Tesla Motors – The Tucker for the 21st Century

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Tag: Electric vehicle, Tesla, DOE, GM, Ford, Chrysler, Nissan, fuel economy, hybrids, Model S, Fisker, Project Nina, CAFE, CARB

September 23, 2009

Earlier this month The Economist ran an article discussing how architectural changes resulting from the electrification of transportation could be a “disruptive technology” that challenges the status quo in what we know of the automobile industry.  By example, the article discusses how the digital camera transformed photography and in a little more than a decade virtually made the film based camera industry obsolete.  A similar situation may arise in the traditional auto industry as a new supply chain is created to support the electrification of the automobile vehicle.  Furthermore momentum is building behind upstart electric car manufacturers such as the sports car maker Tesla and the Chinese company BYD who may begin to seriously challenge the establishment.   

As governments around the world demand more stringent fuel economy requirements the electric vehicle and hybrids will be a preferred powertrain because of their efficiency.  The electricity to fuel an electrified fleet is also less costly.  The Economist goes on to speculate how the automobile might change as the internal combustion engine is replaced by novel electric propulsion systems.  The article then says, the internal combustion engine is also improving but concludes:

But propelling modern transport by means of serial explosions in an array of tin-cans does seem an incredibly primitive way of doing things.  The time is ripe for a change.

The US auto industry is the subject of a round of tongue lashing by the upstart automakers and think they can do it better than Detroit.  Reuters reported:

For those who think billions of dollars in federal money has saved the American auto industry, Silicon Valley’s venture capitalists have a different view to share.

The U.S. auto industry, they warn, can never become competitive again. It remains too wedded to a dying business model and too out of touch with the sources of innovation, they say.

Instead, they look for a new group of upstart companies to shoot to prominence and profitability, overtaking the automakers once known as the “Big 3" just as Google Inc. came from nowhere a decade ago to eclipse established technology companies.

"I do not believe that the U.S. auto business can be competitive," said Ray Lane, a managing partner at Kleiner, Perkins, Caufield & Byers. "I don't see any of these new car companies based in Detroit."

Lane is backing plug-in hybrid carmaker Fisker Automotive, which is planning to launch a $39,000 model. He’s also slated to be chairman at V-Vehicle Co., an auto company unveiled in June that plans to build “environmentally friendly” vehicles in Louisiana with backing from billionaire T. Boone Pickens.

Detroit has lost its entrepreneurial spirit, Lane said.

"For years they have been led by accountants and lawyers, not engineers and entrepreneurs," Lane said. "That's OK if the industry isn't changing."

This article will discuss some of the real challenges these upstart auto companies face in the market with a focus on Tesla Motors as it has the most ambitious plans and is actually producing vehicles.   

Tesla Motors:

One new auto company with a direct link to the entrepreneurial spirit of the computer industry is Silicon Valley based Tesla Motors.  The company began development of its first electric vehicle, the Roadster, in 2004 and it is now available for sale in North America and Europe. According to the company, the Tesla Roadster can travel more than 200 miles per charge using a lithium-ion battery pack and can accelerate from 0 to 60 mph in 3.9 seconds.  The Roadster which went on sale in early 2008, sells for $128,000.  Tesla was initially financed by current chairman Elon Musk, who founded the internet startup PayPal.  PayPal was sold to the internet auction service provider eBay for $1.5 billion in 2002.  

The company has ambitious plans and intends to expland its line up of electric vehicles.  Tesla plans to release by late 2011 the Model S all electric sedan, which is to sell for $49,900 after a $7,500 federal tax credit.  A subcompact will follow with a price less than $30,000.   With the expansion of the model range, Tesla is preparing to build an assembly plant in California.

The company will also develop and produce vehicle components including sales to other auto companies at a new facility in Palo Alto, California.  Tesla is already producing electric vehicle components for Daimler which aquired 10% of the startup auto company in May 2009. Daimler will build the electric version of the Smart car using Tesla battery packs and chargers.   

