Did Tesla Motors Hit a Wall?

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Did Tesla Motors (Nasdaq: TSLA  ) just hit a wall?

The Silicon Valley electric-auto maker's stock was near $35 just a few days ago, but it fell sharply Thursday after a Morgan Stanley analyst downgraded the stock and cut his price target by 37%, saying in a research note that electric vehicles are "not ready for prime time" and that expected market share gains were unlikely to materialize.

Tesla stock is trading right around $30 as I write this on Monday. Is that a buying opportunity? Or is the analyst right that Tesla's road is looking rocky?

There's prime time, and there's prime time
Full disclosure: I'm not an ardent Tesla fan. While I've admired the company's first car, the Roadster, I have been seriously skeptical of the idea that any start-up can enter the automotive mass market and thrive. Building cars to modern global standards of quality, reliability, and safety while making a profit is hard. The companies that are doing it most successfully -- Ford (NYSE: F  ) , Toyota (NYSE: TM  ) , General Motors (NYSE: GM  ) , Honda (NYSE: HMC  ) , Volkswagen -- are global giants with extensive engineering and research resources, decades of institutional experience, and vast economies of scale.

And even with those vast efficiencies and economies of scale, these companies are getting by with margins in the 5%-8% range. If ever there were an industry with an enormous moat, automaking is it. Just ask the Chinese automakers that are finding themselves unable to compete with the global giants in their home market (where the rules favor them).

Tesla's most ardent proponents often argue that the company has no competitors, that its upcoming Model S is a unique and compelling proposition that the mass market will find hard to resist. But plain and simple, it's not: Outside of the small universe of well-heeled gadget geeks and early adopters, it's an expensive luxury car powered by a technology that many buyers will have qualms about. Overcoming the technological qualms is one thing -- and Tesla may well have success there -- but the Model S and the Teslas that follow still have to compete well with the alternatives in the marketplace.

Put another way, the Model S's interior, on-road experience, fit and finish, and safety have to be on par with the BMW or Audi or Lexus that the prospective buyers in that financial weight class are driving today -- if Tesla is going to expand its sales reach beyond its gadget-geek base into the mass market.

That's an extremely high bar -- perhaps the highest in the global auto business. And that, in a nutshell, is why I have been a Tesla skeptic, though I've become more optimistic as Tesla has developed working relationships with several of the leading big-league automakers. But Morgan Stanley's downgrade was based on something a bit different, a big-picture issue, but I think its effect on Tesla is unlikely to be dramatic.

Remember that rush to electric cars? It's not happening... exactly.
Skepticism aside, Morgan Stanley and I agree that Tesla appears to be doing a great job of executing on its business plan. Development of the Model S is on schedule, the company has signed major agreements to supply technology and components to automakers like Toyota and Mercedes-Benz maker Daimler, and the company's marketers have so far done good work laying the groundwork for the Model S's scheduled launch in mid-2012.

But Morgan Stanley's Adam Jonas didn't really downgrade Tesla as much as he downgraded electric cars. Jonas had previously predicted that EVs would make up 8.6% of the global car market by 2025, but lowered that estimate to 4.5% last week. Certainly prospects for EVs look a bit more glum now than they did a year or two ago: Technological teething troubles like the Chevy Volt's battery issue won't help speed adoption, and high prices, lack of recharging infrastructure, and range concerns continue to push buyers in other directions.

Toyota chief engineer Satoshi Ogiso recently made it clear that the company is hedging its electric-vehicle bets in a big way, pushing development of fuel cells and other alternative technologies alongside EV work, because -- in Toyota's view -- it's not yet clear which of these technologies will pan out. Meanwhile, the company (rightly, I think) expects hybrids -- not electrics -- to be the dominant vehicles in developed markets in a decade.

