Tesla Motors (NASDAQ:TSLA) has made arguably the biggest bet on the future of electric vehicles and energy storage of any company, with the $5 billion Gigafactory it's building in Nevada. Tesla is sharing that financial risk with Panasonic (NASDAQOTH:PCRFY), but it's really Tesla Motors' reputational risk that's on the line in the Gigafactory. Elon Musk has convinced the market that his company can create better batteries for less money than competitors and that it will have the demand with its own products to keep the factory running.
So, what if Tesla Motors doesn't have the world's best lithium ion battery business? What if someone else creates a better battery and sells it to Tesla Motors' automotive and energy storage competitors? And what if that's already happening?
LG Chem charges to No. 1
A recent series of Leaderboard Reports from Navigant Research assessed the technology, strategy, and partnerships in the battery business and a number of other criteria, trying to assess who had the best battery business. It put LG Chem (NASDAQOTH:LGCLF) ahead of Panasonic, Tesla Motors' battery partner, for lithium ion batteries in both transportation and for grid storage.
In the transportation space, Panasonic was still in the "leader" category with LG Chem and Samsung SDI, which could be seen as a tie between the three, but in grid storage it was left in the lower "contenders" category with companies like BYD and Toshiba. A report like this doesn't necessarily mean Panasonic and Tesla Motors are necessarily falling behind competitors, but at least that competitors are just as good -- if not better. That's a problem because creating a better battery for less cost than competitors is a central tenant of Tesla Motors' value proposition for both customers and investors.
This comes on the heels of Tesla Motors agreeing to a deal with LG Chem to provide battery pack upgrades for the Tesla Roadster, which is no longer in production. The choice of LG Chem is curious since Panasonic supplied the initial batteries and is supplying Tesla Model S batteries as well.
LG Chem also recently won contracts for a 50 megawatt energy storage facility in South Korea and a 140 megawatt contract in Germany. Could a real competitor to Tesla Motors' EV and energy storage dominance be emerging?
The implications of a better battery strategy
Competition isn't necessarily bad for EVs or energy storage. But I think the implication Musk has long made about Tesla Motors is that it will be a leading company in both markets, commanding high margins of around 25%.
To charge that kind of premium a company will likely need to make the best product and have the lowest cost structure. If LG Chem is already at the point where it has an equal, or maybe better battery, Tesla Motors' high margin thesis could be in trouble.
LG Chem is no small player in the battery business either. The company makes the batteries for the Chevy Volt and upcoming Bolt as well as Nissan's Leaf. It also has deals with Ford, Audi, and Renault SA for vehicles in their pipeline.
Tesla Motors and Panasonic have a lot to prove
I present these reports as a data point investors should think about when analyzing a stock like Tesla Motors. The company is worth $31 billion, it's losing money, and the best-case scenario is that it is able to make 500,000 cars per year, in five years, with industry-leading gross margin of 25%. There's a lot that needs to go right to live up to that kind of hype and if a competitor has a better battery than Tesla it's a big red flag for me.
This isn't to say that Musk, Tesla, and Panasonic can't build the next generation of batteries in the Nevada desert or that it won't be less costly and higher energy density than LG Chem and other competitors. It could very well succeed on both accounts. But hanging a high valuation on an assumption that those improvements are coming is a risky proposition.
Remember too that energy storage is expected to be about one-third of the demand coming from the Gigafactory. Lots of competitors are eyeing the growing energy storage market and by the look of it Tesla Motors may not be the industry leader in energy storage that we thought it was.