Tesla – The business perspective

A lot is being written these days about the pros and cons of electric cars and I am not at all against EVs in general and Teslas in particular, quite the opposite, not least since EVs are forecasted to outsell all other engine types by 2033, five years earlier than expected. But I question Elon Musk’s rationale of vertical integration, in particular from an investor’s perspective.

Manufacturers in any industry are best advised to focus on their area of expertise. No business, whatever it manufactures and then sells, can keep on top of technological developments in, to come back to Tesla, areas as varied as self-driving software and battery technology. That’s why it make sense, as the traditional car manufacturers do, to share platforms and standardise parts. The average ICE saloon of any make will contain parts of possibly 20 or more other makes. Besides that, traditional car manufacturers have for too long stalled their own development of EVs. But they are catching up fast!

From an investor‘s perspective, I am afraid to say, aspects such as production capacity, profit margins and how a business makes these profits do matter. A chunk of Tesla’s current profits are not made from manufacturing and selling cars, but from trading carbon credits: Last year it booked a staggering $1.58 billion in revenue that way. As industries in general become greener, there will be less demand for such regulatory credits and hence their financial value will diminish – and with it their contribution to Tesla’s net profits. Production capacity matters too: as more people switch to electric cars, this needs to be ramped up. According to an IEA report (IEA (2021), Global EV Outlook 2021, IEA, Paris https://www.iea.org/reports/global-ev-outlook-2021) Europe in 2020 has overtaken China as the biggest market for electric vehicles. Accordingly, manufacturers such as Germany’s Volkswagen, admittedly by their own account, expect to have manufacturing capacity of some 1.5 million EVs by 2023. The company’s goal is to produce 50 different electric models by 2025 and it will invest over €30 billion into EV-related technologies. They may be late to the party, but the other traditional car manufacturers aren’t standing still either, and lets not forget the Chinese producers of electric cars such as BYD and NIO who are bound to enter western markets over the coming years as well. All this builds up to some formidable competition for Tesla and its 28% market share of global EV sales.

And in order to grow, Tesla like any other business needs to be profitable at the core. In this respect the number from the company’s Q1 2021 earnings call are not very encouraging: in the first three months of this year Tesla booked a net profit of $438 million, but without $619 million in credits and Bitcoin sales, Tesla would have actually managed to lose $181 million in Q1. In that time, the company shifted 184,800 3/Y units, and while it didn’t build a single X or S in Q1, it sold 2020 units from previously-built inventory. That means Tesla lost around $970 on every car sold in Q1.

As far as the supply of batteries is concerned, the biggest problem is – and increasingly will be – the supply of lithium, which is expected to triple by 2025 according to S&P Global. But will that be enough? OEMs including Tesla, Volkswagen Group, BMW, General Motors, Geely, Ford and many more are investing billions of dollars to secure lithium supply, diversify suppliers and to expand lithium-ion battery and battery pack production. Many vehicle manufacturers and lithium cell suppliers are planning battery plants that will be several times larger than the current largest global gigafactory, the Tesla Gigafactory 1 in Nevada.

A bigger worry at least in the short to medium term may be the supply of microchips: Electric vehicles (EVs) are even more reliant on these than traditional cars. According to Infineon, a manufacturer of chips, there is on average $834 of semiconductor content in every EV, versus $434 for internal combustion engine (ICE) vehicles. The lack of available processors has already led to closures of production lines and falling car sales among the ICE manufacturers and the situation is not expected to improve much in the short term as the lead-times to bring new semiconductor plants on-stream are rather long.

Some people say that it’s wrong to compare Tesla’s completely different business model with the one of traditional car manufacturers. Well, it’s not and normal commercial principles have not been suspended for Tesla. Those like me who are old enough to have lived through the dotcom bubble of 1999 will know what I am talking about: the internet was a rather new and fancy concept and all of a sudden normal business practices seemed to be suspended and fundamental commercial rules no longer to apply, with people arguing that this was a completely novel way to do business, with no comparison to the ‘old world’. Basic economics such as revenue, earnings and valuations didn’t seem to matter, at least until the bubble burst in the spring of 2000 and many of these heavily indebted startups with lofty valuations but no earnings to show for went bust.

I say it again, I am all in favour of electric cars and all things ecological, and in this respect I wish Tesla well! But I remain a sceptic whether the current business model is sustainable for a manufacturer that lacks the economies of scale of its traditional competitors. And I keep wondering how the development of future new models and expansion plans will be financed if it’s core business, manufacturing cars, is not profitable. Will Tesla, being the current market leader as far as EVs are concerned, follow IBM and Eastman Kodak in their footsteps? Both were once upon a time leaders in their respective markets, only to be outdone by competitors with different technologies (personal computers for IBM and digital photography for Kodak). I suppose time will tell.