The Tesla Debate In A Nutshell

Tesla (TSLA) critics make two main arguments:

  1. Electric vehicles are not yet competitive (in terms of price-performance) with gasoline cars or diesel trucks. This applies to electric vehicles in their entirety, not just Tesla. I’ll call this the unviable technology argument.
  2. Electric vehicles are increasingly competitive, but large companies that manufacture cars and trucks are much better positioned than Tesla to produce electric vehicles. Automotive manufacturing is hard, and these older, larger companies have manufacturing scale and experience that Tesla doesn’t. I call this argument the competition thesis.

My two counterarguments are as follows:

  1. Electric vehicles are fast approaching a tipping point where their price performance exceeds that of gasoline or diesel vehicles in a variety of market segments and use cases. Tesla appears to be ahead of the curve in that regard — pushing costs lower than was expected by analysts, and faster than other companies.
  2. With passenger cars, there are four principal reasons to doubt the competition thesis: Tesla’s advantages in software, design, sales channels, and battery pack economies of scale. (Not to mention its short-term advantage in charging infrastructure.) With freight trucks, design and sales channels may not be relevant. With the recently revealed Tesla Semi, Tesla’s software advantage comes into play with active safety features and the ability to semi-autonomously platoon. Software engineering also helps Tesla get more performance out of the same battery pack hardware through its power management software. That edge in power management software complements Tesla’s economies of scale with battery pack production, which will take time for competitors to replicate. During that time, Tesla won’t be standing still.

This list of arguments is not exhaustive. A third major category of arguments revolve around the leadership of CEO Elon Musk. Musk has a confessed “issue with punctuality.” Musk calls complaints about his missed deadlines a “fair criticism” and says he is “doing (his) best to recalibrate.”

Bloomberg journalist Tom Randall has posited that being chronically late is a symptom of Musk’s M.O., which Randall calls “the Musk Doctrine.” The idea is that if you commit yourself and your company to a hyper-aggressive deadline, even if you come up short of that deadline, you’ll be further ahead than if you had set a less aggressive deadline.

In my view, the mistake that analysts frequently make is to automatically assume that when Tesla misses a self-imposed deadline it is inherently harmful to the company’s long-term fundamentals. When delays mean unplanned cash burn or upset customers, there’s the potential it could be. But even these costs have to be weighed against the benefits (if any) of the Musk Doctrine. Other times, as in the case of Tesla’s fully autonomous cross-country drive originally planned for the end of the year, the deadline is simply a line in the sand. The only cost is the credibility of the next timeline that Tesla gives.

SpaceX’s Dragon spacecraft docks with the International Space Station on a cargo mission. Credit: ESA/Alexander Gerst.

Some observers doubt Musk’s abilities as a CEO. They see Musk’s missed deadlines and hear the extraordinary goals he sets for Tesla — such as full self driving with current vehicle hardware and eventual full factory automation — and they are incredulous. They question his intelligence, his sincerity, his knowledge of the automotive industry, and even his sanity.

These questions should be put to rest by Musk’s track record with SpaceX (SPACE). SpaceX has won the admiration of the space community by landing and relaunching an orbital rocket for the first time in history. Under Musk’s leadership, SpaceX has advanced rocket technology in a way that promises to change the economics of space. Reusable rockets, like the reusable airplanes and reusable cars we’re accustomed to, are a prerequisite to making space travel widely affordable.

SpaceX returns a Falcon 9 rocket from orbit and lands it onto a drone ship. Credit: SpaceX.

In fairness to skeptics of Tesla and Musk, Musk sets goals that are so ambitious it can be hard to believe they are achievable. I remember the first time I heard Musk describe SpaceX’s plans to propulsively land its rockets and spacecraft from orbit. I was certainly skeptical. I was on the fence about whether Musk was a visionary genius or out to lunch, and I was leaning toward incredulity.

Now SpaceX has done just what Musk said it would. It has successfully landed a rocket 19 times, and successfully relaunched a rocket three times. More than any other single achievement, SpaceX’s breakthrough with reusable rockets is proof that Musk can achieve his extraordinary goals. It’s proof that Musk is a profoundly gifted engineer and business leader.

Tesla skeptics should learn everything they can about the space industry in general and SpaceX in particular. For a deep dive into both SpaceX and Tesla, I highly recommend Ashlee Vance’s biography Elon Musk: Tesla, SpaceX, and the Quest for a Fantastic Future. If you have a position in Tesla of any significant size, I’ll venture to say that you should consider this book required reading. Musk has a long track record of setting goals that sound crazy — and achieving them. Ignore this at your peril.

