Goldman Sachs downgrades guidance for Tesla stock to “Sell”. There could be more money in batteries.
If you asked me which auto manufacturer would be the most talked about 10 years ago, I wouldn’t have said Tesla and that’s remarkable for several reasons.
The considerable technical progress in mass production electric vehicles that Tesla has achieved with their Model S has been discussed extensively over the Internet and I won’t repeat it here. However, Tesla is 10 years into their progress toward becoming a serious mass production automaker and 2017 looks like the companies most important year yet.
Mass production affordable electric vehicles that can compete with internal combustion engines have been a dream for over 100 years. Large and small automakers alike have tried and failed to make it come true.
In the modern era, General Motors came close with their ambitious EV1 program in the early 1990s. Drivers loved the cars, but the battery technology wasn’t up to the task and GM correctly pulled the plug on the program when it became clear that the vehicle wasn’t a profitable product.
Tesla isn’t profitable either and never has been – that’s why 2017 is going to be a big, big year for the company.
Model 3, the first mass-market electric vehicle with a real chance to succeed, is scheduled for full production in the third quarter of this year, with a projected base price of USD$35,000. Over 300,000 people have anted a $1000 deposit to buy this vehicle and Tesla is projecting annual build rates at five to 10 times the current rate for the Model S.
But there are issues.
A big one is Tesla’s manufacturing capabilities. General Motors and Toyota famously gave up on Tesla’s Fremont, California facility because of the age of the plant, which is in possibly the worst manufacturing jurisdiction in America: California.
California is particularly disadvantaged compared to manufacturing friendly, Right-to-Work states in the southeast like Alabama and Tennessee.
Global automakers are pouring into Dixie for multiple reasons, including access to low-cost labor, generous tax incentives from state and local governments and a critical factor that’s rarely reported: easy and rapid access to a very large Tier 1 and Tier 2 supplier base.
Why is this critical? Because modern manufacturing is most cost-effective when companies outsource larger complex components and subassemblies to specialist suppliers.
Take an air conditioner compressor manufacturer for example. With multiple OEM customers, large economies of scale plus an in-house engineering team, they leverage extensive expertise in air-conditioning compressors. Each automaker designing and building their own unit – different, but with the same function – makes little economic sense.
So far, Elon Musk is advocating vertical integration as the way forward for Tesla, bringing as much of the production process as possible in-house. There are pros and cons to this approach.
The big one obviously is cost. Ford tried vertical integration 80 years ago, with the famous Detroit Rouge complex and found it too costly.
On the other hand, in-house production reduces risk. For example, several automakers are facing major lawsuits due to injuries caused by Takata airbag inflators, a problem unforeseen by automaker safety engineers who specify airbag assemblies engineered outside their control.
So who’s right?
Outsourcing and vertical integration was rejected decades ago by major manufacturers. Is Elon Musk wrong? It depends.
If Tesla builds cars using conventional mass production techniques, it’s unlikely that he’ll succeed with vertical integration – it’s simply the mathematics. However, if Tesla has some new manufacturing trick up their sleeves or plan to use exotic materials not currently known or available in the Tier 1 supplier space, it not only makes sense, it may be the only way to build their products.
The biggest example of course are batteries, for which Musk has built the famous “Gigafactory” in Nevada.
It can be argued that Panasonic is in fact Tesla’s battery supplier, but I think bringing battery production under one roof and locking in supplies with their “take or pay” deal with Panasonic suggests something else.
Mass production of advanced batteries may in the end be where the real profitability is for Tesla, not making cars. If so, it makes sense for Musk to eventually sell off the car making unit and concentrate on home energy generation through the Solar City acquisition, combined with home or grid-level battery storage.
Notably, the word “Motors” has been removed from Tesla Motors recently. I don’t think that Musk is giving up on EV’s, but there’s a chance that there’s far more money to be made selling batteries and drive units to existing automakers than building the cars.
Tesla is burning through cash at a furious rate and will likely go to the markets this summer for another capital raise, increasing the need to deliver Model 3’s to customers in significant quantities by the fourth quarter of this year.
Goldman Sachs recently downgraded their guidance for Tesla stock to “sell”. It’s not panic time at Tesla, but it is crunch time.
