Tesla - A Study of Growth Pains
When Tesla is amongst the ranks of the four highest valued car companies in the US, you know you’re in a tech bubble. Tesla, loss-making luxury electric vehicle manufacturer surpassed General Motors early in April 2017, with markets closing on $51.54bn after an upgrade by Alex Potter, an analyst at Piper Jaffray.
Potter upgraded Tesla’s stock from a price target of $223 to $368 writing that “Tesla isn’t just another company. More so than any stock we’ve covered, Tesla engenders optimism, freedom, defiance, and a host of other emotions that, in our view, other companies cannot replicate,” in a report seen by Reuters.
All optimism, freedom, defiance and host of other emotions aside — let’s compare market shares. Tesla reportedly still only accounts for 0.2 percent of US cars compared to General Motors’ (GM) market share of 17.3 percent.
GM is a classic value investing stock, with a solid portfolio that sells in huge volume. GM’s price to earnings ratio (P/E ratio) is 5.57.
A value investment generally can be denoted by companies with a P/E ratio of 9 and below. GM pays dividends; so you’re not going to get incredible growth, but you’re going to get a dividend each quarter.
What’s Tesla’s P/E ratio? When you compare Tesla’s amount of income or loss available to common shareholders you’re looking at -4.68 in earnings/ share. You’re literally buying a loss.
esla’s current stock price their P/E ratio works out to -64.96.
Pitting this against Tesla’s current stock price their P/E ratio works out to -64.96. That doesn’t even make sense. Perhaps this is what Potter meant by, “the stock’s valuation [being] rich by any conventional metric”.
Since Tesla doesn’t actually turn a profit, the P/E ratio goes out of the window. Which metric then can we use to understand this absurd market behaviour?
Tesla is playing a game of potential.
Elon Musk earlier this month acknowledged that the valuation would be considered absurd if based on past performance. He adds that “a stock price represents risk-adjusted future cash flows”.
“How does one calculate a potential to earnings ratio exactly?”
Markets have a tendency to go nuts around category creating companies.
Tesla is defining the electrical car category. While on paper, they sell very few cars overall (76,230 in 2016), electrical cars have the potential to completely replace internal combustion vehicles. This forecasts a huge market share.
Having defined the category, Tesla is best positioned to dominate the space. So whether Tesla is actually worth its valuation depends on how they tackle short, and long term challenges, and turn potential into profit.
Tesla faces some key challenges to owning the electrical car category.
1. They’re young
As a challenger in the automotive industry, Tesla is up against incumbents which have been around for hundreds of years. It’s the classic under-dog tale, and maybe one of the reasons why we’re all secretly rooting for Elon Musk.
GM has been around for 108 years, Ford 113. Founded in 2003, Tesla now just turned 14. There’s something to be said about adolescent growth spurts though.
2. Launching isn’t quite the same as manufacturing
GM sold 546,838 units in the first quarter of 2016 within US retail alone. Last year, Tesla’s total car production was 76,230 — with 40,000 units sold in the US.
Andy Kiersz @ Business Insider
Pitting market cap against units sold paints a sombre picture.
Musk revealed part I of his master plan in April 2016 — the Model 3, a $35,000 car with 200-plus-miles of range; also the foundation platform for future vehicles.
With 400,000 pre-orders and counting for their consumer Model 3, Tesla is walking a dangerous tightrope balancing a whole lot of unmet demand, with unfulfilled manufacturing.
To meet market demand on the Model 3, the organisation’s bid on the consumer automotive industry, Tesla is going to need to scale their manufacturing to deliver 5 times its current output in 12 months.
3. Tesla has terrible initial quality
Tesla has managed to resonate with the aspirational needs in a buyer’s hierarchy of needs.
Tesla’s mission, to “accelerate the advent of sustainable transport by bringing compelling mass market electric cars to market as soon as possible” speaks towards working to a collective better future, finding natural allies in the early adopters of the world.
Maslow’s hierarchy of needs is a motivational theory in psychology comprising of a five-tier model of human need. Translating this model to provide more context to the customer — brand interaction can help businesses better understand where their product, service, or brand fall short.
Where Tesla struggles, is on the stability quotient, closer to the foundation of the buyer’s hierarchy of needs. Their current market perception seems to be a case of aspiration making allowance for stability.
The high forgiveness quotient of Tesla’s customers and shareholders can be extrapolated as a natural extension of their early adopter enthusiasm (and the fact that they can afford the hefty price tag on one of Tesla’s initial luxury models).
Tesla has been in a unique position in that, they have been given an opportunity to create and iterate on a ‘Minimum Viable Product’ within the automotive industry. Facebook’s ethos of “move fast. break things.” is an albeit terrifying comparison to draw when talking about the automotive industry, but looks like its happening.
The high forgiveness quotient of Tesla’s current customers and shareholders means that Tesla too can move fast, break things and better their processes through quick iteration.