In May 2009, it was announced Daimler and Tesla would form a strategic partnership with the German automaker acquiring a 10% stake.   The press release stated, Tesla had been working with Daimler in developing the electric version of the Smart city car.  In July, Daimler sold a portion of their investment in Tesla.  Daimler’s largest investor the Arab investment fund Aabar purchased 60% of Daimler’s stake in Tesla or 4% of the company.  Aabar had purchased 9.1% of Daimler in March of this year for 1.95 billion.  The German company sought a direct investment to raise cash during the economic downturn over the past year.

The funding for the new Tesla vehicle programs will come from a $465 million low-interest federal loan which was announced by the US Department of Energy (DOE) this June (Conditional Agreement).  The Energy Independence and Security Act of 2007 which increased the fuel economy requirements in the US also established a $25 billion incentive program run by the DOE to support the development of advanced technology vehicles and associated components.   The loans are provided to automobile and automobile part manufacturers for the cost of re-equipping, expanding, or establishing manufacturing facilities in the United States to produce advanced technology vehicles or qualified components, and for associated engineering integration costs.  

With the investment, Tesla expects to sell 200,000 units annually within five years.  It was also announced the company secured an additional $82.5 million in financing. For the first time the company said it achieved overall corporate profitability in July 2009 and has delivered about 700 Roadsters to customers so far. The company announced it made $1 million on $20 million in revenue.  The first of an initial test fleet of 1,000 electric Smart vehicles using Tesla component are expected to be on the road in late 2009.

Discussion:

It is easy to criticize the auto industry and in particular the US Big Three GM, Ford and Chrysler for being out of touch but they still hold a big share of the global automobile market. Specifically, GM and Ford even as sales collapsed in the last year remain significant players in the industry on volume.  In 2007, the last full year of reasonably strong sales, the three US based companies sold over 17.4 million vehicles out of just over 70 million vehicles sold globally.   Fifteen major auto manufacturers accounted for 85% of the total global sales.  Over 30 manufacturers accounted for the remaining 15%.  These statistics illustrate the dominance of the major auto companies and yet how fragmented the globally industry is.  For 2009 global sales are down.  Excluding China which saw sales increase about 18%, vehicle sales in Europe, the US and Japan fell approximately 10%, 30% and 20% respectively in 2009 compared to 2008.  

Let us not count the traditional automakers out just yet and be more realistic about the business plans of the upstart automakers such as Tesla.  With the global push by governments across the globe for automakers to produce more fuel efficient vehicles, car companies have plans in place to develop electric and advanced hybrid vehicles.  However the largest unknown remains will the public in the near term make the switch to these types of vehicles and relegate the internal combustion engine to but a memory?  Electric powered vehicles will more than likely continue to be a niche vehicle until the range and recharging capabilities are similar to vehicle powered by an internal combustion engine.

We may be at the cusp of a revolution in advanced powertrains for automobiles but because of the long lead times involved in this highly regulated industry, swift-moving startup companies such as Tesla do not have much of advantage when compared to traditional full-line auto companies.  More importantly they just do not have the scale to compete.  Also, for such a swift moving company, the Model S is still two years from production assuming significant issues do not arise and delay the program.

In today’s global industry there are few niche manufacturers left.  Ferrari and Masserati are part of the Fiat Group.  Even Porsche that sells approximately 100,000 vehicles a year understood that it needed scale to survive and tried to take over Volkswagen.  It was only recently where after becoming over leveraged in its quest that it was forced to sell the auto company to Volkswagen.

Companies such as Tesla just do not have the resources or facilities to develop and properly vet new technologies.  Tesla’s only production product the Roadster is essentially a Lotus with a new powertrain and is not a ground up design developed by the company.  Moreover at this time it is unclear if the Model S and compact vehicles will be designed in house or farmed out to a specialty firm.  For instance, Tesla applied to the US government to be exempt from certain aspects of the Federal Motor Vehicle Safety Standards in 2005; long before the vehicle was released in 2008.   The government granted the request and cited the following in its response:

Tesla stated that it does not have the technical or financial resources to develop an advanced air bag system independent of Lotus, and will, therefore, need a similar exemption in order to produce Roadster models for the U.S. market. Tesla provided no further information in its petition on its own independent efforts beyond this statement.