But what does that mean for Tesla? From a simple analytical point of view it's easy to say that electric cars will account for X% of sales and Tesla could capture Y% of that, so if X falls then Tesla's sales must fall as well. That seems to be where Jonas is coming from, but I think that's an imperfect equation. If Tesla's cars are good and fairly priced, they'll sell -- whether or not other automakers decide to push on with EV development instead of focusing on hybrids or other technologies, and even if a smaller proportion of consumers decide to make the leap to an electric car. In other words, the pie may shrink, but if Tesla's products pan out, the company seems well-positioned to capture a bigger piece of it.

Now, if EVs are such a flop that no significant infrastructure to support them emerges, that will hurt Tesla's chances. But at least in the major developed nations, that infrastructure is likely to happen anyway; government pressure is already putting things in motion. I think this is unlikely to be a factor.

Long story short, I agree that EVs are unlikely to be adopted as widely and quickly as optimists were projecting a year or two ago, but I don't agree that that necessarily means that Tesla's chances of success are diminished. Tesla's fate, for better or worse, still appears to be in its own hands.

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Fool contributor John Rosevear owns shares of Ford and General Motors. You can follow his auto-related musings on Twitter, where he goes by @jrosevear. The Motley Fool owns shares of Ford Motor. Motley Fool newsletter services have recommended buying shares of General Motors, Ford Motor, and Tesla Motors. Try any of our Foolish newsletter services free for 30 days. 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 (12) | Recommend This Article (7)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 12, 2011, at 6:16 PM, TMFNewCow wrote:

    Great article, John.

    -- Evan

  • Report this Comment On December 12, 2011, at 6:26 PM, TMFUltraLong wrote:

    Don't ask me why but this headline makes me think of Eddie Griffin propelling an Enzo Ferrari into a wall....


  • Report this Comment On December 13, 2011, at 8:33 AM, DJDynamicNC wrote:

    Hard to argue with the analysis here. Good article.

  • Report this Comment On December 13, 2011, at 1:14 PM, lagunagreg wrote:

    Yes, a very good assessment.

  • Report this Comment On December 13, 2011, at 1:18 PM, rapnjoe wrote:

    Remember that rush to electric cars? It's not happening, Yes my point exactly, the reason is simple everybody in the market for an Electric Vehicle would rather wait to buy the best electric car which is a "Tesla" why else would Tesla be sold out of all 5000 2012 S model's ahead of production and already reserved another 1500 for 2013 production' The rush to Electric cars will not be for a low range Leaf or a half Electric car Volt, or any of the other sad looking Electric cars due out next 2 years by the Fossil automobile Industry, the rush will be for the Tesla model X an affordable Tesla and many more models they plan to release in the future.

    the Roadster and Model S are only Tesla's starting point for low volume entry point to the market, you got to start somewhere.

    I have been driving a Nissan Leaf for 3 months now that I decided to lease to build an experience of Electrification stepping stone for me to buy a future Tesla, and I can tell you from experience once you get used to driving 100% Electric and later you get in a gas car it feels very antiquated hearing all the thumping sounds of a gas car that only makes 22% inefficiency use of its energy.

    even if the future is Fuel cell cars Tesla will have its place in them as well because even a fuel cell car has an electric power train and Tesla Power Trains are the best choice, we know this because Toyota and Daimler are already buying them.

  • Report this Comment On December 13, 2011, at 1:51 PM, TMFMarlowe wrote:

    @rapinjoe: I suggest that you learn a little more about the auto business (instead of disparaging it) before you get too attached to that line of argument. If electric cars really do turn out to be the future, and Tesla's products really do turn out to have the magic, I can't see how TM or GM or F or VW or NSANY won't be able to out-Tesla Tesla (meaning, introduce better-executed, lower-cost products with competitive technology) within one or two product cycles -- half a decade, max. Tesla's technological edge isn't something that will be particularly hard to duplicate 3-5 years from now, once battery prices have fallen to a point where a reasonable range is affordable. And remember that each of those companies has resources that dwarf anything Tesla will be able to muster until its sales are well into the millions, and maybe not even then. What does Tesla do when the global giants focus on its niche, crush its margins, and eat its lunch? How does it justify its valuation?