Elon Musk discusses reusable rockets in September 2011. SpaceX landed its first rocket in December 2015.

In the remainder of this article, I’ll discuss the unviable technology argument and the competition thesis as it applies to the Tesla Semi.

Argument #1: The unviable technology argument

Some Tesla critics argue that electric vehicles are not yet a viable technology. Electric vehicles can’t compete with gasoline and diesel vehicles on price-performance, so their market will continue to be small — unless they are sold at a loss. While this was once true a long time ago, it isn’t anymore. Electric vehicles’ time has come.

ARK Invest forecasts that electric cars will reach a tipping point in 2022. That’s the year when ARK predicts that an electric car that has 200 miles of range and is otherwise equivalent to a Toyota (TM) Camry will sell for $2,000 less.

Another tipping point will occur much sooner, according to ARK Invest’s model. In 2019 or 2020, the total cost of ownership of an electric equivalent to the Toyota Camry will fall below that of the Camry.

Tesla appears to have already reached a tipping point at a higher price range. Analyst Gene Munster calculates that the Model 3’s total cost of ownership is only 13% higher than that of a Camry. The Model 3 has unprecedentedly effusive reviews for a car in its price range. It seems quite likely that the overall quality and performance of the Model 3 exceeds that of gasoline cars sold for a comparable price.

In this video, the unsubsidized total cost of ownership of a Model 3 over five years is estimated at just $3,400 more than a Honda (HMC) Civic.

The situation for electric freight trucks also is favorable. According to both Tesla’s own figures and independent research by ARK Invest, Tesla’s electric Semi will have a lower total cost of ownership than diesel semis when it launches in 2019. With Tesla’s stated specs for the truck and its planned Megacharger stations, the Semi will have all the range it needs for long hauls with the heaviest loads.

Full self driving is a wild card, since it fundamentally changes the economics of cars. Self driving enables cars to be shared by multiple people, thus dividing the cost between them.

Full self driving specifically accelerates the adoption of electric cars. With longer lifespans and lower operating costs, the economics of electric cars are unbeatable for an autonomous ride-hailing model.

With full self driving, a Model 3 shared by five people goes from a $43,000 car ($35,000 base price + $8,000 full self-driving feature) to effectively a $8,600 car. That’s two-thirds the price of the cheapest car currently on the U.S. market. Shared by ten people, it’s effectively a $4,300 car — 1/3 the price of the current cheapest car.

The Model 3. Source: Tesla.

Even a $78,000 Model S (including the $8,000 full self-driving feature) drops to $15,600 with five users, and $7,800 with 10 users. That’s a luxury car for the price of the cheapest models or less.

Because of full self driving, Tesla may never need to manufacture a cheaper car than the Model 3. If full self driving arrives later than expected, or Tesla just wants to offer an even cheaper option, a fourth tier of cars may be added. (The $200,000 Roadster is the first tier, the Model S and X are the second, and the Model 3 and upcoming Model Y are the third.)

Argument #2: The competition thesis

The competition thesis is the view that established automakers will enter the electric vehicle market and take demand away from Tesla. On this thesis, Tesla is not believed to have competitive advantages that will sustain demand even as an increasing number of electric vehicle models become available.

I’ve already covered the competition thesis as it applies to passenger cars. Tesla has a durable competitive advantage in software, and quite possibly one in design as well. Tesla’s sales model and economies of scale with battery pack production give it long-term competitive advantages. Eventually, these two advantages will most likely subside as the U.S. car industry is reformed and competing car manufacturers or their suppliers build Gigafactory-sized battery pack factories. In the short term, Tesla’s extensive Supercharger network gives it an advantage up until the point a competing network is built.

The dynamics of the freight truck market are different, so I’ll now consider the competition thesis with regard to the recently revealed Tesla Semi. With the Semi, Tesla’s primary competitive advantage is the ability to offer electric propulsion at a lower cost than either diesel propulsion or competitors’ electric propulsion systems.

CEO Elon Musk presents the Tesla Semi and the new Tesla Roadster. Source: Tesla.

Tesla’s critical advantages in electric propulsion are in the battery pack. The first advantage is simply economies of scale, the Nevada Gigafactory’s reason for existing. At the end of 2016, global lithium-ion battery cell production capacity was 28 gigawatt-hours (GWh). In 2018, Tesla’s Gigafactory is planned to scale up to 35 GWh of production. Tesla will be producing roughly half of the world’s batteries.