It should be noted that it is not uncommon for the government to grant such a request to small manufacturers that might face a hardship to comply with a major new regulations.  The Lotus Elise was also granted a similar exemption and that was the basis for the government granting the Tesla exemption.  However, this sheds some light as to the technical ability of Tesla.

Tesla also plans to sell 200,000 vehicles a year which is believed to be very optimistic.  It was only until recently that Toyota was able to sell that many Prius vehicles a year in the US and at a price point well below anything Tesla plans.  In addition Tesla will have to compete with all the electric and hybrid vehicles traditional automakers plan to release over the next few years.

I would also be very surprised if the US government recoups its investment in Tesla as I am skeptical the company can actually follow through on its business plan.   Furthermore, in the US there are incentives in place for the big manufacturers to sell clean vehicles including electric vehicles and plug in hybrids.  For the thirteen US states that have adopted California’s emissions requirements, it is estimated the larger auto companies will have to sell 120,000 to 180,000 clean-running vehicles from 2012 through 2014.  Therefore it is in the interest of the large companies to squeeze small car companies like Tesla to reach their sales quota.  It just do not believe it is possible for Tesla to sell 200,000 vehicles in the near future.

Tesla stated that in July it made a $1 million profit on $20 million revenue and delivered 700 vehicles since the Roadster went on sale in March of last year.  July was also its best month and delivered 109 vehicles and is producing about 25 vehicles a month.  These number though not stellar are reasonable for a new company.  Furthermore the numbers reflect pent up demand after long delays getting vehicles to consumers.  It has to be assumed that demand will wane within in the next 12 months and hurt cash flow even before the Model S and compact car arrives.  

Tesla’s actual proposal to the US DOE to obtain the low-interest loan it received was not publically available.  According to the Conditional Agreement with the DOE, the money would be used to fund the approximately $60,000 Model S sedan (The advanced vehicle tax credit is excluded from the transaction price for revenue estimates).  Based upon my estimates and assuming that at least 75% of the transaction price reflects direct cost of the Model S sedan, the company would have to sell about 45,000 to 60,000 units over the life of the vehicle to just repay the US government back.  By comparison, established luxury makes such as the Mercedes Benz S-Class, BMW 7 Series, Audi A8 and Jaguar XJ produced 98,796, 45,504, 22,182 and 10,172 vehicles respectively for global consumption.  It is highly unlikely the Model S from an upstart auto company will sell that sort of volume over the life of the program much less in a year.  A couple thousand a year is what I believe to be a reasonable estimate.  Furthermore, the deal to supply the Smart cars electric vehicle componets may provide a steady but small cash flow and it should not be expected to sustain the company.

Assuming Tesla can generate about $30 to $40 million in revenue, the company will have a half billion in debt to service (The terms are presented in the Conditional Agreement).  For comparson GM had about $30 billion in debt but was generating about $180 billion in revenue prior to the market collapsing and subsequent bankruptcy.  It would appear that the DOE's lending practices are relatively loose and consistent with what we saw from venutre captialist during the internet bubble; companies with little to no revenue receiving a lot of money and over valued.

Big auto companies may not move as fast as Silicon Valley, but when they do they have a lot of momentum behind them because of the large investment involved.  Traditional auto companies do not need to become more like Silicon Valley but they need to continue to embrace advanced powertrains.  Government pressue will assure that.  The economics of scale is going to be critical to making it more affordable especially the battery pack.  Only when larger companies begin to sell electric vehicles in sufficient numbers will the supply chain be able to invest and drive the cost down further.  As for small startup companies like Tesla, I remain skeptical.  In many ways the government bailed out the company with the $500 million loan.  

