Tesla Motors to $70? Seriously?

Shares of Silicon Valley electric-car startup Tesla Motors (Nasdaq: TSLA  ) popped 17% Thursday after an analyst at Morgan Stanley released a glowing 50-page report on the automaker's prospects -- complete with a $70 price target.

Yep, seventy bucks a share. For an "automaker" that has never made a profit, has built (or more accurately, has had someone else build) a grand total of about 2,000 $100k-plus sports cars, and was trading at about a third of that number when the report was released.

And this isn't an April Fools' joke.

Tesla to $70? Seriously?
The folks at Morgan Stanley are already calling Tesla "America's Fourth Automaker" and predicting great things for the company, thanks to a soon-to-be-burgeoning market for electric vehicles and help from giant Toyota (NYSE: TM  ) . In a nutshell, they see electric cars accounting for 5.5% of the global market by 2020 and Tesla accounting for 7.3% of that.

That, in turn, would mean Tesla moving 240,000 vehicles a year and generating annual sales of $9.5 billion, EBITDA of $1.5 billion, and net income of $976 million.

Nine years from now. Maybe.

Do they really have a case? Let's consider the big questions.

Will electric cars sell?
Of course they'll sell, say the smart kids at Morgan, thanks to high oil prices and government support. But oil prices and government incentives are already high, and so far, that's just a thesis. Sure, Tesla's Roadster has sold more than 1,000 copies, but selling a high-priced niche product to well-heeled gadget geeks isn't a proof of concept.

Down here in the mass market, at least so far, evidence is lacking. Through March, Nissan sold a grand total of 452 examples of its electric Leaf in the U.S. General Motors (NYSE: GM  ) has done better with its Chevy Volt, but the Volt comes with a gasoline engine. And in any case, these are both essentially experimental products, designed to test the waters and introduce the technology. I do think EVs will find a market as ranges go up, prices come down, and the major automakers introduce more mainstream-seeming products. (Ford's Focus Electric, due later this year, will be an interesting test.) But right now, it's far from a slam dunk.

Can Tesla crack the mainstream market?
I've been skeptical about Tesla's chances all along. As I see it, Tesla, as an upstart, needs two things:

  • Cars that are as good as everyone else's. I'm not talking about the drivetrain technology here. I'm talking about things like dashboards that don't rattle, doors that don't rust, five-star crash ratings, interior panels that look expensive, infotainment systems that reliably infotain, heaters that work quickly on January mornings in Maine, that sort of thing. Building a car that competes with the world's best is hard -- ask any Chinese carmaker. The upcoming Model S sedan is going to go out the door with price tags in BMW territory. Unlike the Roadster, which is mostly built by other companies, Tesla's building the Model S itself. Will the ownership experience compare?
  • Technology that's better. Range is everything in the electric-car business. The near-term Holy Grail is a car that can go 300ish miles without recharging, just as most gasoline-fueled cars can. Right now, today, of products that are actually on the market, only Tesla's is even close to that. This is what people who follow technology companies (but who don't know a lot about car companies) typically hold up as Tesla's disruptive advantage.

But here's the thing about that technology: That's today, and that's with a six-figure product. Range right now is mostly a matter of more expensive batteries.

Can Tesla bring the cost of that advantage down? Probably, eventually. But the major automakers and megasuppliers like Johnson Controls (NYSE: JCI  ) are investing billions in efforts to move forward as quickly as they can. Tesla's next product, the Model S sedan, isn't expected to ship until late in 2012. Do you think companies like Ford (NYSE: F  ) and Honda (NYSE: HMC  ) -- not to mention GM, with its huge Chinese operation, and green-obsessed Toyota -- won't have managed to move the goalposts by then?

Look, what Tesla has already done is undeniably impressive. It's developed and sold an all-electric car that competes directly with the likes of Porsche, and from what I've seen and heard, its customers are for the most part very happy ones. This is a huge achievement, not least because it's extremely hard (and expensive) to develop a car that meets regulatory standards around the world.

But going from a boutique producer of six-figure sports cars to a mass-market manufacturer that can compete on quality and technology and price with the giant global companies that rule this industry -- which is what Tesla will have to do to justify anything like a $70 share price -- is a huge, huge leap. Maybe an improbable one.