““Even if the Model 3 production launch goes badly, we think customers (and more importantly shareholders) will withhold judgment.””
Alex Potter believes that investors ignore Tesla at their own risk. “Even if the Model 3 production launch goes badly, we think customers (and more importantly shareholders) will withhold judgment,” he noted in his analysis.
Matthew Debord doesn’t think the market will be as lenient with the Model 3. Consumer Reports’ Mark Rechtin concurs over Tesla’s future plans saying, “It’s one thing to have a quirky, problematic car that sells 20,000 units per year to wealthy people who probably own at least one backup vehicle,”. It’s quite another when Tesla goes to the mass market with the Model 3 targeting a new vertical of customers who “may not have the luxury of being so forgiving”.
Tesla in looking to crack the consumer automotive market will have to live up to a higher standard in terms of reliability and consistency. Mass-market buyers lean closer to the bottom of the pyramid valuing usability and stability over aspirational alignment.
Consumer Reports ran a survey to gain a measure of car quality by analysing problems reported in the mechanical quality and design of areas such as powertrain, body and interior, and features and accessories.
Tesla’s does not fare well when it comes to reliability. Consumer Reports surveyed 1,400 Model S owners “who chronicled an array of detailed and complicated maladies” with the drivetrain, power and charging equipment and giant iPad-like centre console. There have also been complaints of the body and sunroof squeaking, rattling and leaking.
“Door handles continue to be an issue”. These ‘little’ things are what matter in cracking the masses. Based on this survey, Consumer Reports forecasts a worse-than-average problem rate for the Model S.
“Investors are betting on the Model 3 being a mass-market car, but having low-quality marks is a real knock if you are going to put out a volume car,” Emmanuel Rosner, autos analyst in CLSA Americas an international investment firm, said.
Tesla has to get its quality issue in order to ensure Model 3’s success with its target demographic.
4. Their distribution model will struggle to scale
GM works with a channel of distributors, who pay for cars up front and add another layer of quality assurance before they reach a customer. Tesla, on the other hand, favours a direct-to-consumer model. This lack of front line quality assurance could possibly be one of the factors which have led to high rates of issues with new cars.
Direct-to-consumer is great. You know who else loved the walled gardens? Jobs himself. By avoiding dealership channels, Tesla controls every touchpoint with which a customer could interact with its brand.
“You know who else loved the walled gardens? Jobs himself.”
This is probably one of the reasons why Tesla have garnered a reputation for stellar service. Their attention to customer service was a noted constant across almost every respondent in the Consumer Reports survey.
The reseller channel, which seems like the quick answer to scale has been shunned before by entrepreneurs looking to deliver and control the exceptional customer experience they are looking to provide. The important question then becomes: How does Tesla scale this direct-to-consumer operation for the Model 3, without blowing out its overheads?
Not that, that seems like much of a priority. A cursory glance at Tesla’s financial statements shows a cavalier attitude towards debt.
5. Keeping laser focus
It’s curious how the concept of growth throws common business sense out the door.
Mid-April 2017, Musk put a deadline on when Tesla would unveil its bid on the semi-truck industry. And we know Tesla’s track record with deadlines…
The semi-truck industry play is part of Part II of Musk’s master plan, which looks to spread the scope of Tesla from electric car manufacturer to revolutionising transportation at scale. More specifically the “to address all major segments” clause.
Sometimes platform thinking gets in the way of creating and growing a niche. The consumer automobile industry is a tough chestnut in and of itself. The semi-truck industry is a completely different market with a completely different manufacturing process.
While his long-term view of where Tesla should be playing is admirable, Musk’s incapacity to create bridges between his vision for the future, and current business challenges is where it all begins to fall apart.
Making a serious move into the consumer automobile industry is currently the biggest challenge Tesla is undertaking. Pitting yourself against behemoths singularly focused on the market they’re looking to crack calls for singular focus.
Juggling scaling out manufacturing and optimising quality and distribution should be all team Tesla should be focused on.
Now isn’t the time for another moonshot.
In Conclusion
Tesla is doing the heavy lifting for the electronic car category, making massive investments into the build out of infrastructure, expansion of supercharger recharging station networks, and other capital expenditure-heavy initiatives.
Open sourcing their IP means that they are flanked by well-armed competitors with the infrastructure to deliver. While I commend Musk for his progressive business ideologies this move calls to question his business savvy in a cut-throat industry.
Tesla needs to carve out market share in the competitive consumer automobile vertical in it’s continued bid to define the electric car category. And it has a shot at it too. It must undertake its mission to define the category responsibly, with measured steps that chip towards the big picture.
Right now, keeping laser focus while optimising manufacturing and distribution for the consumer automobile market will help position Tesla to deliver on part II of Musk’s master plan in the future.
“Common sense is genius dressed in working clothes .
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