Note: This article originally appeared in Motley Fool Rule Breakers on Nov. 19, 2014, but numbers have been updated. Tesla is an active recommendation of Rule Breakers, which you can join free for 30 days.
I've been doing a lot of thinking lately about Tesla Motors (NASDAQ:TSLA).
Two weeks ago, I dove into the company's earnings report. Last week, I had lunch with an electrochemist. And it didn't take me long to realize that five years from now, this company will be doing much more than making electric cars.
Let's start with the Gigafactory. CEO Elon Musk and Co., along with help from partner Panasonic, are ponying up $5 billion for a factory that by 2020 will provide the equivalent of the world's current annual supply of lithium-ion batteries. (It's supposed to be completed in 2016.) Tesla said the Gigafactory would provide batteries for the existing Model S luxury family sedan, the upcoming Model X SUV, and the still veiled "Model 3." The Model 3 aims to be a more affordable electric vehicle that will sell for about $35,000. Tesla believes the mass-market-affordable price point will spur the adoption of electric vehicles, and the Gigafactory is designed to supply enough batteries for 500,000 vehicles per year.
That last part made me raise an eyebrow. Half a million cars per year is an ambitious expectation, even for the company's Midas-touch CEO Musk.
Don't get me wrong; the Model S has been selling well. With the recent upgrades to Tesla's manufacturing plant in Fremont, California, the company now expects to be able to supply 100,000 vehicles a year by the end of 2015. And I have no doubt that the Model X and Model 3 will be well received by the market.
But to put things into perspective, new-car sales in the United States peaked last year at 15.6 million. The single best-selling line of vehicles was Ford's F-series pickup, which sold 763,000 units. The best-selling car was the Toyota Camry, which sold about 404,000 units.
Tesla's plan to sell 500,000 vehicles a year -- even if split among three models and selling globally -- would vault any one of them into near-best-selling territory. And that's assuming that the Fremont plant continues to aggressively invest to upgrade the assembly lines.
Perhaps Tesla can pull it off. After all, it's Musk. But even if demand for the S, X, and the 3 doesn't keep the Gigafactory running at full capacity, the company has plenty of other options.
As you've probably noticed, other automakers are showing an interest in electric vehicles. Nissan, Ford, and most of the other large manufacturers are introducing electric models of their own -- trying to capitalize on this growing trend without disrupting their core businesses too badly. Tesla has publicly stated that it will open up its patent portfolio to encourage other carmakers to drive the adoption of this new industry. Of course, with best-in-class technology and a huge lead on the competition in manufacturing, Tesla would have no problem selling its batteries to rivals as a pretty lucrative side business. Batteries are one of the most integral parts of an electric vehicle, and Tesla thinks the Gigafactory can reduce their cost by 30%.
Or perhaps there's a more disruptive solution: Tesla could consider leasing the batteries to drivers, who would replace them every few years to improve a car's performance. This would turn one of the weaknesses currently limiting the adoption of electric vehicles on its head: If consumers are concerned about a vehicle's range before the battery needs to be recharged, why not upgrade the battery itself every now and again? Drivers could significantly extend a vehicle's lifespan and lock in a long-term relationship with Tesla.
But why stop there? Couldn't Tesla's batteries also be used for other things? Back to my discussion with that electrochemist.
While enjoying a lunch of Thai drunken noodles (which were so spicy that my cheeks were sweating), I learned that there is very little difference between a lithium-ion battery used to power a car and one used to power a cellphone. A battery's applications are largely governed by its power (that is, its size and amperes of output) and its number of life cycles (how long it lasts before going bust). Other than that, battery chemistry is agnostic. A lithium-ion battery could be used to power Tesla's vehicles in fundamentally the same way that it powers Apple's new iPhone 6.
That last point could be an important one. Smartphones are getting packed with software that chews up battery life ever faster. Musk's Gigafactory will let him simultaneously optimize battery performance and minimize costs -- the holy grail for consumer-electronics companies. About 1.2 billion smartphones are expected to be shipped during 2014, up nearly 20% over 2013. Consider that battery demand and then add in rising demand from the utility industry (i.e., SolarCity) and wearable technologies (i.e., Google Glass), and Tesla's "side business" of supplying batteries to other original equipment manufacturers could very well supersede the demand it sees from its core auto market.
I can't tell you how many times I've heard Tesla called overvalued in the past year, mostly based on variations of a "right now" analysis. Right now, Tesla has a market cap of $25 billion and is expected to ship 35,000 cars this year. Right now (with a bit of rounding) that is a roughly $1 million valuation for each car Tesla annually ships. Right now, much of the market thinks Tesla's valuation is preposterous.
Valuation is subjective for each investor, but my point is that the future Tesla could look very different. Its Gigafactory will be a game changer, and I'm excited to watch the company accelerate into a few new industries.
Simon Erickson owns shares of Apple and SolarCity and has the following options: short April 2015 $105 calls on Apple, short January 2015 $50 puts on SolarCity, long January 2016 $50 calls on SolarCity, and short January 2016 $50 puts on SolarCity. The Motley Fool recommends Apple, Ford, Google (A and C shares), GoPro, SolarCity, and Tesla Motors. The Motley Fool owns shares of Apple, Ford, Google (A and C shares), SolarCity, 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.