I suspect that the crew at Morgan Stanley doesn't quite get that.

Want to stay up to date on the ongoing electric-car revolution? Just click here to add all of the automakers mentioned in this article to My Watchlist.

Fool contributor John Rosevear owns shares of Ford and General Motors. You can follow his auto-related musings on Twitter at @jrosevear. General Motors is a Motley Fool Inside Value recommendation. Ford is a Motley Fool Stock Advisor pick. The Fool owns shares of Ford. You can try any of our Foolish newsletter services free for 30 days with no obligation.

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (16) | Recommend This Article (12)

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  • Report this Comment On April 01, 2011, at 7:31 PM, Canuck2010 wrote:

    The price of a stock matters little without knowing the number of stock out there; i.e. the market cap. A stock can be cheap at $500 or overpriced at $1. It's the market cap that is the issue more than the stock price.

  • Report this Comment On April 01, 2011, at 7:51 PM, TMFMarlowe wrote:

    @Canuck2010: Very true. Alas, I didn't have enough space to properly lay out a valuation case in addition to the point I wanted to make (which, in a nutshell, is that any optimistic case is a long shot here). I'll see what I can do next week.

    Thanks for reading.

    John Rosevear

  • Report this Comment On April 01, 2011, at 9:07 PM, ellidyr wrote:

    Well, considering Tesla is trading at $26-$27 range, I wouldn't exactly call it overvalued right now. Still seems quite feasible that the stock could make a run up -- perhaps, not to $70 or even close to it, but $30 or $40 in the next 12 months definitely seems feasible and not far-fetched.

  • Report this Comment On April 01, 2011, at 11:05 PM, steven107 wrote:

    You write as if they have to become mass-market low-cost car company, as if they cannot end up a niche high-margin company selling just a few thousand cars a year.

    You also write as if they have to become that mass-market low-cost instantly-profitable company tommorrow, rather than just aiming for it eventually, and having a niche slot to fall back on if they fail that goal.

  • Report this Comment On April 02, 2011, at 12:02 AM, ramon123 wrote:

    The reason I find that arguments of critics of Tesla less than pursuasive is that they never seem to know anything about the company, except that it makes electric cars. Roosevear misleads when he claims Tesla has never made a profit. Before Tesla took on debt to develop their Model S, they most certainly were making a profit from their 1500 (not 2000, as stated by John) roadsters in service. Roosevear's logic concerning the company's basis of profitability

    is also totally incorrect. They can make a good profit even if they only sell 10,000 Model S vehicles per year, I'm talking base models no less. They will, I guarantee, be able to sell at least 20,000 per year.

    They already have in hand over 4,000 customers who've ponied up $5K apiece to get in line. Likewise nonsensical is Roosevear's skepticism about Tesla Model S build quality. Anyone can view the company's architecture videos and see who's involved and what the design looks like. The Model S isn't any typical crappy GM or Ford product, built by $140K UAW workers and designed by stooges. From everything that I've seen in closely following the Volt and now the Model S development, Tesla has more talent than either GM or Ford. Look at what GM spent (over 1.5 billion, borrowed from the Feds) to develop the junky Chevy Volt, priced at $42K, then look at what Tesla is building, priced at $57K, at a cost of less than $450 million, roughly one third of what GM spent on the Volt development. If that doesn't convince you that Tesla is more than able to successfully compete against the "big [and mediocre] automakers" , then I suggest you stay away from auto stocks altogether. Tesla also bought the NUMMI assembly and stamping plant from Toyota for a song, another huge factor either unknown or hidden by Roosevear. Tesla knows very well that high battery prices mean that EVs can only successfully compete against the likes of BMS and Mercedes at this period in time. GM sure didn't know that when they conceived the Volt, then announced their cost estimate of "less than $30K" only to later find out what batteries actually cost and revise their prices upwards by roughly 50%. Does this validate the confidence that Roosevear has in this just-back-from-bankruptcy "bigname" company?

  • Report this Comment On April 02, 2011, at 3:32 AM, baldheadeddork wrote:

    @ramon123:

    You're wrong about Tesla being profitable. According to their IPO filing they lost over $240m from 2003-2009, and they lost an additional $154m last year.

