Topic: Tesla & barriers of entry (plus the difference between stocks and companies)
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Today, however, I’ll write about finance, and Tesla, again. It’s not a hardcore investment article, but still, if you’re not interested in economics and stocks there’s probably precious little for you here today. The post is about whether Tesla is inside or outside the car industry’s high barriers of entry.
Topic: Tesla & barriers of entry (plus the difference between stocks and companies)
Conclusion: be careful what you wish for; you might find yourself on the wrong side of those coveted protective barriers to entry
Trigger: a comment about high barriers to entry in the EV industry (implicitly, and wrongly, benefiting Tesla)
Length: ten minutes?
It’s a car company!
Tesla is a company that produces vehicles for human transportation, a “car” manufacturing company. In order to develop, design, manufacture, deliver and maintain its products Tesla has chosen to design and manufacture the following (among other things):
- Electric motor
- Battery pack
- Car body and chassis
- Assisted driving software
- Battery chargers
Tesla designs, develops and manufactures these parts and then assembles them in “car factories”. Their competitors within (cars and) EVs do more or less exactly the same. Those competitors include companies like BMW, Porsche, Jaguar, Volkswagen, Audi, Volvo, General Motors, and many more. Actually, it’s probably safe to say that ten years from now all car companies will be EV companies, but up until now Tesla has been more or less alone in the market for upscale EVs. As of mid-2018 and going forward, Tesla is trying to enter the mid market, at the same time as it’s most competent industry peers are entering Tesla’s home turf of upscale cars.
So, whether you consider EVs a separate market from gas cars or not, which I don’t, at least not long from now it won’t be.
Remember that the main part of Tesla’s stock market valuation is based on profits and cash flows occuring beyond that ten-year mark. So, if you think competition ten years from now is irrelevant, think again.
Tesla’s operations are currently worth about 70 bn USD, of which some 10bn is debt and 60bn is equity (share price 350). Most analysts expect Tesla to keep losing money throughout 2018 and 2019, and at most make annual profits of a handful of billion a year after that. Let’s say profits go from negative to zero to 5bn/year pretty linearly. In that case Tesla’s total profits 2018-2027 amount to around 20bn. The remaining 50bn of value, not even counting the discounting effect, need to come from the year 2028 and after.
Please note that this is not meant to be a professional forecast*, just a way of picturing when and how much value needs to be created in order to warrant the current share price. I’m fully aware that a profit of 4 800m in 2027, that is growing by 12% a year, by then could be worth 20x, or a 100bn (which generously discounted to today at 7% per year could actually be close to the needed 50bn. You would, however, still need to explain how and why Tesla would grow profits that quickly in competition with every car manufacturer in the world, including potential newcomers).
* Actually, I don’t think Tesla in its current form will make any profits ever (except through very creative accounting for a single quarter or two)
The point here is just to show that you can’t disregard competition in what might seem like a distant and irrelevant future, if you actually want to value the company rather than just speculate in its short term share price movements. Tesla’s value most certainly lies beyond the 10-year forward mark, and must be created in competition with formidable players that have streamlined their best practices (and political lobbying) over the last half century or more.
Barriers to entry
Some of the barriers Tesla is facing include but aren’t limited to the following
Access to capital: Tesla is already overreaching finacially, with several billion in negative net working capital (suppliers can only be pushed so far, no matter if they are “fans” or not. Soon they will have other paying EV clients requesting delivery — guess who they’ll prioritize), half a billion of client prepayments (deposits for cars they may never see, and that in any case are significantly delayed which with increased competition could mean clients switch to more reliable alternatives), not to mention 7bn in net debt before recent and coming losses during 2018. Volksvagen, GM, Porsche, BMW, Audi and many more are actually profitable and have ready access to capital Tesla might soon find out it doesn’t
Production best practices: Tesla has tried to take short cuts around established processes and methods with poor results and lost time and money. Tesla tried rapid automation and failed. Tesla is currently trying throwing massive amounts of manual production staff and round the clock manufacturing on the problem, with its predictable quality issues and production stoppages. It takes years to create prototypes, perform test drives, streamline a combination of automation and manual oversight in order to create the beautiful and robust machines cars need to be. Vehicles are emphatically not “basically a motor and a shell”, they are masterpieces of engineering — and there is a reason there are such things as “legendary quality management officers” within the car and truck industries. The only thing really legendary about Tesla’s officers is how quickly they jump ship once they see what’s going on there.
