We are going to spend staggering amounts of money on CapEx. -- Tesla Motors CEO, Elon Musk
With one sentence, Elon Musk highlighted both the incredible opportunity and incredible risk ahead for Tesla Motors (NASDAQ:TSLA). His industry leading electric vehicle company is essentially starting from scratch building vehicles in an automotive industry littered with failed start-ups that couldn't make a solid return on the capital they invested in production plants.
Tesla thinks it can break that mold and invest billions in capital, generate a high return, and continue to grow at a rapid rate. It would be a monumental feat for Musk to pull it off.
Numbers behind Tesla's "staggering" investments
It's true that Tesla has a lot to invest in, and if Tesla plans to become a major auto player, the amount it has to invest is truly staggering. The Gigafactory alone will cost $5 billion to build, shared with battery partner Panasonic (OTC:PCRFY), and that's just to build batteries -- not included is the cost of building out fab facilities for the Model X and Model 3. In fact, in total, Tesla has only invested a net $1.83 billion in capital expenditures in its entire lifetime. That's a good quarter for most of Tesla's competitors.
You can see below that Ford (NYSE:F), General Motors (NYSE:GM), Honda (NYSE:HMC), and Toyota (NYSE:TM) all consistently spend billions, even tens of billions, on capital expenditures each year to keep tooling and retooling production. It's really upkeep for auto companies, not just growth spending.
That's a look at how much they spend each year on capital equipment, but look at what they have in net accumulated property, plant, and equipment (PP&E). This is the money they've spent over many years without pulling out depreciation. Toyota Motors alone had $185.3 billion in total PP&E at the end of 2014.
Tesla is going to have to spend tens of billions to even approach the 1 million vehicles by 2025 figure that Elon Musk has said he hopes to achieve. To approximate what Tesla might have to spend, I looked at BMW, who is the closest approximation to Tesla in the auto world, selling high-price, high-margin vehicles. BMW sold 2.1 million vehicles in 2014, so it's a decent benchmark for how much Tesla may have to invest to reach production of 1 million vehicles. A look at BMW's most recent financial report shows that the company has $48.8 billion in PP&E, including land.
Since Tesla is building battery manufacturing and starting from a higher cost basis (due to inflation), it's likely Tesla will have to spend $50 billion by 2025 to reach half of BMW's production, or 1 million vehicles. To do that, Tesla would have to invest an average of $5 billion per year for the next decade, up from just less than $1 billion in 2014. Keep in mind that this is cash flow it currently doesn't have from its operations.
Why the capital spending plans are dangerous
What makes the auto business so dangerous is that one slip-up can spell the end for a start-up. Tesla currently has just one model, and even after it launches the Model 3, it will only have three. If any single product misses, it could literally mean the end of the company. Imagine if competitors get their act together in the next decade while Tesla is spending tens of billions on capex, and suddenly Tesla can't keep its factories running at full speed, leading to losses and burning up cash.
Of course, that's not a concern for Musk today. Tesla is planning to have higher margins than competitors, but you can see below that return on invested capital isn't typically very high in the auto business.
Today, Tesla's return on invested capital is actually negative, so do we really believe that Elon Musk can outperform auto rivals by a wide margin long term? Investors certainly hope so, but there's no proof that Tesla will actually live up to that expectation.
In Elon Musk we trust
The bottom line is that investors are putting a lot of faith in Elon Musk and his audacious plans to grow Tesla Motors' sales and profits. So far, he hasn't proved the ability to produce the return on capital spending he's promised and has no history of ever building profitable companies (Paypal wasn't profitable when it was sold to eBay). If Tesla can't generate a return on the capital it spends, it will be just another cautionary tale in the auto industry.
Investors are giving Tesla Motors more than the benefit of the doubt, and with tens of billions of dollars in capital to be invested over the next decade, Elon Musk and company better perform absolutely flawlessly. Maybe missing 2014 delivery targets and multiple delays of the Model X should be a bigger concern considering what's on the line.