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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