(additional barrier: attracting competent senior officers)
Lagging battery technology: In order to save time and cement its lead in EVs and batteries, Tesla entered into a huge battery purchase agreement with Panasonic. I don’t know this for sure, but “according to sources” Tesla needs to buy 16bn dollars worth of battery cells of a certain – now obsolete – kind before it can source the cells elsewhere. Meanwhile Tesla’s competitors are free to buy modern cells from any battery manufacturer they like, including Panasonic. It will take years, or likely billions in compensation, before Tesla has worked through this first mover disadvantage backlog.
Lagging driver software technology: Tesla’s “autopilot” is ranked last or next to last by industry researchers. The most recent “keep hands on wheel at all times” update seemed to only cement that position. Recent communication from Tesla indicates Tesla is about to start from scratch as its current software is beyond fixing. Tesla may have been first in AP for a while, or at least regarding the audacious promises Musk dared make, but now the company is finding out reality tends to win against fantasy, and that being last means you’re outside the moat and walls with little chance of getting in.
From first to last within chargers: Chargers tell much the same story as batteries and software: Tesla was first off the blocks, but that also meant building in technological cul-de-sacs and spending money on dead ends that second movers could avoid. Much of the story of Tesla is about Musk blazing the way in a glorious attempt to save the world and make history, but wasting too much money and making too lofty promises he can’t keep. Several competitors are building networks of more numerous as well as more efficient chargers. Once again Tesla will find itself outside the barriers to entry, not benefiting from the security inside it hoped for.
But, but, but… barriers to entry and such
I got a comment the other day saying Tesla is worth a lot since the barriers to entry for the EV industry are so high and protective. Yes they are. The problem is that Tesla finds itself outside those barriers and my assessment is that they’ll never manage to climb over them. I imagine Tesla bulls think Tesla is already inside and more or less alone there.
Sadly, nothing could be further from the truth.
Tesla is the new kid on the block; the block being car manufacturing, not some fantasy “EV” or “tech” castle. As the newcomer Tesla needs to come up with at least as good design, testing and production practices as its super experienced peers. Tesla needs to find ways of effectively procuring the products it doesn’t necessarily have to produce itself.
So far, Tesla’s real claim to car manufacturing fame is betting on a high performance electrical engine and putting it into a beautiful but expensive metal body. Tesla’s early adopters had nothing to compare the S and X models to, and I understand why they view Tesla and Elon Musk through rose tinted glasses. The S model was definitely before its time, and Musk could just as well have been a robot sent back from the future to save mankind from global warming.
It was a good try, and it could have worked, I think, if it weren’t for subsequent short cuts and the predictable first mover disadvantages that tend to befall trail blazers.
On the wrong side of an alligator moat
Today, Tesla has an average engine, a poor body job, costly and lagging chargers and batteries, not to mention huge debts and other obligations. Despite being first and making cars consumers and politicians loved, Tesla has run larger and larger losses and cash outflows. Starting now, effectively debt free and massively cash producing competitors, with their subsidies ahead of them, not behind like Tesla, show who’s on the inside the barriers to entry and who’s not.
The stock is a whole different story (currently at 354 USD/share), but mostly without consequence for Tesla’s real life operations and expected longevity. Sure, Tesla might be capable of another stick save in the form of a share issue at all time highs, and/or bond conversions to equity. That would buy Musk and other Tesla longs some time.
No matter, it’s not a few billion here or there that are critical; it’s whether Tesla can produce fully functional cars at a profit in competition with experienced players in one of the most important and competitive industries on Earth. Given the Game Of Thrones Wall-high barrier of entry I find it highly unlikely. Until reality rears its beautiful and effective head, enjoy the imaginative stock price journey signed one of our time’s greatest dreamers: Elon Musk.
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As always interesting reads. However, I guess about half of the employees at Tesla does not belong to the motor division but to former Solar city. I really don’t know if this makes your case better or worse…
Agree. Worth thinking about, but hard to draw any strong conclusions. Are engineers engineers, or are they too specialized? I thought it was difficult to find engineers to emply these days — alarming to let them go rather than move them from SCTY to TSLA
“at the same time as it’s most competent industry peers are entering Tesla’s home turf of upscale cars.”
Entering… Like BMW, Audi and Lexus has never been in that market before…
“Some of the barriers Tesla is facing include but aren’t limited to the following
Access to capital”
Yeah, Tesla clearly has been struggling with access to capital during their history.