    About the profitability of the Model S, I know this business pretty well. I don't care if you have unicorns and fairies working on the assembly line and Jesus H. Jobs himself running the show. You're not going to be profitable selling 10,000 cars at $57K retail.

    You either need to sell at a much higher price to be profitable at that volume, or you need to sell a lot more cars to be profitable with a $57K retail. To put Tesla's volume and retail price plans in perspective, $57K is well below the average selling price for Jaguar. In a bad year Jag sells 50,000 cars worldwide, five times Tesla's target. But it's been decades since they were profitable enough to survive as an independent company. Tesla supposed to be profitable at 1/5th the volume and a lower average vehicle cost, even though their powertrain costs are significantly higher than a conventional car? Forget it.

    About Tesla buying NUMMI, they still have to buy their own stamping machines and build their own assembly lines. Here again, the scale of Tesla's plans creates big financial problems. If they were aiming for lower production like 1,000 cars a year, they could get away with a low-cost workstation assembly system like many exotic car builders use and sub out their stamping operation. But if you want to build 200 cars a week (10K/yr), you have to go with a traditional assembly line. That costs tens of millions of dollars, and the cost of building and operating the line doesn't scale in proportion to the volume you want to get from it. An assembly line that builds 10,000 cars a year will not cost significantly less to build or operate than one that makes 100K cars per year. Tesla is going to have massively higher manufacturing labor and infrastructure costs per vehicle at that volume.

    If you're not getting the point yet, let's look at your own numbers for R&D on the Model S. $450m is low for developing an all-new car, but it's not low enough for what Tesla says they want to do. Even if Tesla made a gross profit of $10K per unit and they found 10,000 people to buy the Model S, just recovering the R&D costs would eat every cent of profits for 4 1/2 years. But long before they get to that point, they'll need to start spending another half billion on R&D for the Model S v2, plus a hundred million or so on a mid-life update for the first car.

    But that's a fantasyland example because they won't make $10,000 profit per unit. Ford had an amazing year in 2010 and their automotive operations made less than $900 average profit for each car they sold. Tesla will be lucky to do that well, which means it would take decades to recover the R&D costs of the Model S.

    The only viability I see in Tesla's business model is if they're hyping themselves up in hopes they're bought by a bigger player before it all comes crashing down. If so, then Musk really is running Tesla like a Silicon Valley startup instead of an automaker.

  • Report this Comment On April 02, 2011, at 5:29 AM, baldheadeddork wrote:

    John, if this isn't an April Fool's joke it should be grounds for a drug test - for the analyst and anyone who buys into it.

    To Canuk2010's question about market cap, TSLA@70 would give it a market cap of nine billion. That would be just 1/6th the market cap of Ford today, but Ford builds a lot more cars. Even if Tesla made 240,000 cars this year they would be outsold by Ford 23:1.

    The big unknown is how much profit Tesla could make per vehicle at those numbers. The production inefficiencies I noted above can go away if they get to a quarter-million units a year. At that volume they could be very profitable if they can stay in the >$50K average retail price but that's a really tall order. Lexus sells about 300K cars a year worldwide after twenty years and they didn't have to build a dealer network or a brand reputation from scratch.

    Tesla's most realistic shot of reaching a quarter million units a year is if they go into lower cost categories but that would shred their profitability. There will have to be a quantum breakthrough in battery technology for pure electrics to be profitable even in the $30K range. Maybe that miracle happens, but I wouldn't price it into a stock analysis.

    You've written several times in the past about Tesla's challenge in just surviving if they have to compete against the big automakers like Nissan and Ford. Your point was the big automakers could get products to market faster than a small independent, they had massive cost advantages, and they already have thousands of dealers worldwide.

    All true, but the early experience of the Nissan Leaf leads me to wonder if Tesla's greatest risk from the majors is that the market will pass judgment on all pure electrics long before they can even buy a Model S? The Leaf wasn't a half-assed attempt by any measure, yet it has dismally underperformed on range and recharging. It's simply not viable as a winter vehicle in most of the US, Europe and Asia, or in cities unless you have a garage, or if you can't keep it plugged in for twelve hours on household current every single day.

    Those are big barriers to ask consumers to overcome, especially when 40mpg from hybrids and conventional ICE cars is commonplace. So how expensive does gasoline have to get for a large number of consumers to take on the limitations and extra cost of a pure electric?

