Tesla (NASDAQ:TSLA) has made headlines this week by passing automaker Ford (NYSE:F) in market capitalization after reporting Q1 vehicle deliveries. This accomplishment caps a sharp recovery in share price from 52-week lows in early December, with TSLA closing Tuesday up a whopping 70% from those lows.
TSLA data by YCharts
Naturally, the Q1 delivery numbers, subsequent stock gains, and passing Ford in market cap set off passionate reactions on both sides of the bull-bear debate. Bulls claimed the delivery numbers were strong and the price increase justified, while bears claimed the bulls are in a state of irrational exuberance about a company that doesn’t make a dime of profit. Elon Musk also weighed in on the debate with a tweet reading “Stormy weather in Shortville”. Immature? Maybe. Premature? Probably.
I set up this context because so many people seem baffled by just how valuable Tesla has become – why is a car manufacturer that trails substantially in volume, margins, and profits almost the industry’s most valuable company? The answer, of course, lies in the future. Musk imagines a future where autonomous Tesla vehicles, powered by Tesla-produced lithium-ion batteries, can drive around the country and recharge at Tesla-owned Superchargers. And SolarCity presumably has a role in charging Tesla vehicles, powering Tesla Powerwall storage devices, and generally offering solar energy to consumer markets.
If it sounds like Tesla has many of the “green” frontiers of the future covered, it’s because that is exactly the plan. Musk doesn’t want to control a slice of the renewable energy market, he wants to be everywhere. He wants to create an ecosystem where Tesla has significant control over its supply chain and is deeply horizontally and vertically integrated.
First, I think it would be useful to establish just how wide the operating gap between Ford and Tesla is. In 2016, the former sold 2.6 million vehicles and earned $4.6 billion in profit, while Tesla sold 76,000 cars and lost $675 million. Yet we see the following:
TSLA Market Cap data by YCharts
Does this make any sense from an operating results perspective? Of course not. But it’s not always about current performance. I think Apple (NASDAQ:AAPL) provides a good example of how a company can go from almost no market presence to dominating the entire space in a short time period.
When Apple released its first iPhone model in 2007, it sold 4 million units, which was dwarfed by Nokia’s (NYSE:NOK) 435 million and Motorola’s (NYSE:MSI) 164 million. Based on current performance at that time, many investors would have written off Apple as a small market player that would be crushed in time by its larger competitors. However, what the market did not see coming was the approaching paradigm shift in cellular devices that would give us the smartphone. Nokia underestimated this shift and played the situation passively, assuming that they could continue to milk their current soon-to-be legacy products and then pivot to smartphones later on.
But it never materialized. Nokia floundered and could not compete with the iPhone considering how far ahead of the curve Apple had gotten. Soon Apple was on top of the industry and now (here’s a factoid we’ve already probably heard many times) earns most of the profits in the smartphone market with only 20% market share. How does this relate to Tesla?
Just as Nokia thought it could easily pivot to smartphones to stay ahead of or keep pace with Apple, Ford also appears content to continue focusing on ICEs (with some electric vehicles, hybrids, and autonomous vehicle research here or there) while Tesla is plunging head-on into autonomous electric vehicles. I think it is fairly apparent who will have the advantage once autonomous and electric vehicle market share goes up for grabs.
In addition to the first-mover advantage and not being burdened down by an ICE business that will soon enter decline, Tesla has the unique advantage of having significant control over many aspects of the production of its vehicles, with more control approaching in the future. On the hardware side, Tesla manufactures the powertrains and batteries for many of its vehicles, with the Gigafactory expected to give the company an even bigger advantage over competitors in the future due to lower battery costs.
On the software side, Tesla is a Silicon Valley company at heart and has top-tier software engineering talent. The company is building its autonomous driving software in-house, which provides yet more control over the production and costs of the final product.
Tesla, and Musk specifically, is trying to establish a monopoly on the most popular markets in the renewable energy space – trying to establish a “green” ecosystem (that works almost too well!) If all goes according to plan, Tesla will have full control over the software in its vehicles, the major components of its vehicles (mainly batteries), the primary and secondary infrastructure for charging its vehicles (home charger and Supercharger respectively), the way many homes receive electricity (solar) and a way to store excess electricity (Powerwall).
It is easy to imagine how, if successful, this type of ecosystem could be worth well over $100 billion. This scheme would be a mesh of criss-crossing horizontal and vertical integrations, which would allow Tesla to keep costs under control and charge a premium if the company so desires. For any investors that have wondered why Musk has pushed ahead so aggressively and so quickly with Tesla’s operations instead of waiting for profitability, it’s because this ecosystem will be impossible to accomplish with a strategy that is anything but full speed ahead at all times. And so far, it appears to be working.
The Gigafactory will indeed give Tesla a cost advantage over other automakers when it is operating at full utilization, the Supercharger infrastructure is miles ahead of any other competitors, and Tesla has the pieces to make the ecosystem work if it can accomplish one thing: sell cars. Without deliveries and booming success for the Model 3, Tesla will collapse in on itself before even getting close to Musk’s dream of a “green” ecosystem.
My argument has always been that the success or failure of Tesla hinges on the Model 3. If it’s as innovative and popular as many seem to think it will be, then a wide-reaching “green” ecosystem could be a very likely scenario, which would be hugely beneficial for Tesla and its shareholders. But of course there are also many risks and obstacles that pose a threat to that ecosystem, some of which include:
1) Ford and other automakers convince consumers that its EVs are more desirable
2) Tesla has nagging issues with autonomous vehicle development that hinder its ability to compete
3) The Model 3 is not a blowout success. This, in my opinion, is the most dangerous threat to Tesla. Even a modest success will not be enough to bail the company out of its precarious financial situation.
4) Another company or group of companies develop a “green” ecosystem that is superior to or implemented earlier than Tesla’s.
5) Lithium-ion batteries become cheap as heck and the Gigafactory becomes irrelevant to cost advantages. This would put Tesla in a very tight spot.
There are plenty more as well. But the only question investors should be asking themselves regarding Tesla is, as I’ve been saying for a while now, “will the Model 3 be a significant success?” If you think the answer is no, don’t own this stock. Tesla’s financial situation is such that it likely cannot survive without this condition. If the answer is yes, then keep an eye on developments regarding the Tesla ecosystem – that’s where the real money is.
Traditional automakers with less control over their product, no ecosystem presence, and those not fully prepared for the paradigm shift from ICE to EV (and autonomous vehicles) could very well find themselves trailing Tesla in operating results as well as market cap. There’s still a long way to go until we see any of these potentials materialize, but the market certainly already sees the possibilities.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.