street trying to guess how much they owe to Tesla’s own slips, and how much to a ceiling on the demand for electric cars.
With the Model 3, Mr Musk is aiming at a “completely different demographic” that has not shown interest in electric cars before, says Michelle Krebs, an analyst at Autotrader. Unlike many of the company’s existing customers, these are not people who can afford multiple vehicles, or who like to wear their eco-credentials on their sleeve. These potential customers “are intrigued by electric cars, but what they buy is sports utilities”, says Ms Krebs. “Gasoline prices are super cheap, and engines get far better fuel efficiency than they used to.”
Slow route to profitability
Until now, electric cars have been a niche market — a result of their relatively high prices, limited driving range and reliance on a patchy charging infrastructure. They account for about 1 per cent of total vehicle sales in the US and 2 per cent worldwide. Sales have owed as much to government subsidies and mandates on carmakers as they do to inherent demand. In the US, half of all electric cars are sold in California, which has long required carmakers to sell a proportion of zero-emission vehicles in the state.
That has created a generation of customers as attuned to financial incentives as the quality of the vehicles. Ernie Petrocine, a Tesla owner in Colorado, calls the Model 3 “the best car in the world for $35,000”, though he doesn’t expect it to cost him anything like that. With $7,500 in federal subsidies and a further $6,000 from Colorado, he hopes to bring the cost down to $22,000. With an eye to reselling the cars, Mr Petrocine put deposits down on six of the vehicles, though Tesla later cut him back to the maximum two.
Boosting production next year to 500,000, up from 84,000 in 2016, will present Tesla with a huge challenge. As the company admits, even ramping up production of the much lower-volume S and X caused headaches. It has also faced quality issues, from the software glitches that affected the sunroof and the display screen of the S to door and seat faults in the X.
A slower increase, in turn, could put further strain on cash flow and force Tesla to raise more money, says Adam Jonas, auto analyst at Morgan Stanley.
Mr Musk has turned repeatedly to Wall Street for cash — and the markets have been more than happy to oblige. Tesla topped up its coffers by selling another $1.4bn worth of equity and convertible debt this year: less than a month later, it overtook Ford and General Motors to become the most valuable carmaker in the US. Its market capitalisation is $54bn.
Even Mr Musk seems puzzled by the strength of Tesla’s share price. At a meeting of US state governors this month, he suggested that the shares were “higher than we have the right to deserve”. But when the price slipped on the next trading day, he took to Twitter to offer reassurance. Though the price is “obviously high based on past and present”, he said, it is still “low if you believe in Tesla’s future”.
Successfully ramping up production of its new car and riding out any share price volatility or funding pressures, meanwhile, will still leave Tesla with a fundamental question: how to make a profit from selling the cars.
Mr Musk is up against volume manufacturers with lower cost structures, says Mr Lutz.
“No one can produce a car that size, and with that amount of battery, at a lower cost than General Motors,” he says.
He adds that other carmakers are only in the electric business because they have been forced by government mandates, making them view the cars as lossmakers as they look instead to the rest of their fleets to make money.
“Nobody else but Tesla looks at electric cars as a source of profitability,” he says, making it hard for the company to set prices at a level that will bring a profit. “The losses and the cash drain will be what they’ve always been.”
Mr Musk’s hopes of avoiding this fate ride on two things. One is to pull down costs. Thanks in part to producing batteries at its so-called gigafactory in Nevada, the Model 3’s cells will be 30 per cent more efficient than the S, according to JB Straubel, Tesla’s chief technical officer. But as China and other countries build their own large-scale battery plants, maintaining a cost advantage may be difficult.
The other answer is to persuade buyers to pay well above the Model 3’s base price. Tesla has its sights on pushing the price of the average vehicle up to $42,000. The cameras and sensors needed to one day make the cars fully autonomous will come as standard, but Tesla plans to charge for the software needed to bring different levels of augmented and self-driving capability. Mr Musk will need to persuade customers that this will make Tesla cars much safer than other vehicles on the road.
Maintaining premium pricing while fending off some of the big carmakers will not be easy. It has been tempting for investors to view Tesla as the latest in a line of disruptive Californian companies that will go on to dominate a new industry, says Bruce Greenwald, a professor at Columbia Business School. But he adds that, unlike Apple and Google, there are no “moats” to protect its business from competition and it does not dominate any single market.
Mr Musk is not standing still. He has said that full self-driving capabilities should come to Tesla cars by way of over-the-air software updates within two years, a far earlier arrival than most people in the auto industry predict. With the technology in place, Tesla owners would be able to rent out their vehicles on a company-owned network.
Some customers are dreaming of a time when this brings a profitable sideline to their personal cars. “If Tesla develops their own Uber, maybe you send the car to the city and you never see it,” says Mr Petrocine.
About a quarter of Tesla’s market value is already justified by the promise of this future network, according to Mr Jonas at Morgan Stanley. That makes the Model 3 a “bridge” to what he predicts will be Tesla’s real business in the long term: providing “mobility services”, rather than just selling hardware.
However, competing against richer and bigger companies in new markets like self-driving software and ride-sharing services will add to the pressure on Tesla, says Mr Greenwald.
A year ago almost to the day, Mr Musk laid out what he called Tesla’s “Grand Plan, Part Deux”, an update of the first strategic vision he outlined a decade ago.
It calls for the addition of heavy trucks, buses and pick-up trucks alongside self-driving software and a ride-hailing service. Since then, Tesla’s stock has risen nearly 50 per cent.
Keeping his shareholders’ gaze fixed on the far horizon, where the next great opportunity looms, has proved a winning formula for Tesla’s share price. But with so much riding on the Model 3, it looks like the time has finally come for Mr Musk to prove that he can also deliver in the here and now.