“Production best practices: Tesla has tried to take short cuts around established processes and methods with poor results and lost time and money.”
Yeah, and that has failed so badly. Growth has been horrible and they are so far behind those crazy bull cases:
https://www.noozhawk.com/images/uploads/1000-th-tesla3-image4.jpg
Tack för bra artikel!! /Mats
Tack
We don’t know our host. But judging by the number of articles on this company, it has a large place in his mind. I appreciate the fundamental analysis we are seeing, and I believe this company will someday be the short of the decade.
As I commented earlier, I don’t understand story stocks or status symbols. I have no idea why someone would buy a Tesla, when you can get a much better car for 1/3 the cost. And that cheaper/better car can be driven across the continent without waiting more than 2 minutes to fuel up. Owning it is like wearing a sign saying “I’m dumb, but very very proud”. I also don’t understand wanting iPhones or expensive watches, hand bags or any other product meant to be “seen”.
The difference between Apple and Tesla is Apple sells an inexpensive product for high margins. Ditto the other status symbol companies. If Musk were so smart he would have designed a much cheaper product and marked up the price for green minded status seekers. So Musk is not that smart.
Yes, the weird thing is Musk sells an expensive product at negative margins… I think the low hanging fruit of hollywood stars and fanatics are running out soon. What’s more acute though is that Tesla is running out of cash very quickly — albeit always more slowly than I think. ANYTHING with a price tag of 60bn takes a long time to kill no matter how flawed.
Thank you for your thoughts!
“Actually, it’s probably safe to say that ten years from now all car companies will be EV companies”. If so, it’s because governments force companies to by law and fleet emmission standards to burn money.
Electric cars are very different than ICEs. They are much more expensive, and will probably be forever, as reduction of battery prices will NOT continue with current rate, especially not if you want to build batteries to replace internal combustion engines.
“Electric cars are a toy for people with the right combination of wealth and guilt”. Petr Beckman
Most importantly, they are not a means of freedom and mobility -not in the same extent-by a long shot. The charging time of batteries is physically determined and can only be shortened so much by insane charger amperages or switch battery systems, all causing a myriad of problems.
No one but a few want to plan each longer trip along charger stations and “take a coffee break for only 20 minutes for 90% battery load”, or twice.
It is totally beside the point how many “% of rides under 20 or 30 miles the average person” has- people want a toaster, a TV and a car that works 100% of the time if possible, not the one twice the price (or even the same price) for 90% of trips.
E-cars will never be mass market. If governments force people into them, they will probably stop buying cars, because most who can do with a electric car don’t _really_need_ a car in the first place.
Since the invention of the electric cranker ca. 1910 electrics have been a niche. They will never be anything else.
Which is another nail in the coffin for Tesla.
In order to take over the auto market, EVs would have to have some clear advantage over conventionals that would offset their disadvantages. It isn’t performance. It isn’t pollution; EVs result in a net increase in emissions (primarily CO2) from fossil fuel power plants. I doubt it will be government intervention; not even the US government is going to take on buying electric cars for everybody and the auto industry won’t give up its high-margin US market for conventional cars. Certainly EVs will never be cheaper to make. They /could/ be made more durable and easier to maintain, but the auto industry seems to have a universal agreement to continually make cars less durable and more difficult to maintain.
The only force I can see that could make EVs take over the mass market would be a huge increase in the cost of gasoline. That may be possible, but the End Of The Oil has been imminent for half a century now and I’m not holding my breath.
Consider also that EVs aren’t necessarily the only alternative when Saudi Arabia sinks into the ocean. There are other ways of moving people and stuff, and by then, perhaps, much less need to move them at all. There are also ways of producing gasoline artificially that might keep conventional autos competitive in the absence of any petroleum at all.
I and a partner are making a small EV, a jetboard. At that scale everything is better with electrical vs ICE. Performance, range, service, cost… The difference, however, is that a jetboard is a toy made for 30 minutes of playing at a time.
Agree on most of what you say. Batteries improve very slowly. Perhaps an unexpected breakthrough will change that but would be at least a decade away. Hydrogen cars (H stored in nanolattices) could work, but that’s actually an ICE solution. Maybe Hydrogen -> battery -> electrical engine… No matter, all those are pies in the sky right now. That said, there IS a small market for EVs right now, thanks to humans being irrational.
Are you Short Tesla?
Yes