Bloomberg New Energy Finance forecasts global battery cell production to grow to 273 GWh in 2021. Musk has said that the Gigafactory will be scaled up to a production capacity of 105 GWh in “perhaps 2020 or thereabouts.”

This year, Musk revealed plans for 2-4 new Gigafactories. By splitting production into multiple factories intended to serve local markets, what Tesla loses in economies of scale it makes up for in reducing transportation costs. Assuming the production capacity of each Gigafactory is 105 GWh, total production would be 315 GWh to 525 GWh.

On Tesla’s Q3 2017 earnings call, Musk set a “rough target” to begin production at a planned Chinese factory in “about three years,” so in 2020 or 2021. Based on Musk’s previous statement that battery and vehicle production will be integrated into “one big facility,” my expectation is that the Chinese factory will be a combined battery and car Gigafactory. My guess is that other Gigafactories will be built along a similar timeline to the China Gigafactory.

So, even as global battery production grows, Tesla’s battery production appears set to grow proportionally, still accounting for roughly half of global battery production through to 2021. What’s more, less than half of the cells produced by other companies will be suitable for electric vehicles. A large portion will be for consumer electronics. Battery packs used in electric cars and trucks require cells with a different battery chemistry and form factor.

Barring a change of plans by competing vehicle manufacturers or their suppliers, Tesla is on track to maintain advantages in economies of scale and, later on, transportation costs for its battery packs. Beyond 2021, other battery producers will likely catch up. However, Tesla can use the intervening years to invest and innovate in other areas, such as factory automation.

Musk and CTO JB Straubel explain Tesla’s thinking behind the Gigafactory at its grand opening.

The second advantage that Tesla has with its battery packs is the software it writes for power management. In an interview with Bloomberg, venture capitalist Marc Andreessen said the following about Tesla:

Sort of a secret advantage of Tesla people don’t talk about that much is they buy the batteries from someone else, but they write the software that manages the power, which is a big part of getting the range.

On the same note, automotive journalist Alex Roy wrote the following in a recent article:

The Tesla Model S was the first EV to get cross country in a time that wasn’t laughable, with total hours logged in the mid-60s. Then a team made the run in a P85D in just over 59 hours.

Then I joined another team who got across the country in 58 hours, 55 minutes (again in a P85D).

Then I joined another team in a 90D and drove across in 55 hours. A bigger battery pack in the same car doesn’t explain the enormous time improvement, nor did our attempt to optimize our speeds, or use the expanding Supercharger network.

Something is happening, and it’s in Tesla’s battery management software. Let’s keep going down the rabbit hole.

A few months later another team—in a P85D, not a 90D—got across in just over 51 hours. That’s an improvement of over three hours, with the smaller battery.

Even with manufacturing and hardware parity, Tesla’s battery packs can quite plausibly exceed the performance of battery packs produced by companies with less software acumen. The power management software is the second aspect of the Tesla Semi’s battery pack that will not be easy for competitors to replicate.

The financial implications: Investor and Tesla Daily host Rob Maurer does some back-of-the-envelope math to find that, at a 40% global market share, the Tesla Semi could generate between $60 billion and $80 billion in annual revenue. The historical price/sales ratio of the S&P 500 is around 1.45. Diesel truck maker Paccar has a similar price/sales ratio at 1.38. Based on these ratios and Maurer’s revenue estimate, sales of the Tesla Semi alone could justify 125%-plus of Tesla’s all-time high market cap.

Conclusion

In my view, Tesla critics make two principal errors: 1) they fail to see that the world is on the precipice of a rapid transition to a new technological paradigm for vehicle propulsion and 2) they fail to see Tesla’s competitive advantages both related to electric propulsion and unrelated. Some critics disparage Elon Musk’s leadership without understanding his outsized success in the space industry.

It is reasonable to think that by 2030 nearly 100% of new vehicles produced will be electric. Once the total cost of ownership tipping point is reached in 2019 or 2020, and the sales price tipping point in 2022, the growth rate for electric vehicle adoption will explode.

From the beginning, Tesla has been built to accelerate this transition. Its competitors are built for the old paradigm of gasoline and diesel propulsion, and they have been slow to wake up to the future. With software edging onto center stage, old industrial companies will struggle to adapt. Tesla, by contrast, is a software company, down to its roots.

It’s a fascinating time to be following Tesla. If my two-part thesis about electric vehicles and Tesla is correct, its truth will become increasingly clear over the next 6-12 months.

Disclosure: I am/we are long TSLA.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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