The irony of it all is that not only did Tesla get their venture capital from the government, the DOE just announced yesterday, that Fisker Automotive will receive a $528.7 million conditional loan for the development of two lines of plug-in hybrids.  In the first stage of the program, Fisker Automotive will use a $169.3 million loan for engineering integration costs as it works with primarily US suppliers to complete the company’s first vehicle, the Fisker Karma.  The second stage includes a $359.36 million loan for the company’s Project Nina plug-in hybrid project.  Fisker estimates that up to 75,000-100,000 of these highly efficient vehicles will roll off assembly lines in the US every year beginning in late 2012.*

Much as I argued that Tesla’s volume projections are over optimistic, the same can be said about Fisker.  Also like Tesla, Fisker has no experience at full scale manufacturing at projected volumes.  Besides the inevitable glitches associated with a new plant, production quality as measured by JD Power and Consumer Reports is a serious concern. Yugo did not last long in the US and the US Big 3 are still overcoming a negative perception of building poor quality products in the 1970s and 1980s.  Lastly, I also have to wonder if these new vehicles will be designed to earn a 5-Star and Good ratings in the government and Insurance Institute for Highway Safety's crash tests.

Conclusion:

So much for the entrepreneurial spirit when these companies must rely on the US government for their venture capital.  No matter what the upstarts may say, my money is still on the traditional auto companies bringing the true innovation to market.  The simple reason is they have the talent, the scope and scale to actually produce real product.  Tesla, Fisker and other upstart companies may make for good press, however, there is little justification for the government to invest the type of money and expect a return.  For these reasons, I remain a skeptic.  My thoughts are also consistent with what I have said in the past with respect to the upstart Chinese manufacturers.  The larger traditional auto manufacturers will continue to dominate the global landscape.  Moreover, I will also continue to argue that even among the large companies, there needs to be consolidation to remove excess capacity.  There simply are to many auto companies scattered around the globe competing for a finite amount of customers.

Finally, with all the money being allocated by the government and industry into electric vehicle technology and full vehicle production, it is possible a bubble will form that results in overcapacity for these types of vehicles including the infrastructure to produce the batteris and electric motors.  The positive is this should drive the cost down.  The lithium-ion batteries is the most expensive part of the powertrain and can cost $10,000.

Nissan-Renaults CEO believes that electric vehicles could be 10% of the market by 2020 and Tesla’s CEO says electric powered vehicles will be the majority in 20 years.  In the long term, electric vehicle will likely replace the internal combustion engine for most conventional applications but right now the technology and infrastructure is just not ready.  For those reasons, the electric vehicle appears it will remain a niche vehicle for the foreseeable future and not a "disruptive technology" that will forever change the automotive landscape.  The internal combustion engine in some form will continue to power the vehicles of the future for some time.

 

*For completeness it should be noted that Ford received $6 billion and Nissan received $1.6 billion from the DOE.  GM and Chrysler have yet to be approved to receive money for projects they have applied for.  



References:
The electrification of motoring, The electric-fuel-trade acid test, Economist, September 2009
Advanced Technology Vehicles Manufacturing Loan Program, US Department of Energy







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Comments
Wed Sep 23, 2009 4:26 pm
Name: haypops | Comment: I haven't red the article you referenced, but I would think any assumption that the big three are to dumb or slow to "electrify" seems unlikely. Detroit handled the computerization of the car easily, and that is a more technically difficult deed than electrification.

Sat Jul 03, 2010 7:08 pmhttp://www.autoextremist.com/current/2010/6/29/the-autoextremist.html

http://www.fastcompany.com/1665844/tesla-unveils-roadster-25

http://www.bloggingstocks.com/2010/07/03/comfort-zone-investing-tesla-ipo/



Thu Dec 26, 2013 8:07 pmOver 4 years later I stand behind every word in this article.

http://wattsupwiththat.com/2013/12/21/the-tesla-battery-swap-is-the-hoax-of-the-year/

None of the major auto companies will touch Tesla at current valuation. The company continues to offer little beyond some brand building.

http://finance.yahoo.com/news/could-tesla-swallowed-big-three-113518141.html;_ylt=AmiTF6MXqNjzGjgFvUrHipHQtDMD;_ylu=X3oDMTBsYnNqdmNmBGNvbG8DYWM0BHBvcwMyBHNlYwNzcg--



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