    Again, maybe there is a breakthrough that lets you drive for a week on a single charge, but "then a miracle happens" shouldn't be in a stock analysis.

  • Report this Comment On April 02, 2011, at 9:45 AM, Jescal7 wrote:

    Hey John,

    Here is a basic question that isn't nessecarily about Tesla, but it does regard analysts price targets.

    It seems analysts have a lot of pull when they set a high price target and causes the stock price to jump and move towards there target.

    Is it possible these analysts or their firms or contacts own these stocks and if they set up a high target, the price will jump?

    Such as with the case with Dolby, an analyst set up a target of 46 or 48 for Dolby, with in several months that target was spot on.

    So my questions is kind of like the chicken or the egg question which came first? Was the price jump or decline caused by the analyst's target or by the companies actual performance? Or maybe the companies performance caused the analyst's price target?

    What do you or anybody else reading this think?

    Thanks for your time and comments,

    Jesse

  • Report this Comment On April 02, 2011, at 3:42 PM, baldheadeddork wrote:

    @ Jesse

    What you're describing did happen during the dotcom boom. Analysts at investment banks were told to give positive forecasts without disclosing that the bank was doing business with the company or had a stake in the IPO. Some people went to jail for this and the disclosure rules were tightened after the meltdown.

    Beyond the changes to federal law on disclosure, every firm I know of prohibits analysts and immediate family from owning stock at least in the industries they cover. Some firms prohibit analysts from owning any stock, period. The liability exposure for the firm if an analyst is caught manipulating reports for personal gain is far too great to risk it.

    How much a price target affects movement in the share price depends mostly on the general mood of the market about that stock. When the market is optimistic about a stock an upgrade or rise in the price target can create a self-fulfilling prophecy. But a positive report from an analyst usually won't change a market that is bearish or even ambivalent about a stock.

    Tesla rose on this (ridiculous, imho) new target price because investors as a whole were already bullish on the company. Tesla has yet to turn a profit so you can't measure its valuation on P/E, but its market cap was almost as large as its enterprise value even before this upgrade. Established automakers have market caps less than half of their enterprise value. The market had already accepted a huge amount of growth in TSLA's price and Morgan gave them another reason to believe.

    That doesn't mean it will always work like this for Tesla investors. In the last year Ford has been a great example of how investors can believe and then ignore analysts. The stock began to take off in the second half of last year and I remember some of the biggest gains came on days when it received an upgrade or higher target price from some analyst. But the market pulled back about 20% between mid January and this last week, even though analyst reports for the longer term remained very positive and the median price target was still almost $20 a share.

    Bottom line, the effectiveness of price targets is all about the power of affirmation. Investors love to be told what they already believe is correct, and most ignore opinions that disagree with their preconceptions.

  • Report this Comment On April 02, 2011, at 11:50 PM, elemeno wrote:

    Porsche makes 28K per car, so it is possible. And Apple is able to charge more than its competitors by building great products. But becoming a Porsche or an Apple is no mean feat. As of now, the Tesla brand does have a modern green cache that could be the center of a great brand. But they will have to build some amazing products to inspire the kind of devotion that Porsche and Apple do. Cautiously optimistic.

  • Report this Comment On April 03, 2011, at 1:27 PM, TMFMarlowe wrote:

    @ramon123, baldheadeddork answered you better than I could have. TSLA has never made a profit and has daunting challenges in its path.

    @baldheadeddork: Yeah, the Leaf's reception has been instructive, but I have to fall back on the caveat that this technology is moving quickly, and the 2014 Leaf (for instance) could be a radically improved proposition. Question is, will consumers have decided that the tech is an albatross in the meantime? We'll see.

    The thing about the dialogue around this company that's most interesting is that its proponents tend to see it as a tech startup. But it's not. It's a car company, and those who fail to understand the story from that direction are missing some big, big issues. I wonder if the guys at MS really get that.

    John Rosevear

  • Report this Comment On April 03, 2011, at 10:34 PM, baldheadeddork wrote:

    @ elemeno - Porsche's average selling price is way, way over $57K. The only cars Porsche sells below that are the base Cayenne, Cayman and Boxster, and that's before you even breathe on Porsche's infamous options list.