    Answer me that and you'll have an investment case. Not until.

    John Rosevear

  • Report this Comment On December 13, 2011, at 2:15 PM, TMFMarlowe wrote:

    I should amend my last comment to say that I do see a path for Tesla to thrive when that happens. But I wonder what the company's most ardent fans think they see when they confront that question. Mostly I don't think they confront it at all...

    John Rosevear

  • Report this Comment On December 13, 2011, at 2:43 PM, DJDynamicNC wrote:

    @TMFMarlowe - Branding. People who buy an electric car want other people to KNOW they have an electric car for the same reason that people who order vegetarian at a restaurant want everyone else to know that they didn't just order a particular meal, they ordered a meal with no meat in it. Just as Prius is THE hybrid, Telsa is THE all-electric car - not the Leaf or the Volt.

    I'm not saying this is a slamdunk for Tesla by any means, but if I can see a viable model for them from out here, I'm sure a company which has been managed as well as Tesla can see the same thing (or a better one). If Ford or Honda start gunning for Tesla by introducing lower cost variants, Tesla pitches itself as the Lexus of electric; if the big autocompanies instead try to compete on technology, Tesla pitches itself as the trendsetter. Markets don't care a lick about the actual value of a car; so long as markets are made up of human actors, it's the perception of value that matters, and Tesla is the king of the electric field in perception. Americans like an underdog, and Americans like a company competing on new technology and solid engineering. If Tesla tries to be GM, it'll get crushed, but Tesla only needs to keep being Tesla to be profitable.

    Obviously things can change, as always, but I think a case can be made for holding Tesla at current valuations and the company should not be written off too quickly.

  • Report this Comment On December 13, 2011, at 3:48 PM, TMFMarlowe wrote:

    @DJDynamicNC, you're thinking along the same lines I am. I'm not sold enough on their chances to buy the stock, but I think that's their path: Apple cars.

    Thanks for reading.

    John Rosevear

  • Report this Comment On December 13, 2011, at 3:49 PM, TMFMarlowe wrote:

    I hit enter too fast again. That, and supplying tech to the major OEMs, which I think is key to all this.

    John Rosevear

  • Report this Comment On December 14, 2011, at 11:15 AM, AdvanderMeer wrote:

    Electric cars cannot take off by the lack of attractive supply. The Volt is not really an EV, so many pioneers are not impressed. The Leaf is a reasonable car with a so-so range and hasn't been offered in all states.

    The success of the electric car will be decided by the willingness of the OEM's to stray from the business model that they know will make them money: The ICE driven car. They will strap a little battery and an electric motor to it, but they'll be damned before dropping the gas guzzler. The ICE garantees them cash flow like they know the electric engine will not. No more oil changes, filters, exhaust, catalyst converters, clutches, gearboxes etc to provide cash flow long after the car has been sold. The dealer system as we know it would drastically change as these dealers can't just live of the business of selling new and used cars: They need the service and repair income.

    Seriously, if Tesla can bring the Model S to market for the price they have promissed, why aren't BMW and Mercedes offering even better cars? After all, they have more petty cash than Tesla has spent on Model S. They have over 100 years more experience than Tesla, so why is Tesla offering a car that the OEM's have been telling us cannot be done.

    I guess unicorns do exist but OEM's insist on selling us modernized dinosaurs. The OEM's have the cash and the influence to slow the electric car down and it seems like they do. We will have to see if Tesla and other believers can make it upstream to mainstream.

  • Report this Comment On December 15, 2011, at 8:08 AM, TMFMarlowe wrote:

    "They have over 100 years more experience than Tesla, so why is Tesla offering a car that the OEM's have been telling us cannot be done. "

    Because they don't see a market for it. So far, that looks like a reasonable position. When that changes, so will their approach -- bet on it.

    John Rosevear

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