    You can make a high margin per vehicle if you're starting with a very high retail price. $57K ain't it.

    About Apple, there is an ocean of difference between the two. The unique hardware Apple uses is much simpler to design and make than a car. (So is the software, but that's another battle.) Apple also produces in extremely high volume which reduces the engineering and manufacturing costs per unit.

    But you're right that Tesla should be able to sell their cars for more than their competitors if they build a great product. Fisker went that route and priced the Karma at $100K. Pricing the Model S at $57K was incredibly stupid. They could have set the MSRP starting at $75K, pocket an additional $20K profit per, and not lose a single sale.

    @john - I'm not as optimistic about battery evolution. It will happen, but I don't know if electric car enthusiasts have taken a clear look at the cost of progress.

    Moore's Law doesn't apply to batteries. When capacity increases, the price does. too. It's not an issue with personal electronics because the battery is small and is only a small part of the overall cost. If Apple has a breakthrough battery for the next iPhone that costs 50% more, it's only going to add $3 to the cost of the phone and the battery will make up less than 5% of the total cost.

    That gets turned upside down for cars. Tesla is charging $20,000 for the 300 mile battery pack in the Model S. All Cars Electric estimates the cost of this battery is $43K. That's over half the total cost of the car.

    I'm going to give Tesla the benefit of the doubt that the Model S will be able to go 300 miles on the optional battery. But that's over $40K in battery costs - and a $20K premium over the stock 160 mile pack - just to be able to match the single tank range of a gasoline-powered sedan.

    That's using li-ion batteries that have been in widespread use for almost a decade. Which gets us back to the next-gen iPhone battery I mentioned earlier. That kind of breakthrough would add another $20K to raise the range to 450 miles. Electric cars are on the wrong side of the cost/benefit curve when it comes to battery innovation.

  • Report this Comment On April 03, 2011, at 11:49 PM, kingfarnut wrote:

    My first thought is maybe they're attempting to influence stock price with their recommendation for whatever reasons that might benefit them, similar to what James Altucher did last fall with his series of articles on Kingold Jewelry that he posted on seekingalpha.com. It created enough interest to take a $2 stock up to $9 for a few weeks before it settled back to its original price (btw, thanks James, I bought that one high).

    I find that type of behavior reprehensible, particularly in this case with Tesla being sooo reminiscent of the tech stocks bubble companies of years ago where tech companies had insane market value yet generated no profits at all.

    Now when I read a market recommendation and the author is long or short on the company, I take it with a grain of salt. Perhaps the SEC will find the time to give Morgan Stanley a call about their recommendation.

  • Report this Comment On April 04, 2011, at 10:25 AM, cdtfuser wrote:

    "Through March, Nissan sold a grand total of 452 examples of its electric Leaf in the U.S."

    I would like to point out that this is a production and not a demand problem. Nissan has so many people waiting for the Leaf that they have stopped accepting orders.

    Aside from that I agree with the sentiment of this article and appreciate responses by baldheadeddork.

  • Report this Comment On April 05, 2011, at 10:47 AM, earlystart wrote:

    I feel that mass market electric cars are poised to take off, but as you said, there needs to be a decent offering first. If the Model S is the real deal, I believe it could be a monster seller. Even if the big boys get there first with a good product, there's a biiiig electric car void to be filled. Can Tesla launch it on time and meet the demand? I don't know.

    The Leaf hasn't sold because 1) it's hideous, and 2) it doesn't quite have the range consumers demand. The Volt has the range and is attractive, so people are buying it. I don't think consumers are attracted to the gas, and most probably make a point of using the gas generator as little as possible. If the Volt had acceptable range with no gas alternative, GM would rule the world. I have high hopes for the Fusion electric. Definitely best to wait and see what the future holds for both of these companies.

  • Report this Comment On April 05, 2011, at 11:13 AM, TMFMarlowe wrote:

    @earlystart: I still feel that the companies to bet on in the EV space are the most familiar ones: Toyota, Ford, GM, VW, maybe Nissan, maybe Honda or Daimler, etc., etc. It's an awfully hard industry for a newcomer to "disrupt".

    Thanks for reading.

    John Rosevear

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