Inside Business

July 3, 2013 6:55 pm

Real tests still lie ahead for Tesla

Zero-emission credits and tax benefits can’t be counted on indefinitely, writes Richard Waters

A few years ago, Bill Ford, scion of the automotive dynasty, was politely scathing about electric car company Tesla Motors.

The two-seaters it was turning out at the time, based on bodies produced by Lotus, were certainly eye-catching. But according to Mr Ford, building a fully fledged car company – mastering everything from global supply chains to the handling of regulatory agencies around the world – was simply beyond the reach of a start-up.

This month, as Tesla’s Model S electric sedans start to roll off the boats in Europe, he might want to reconsider. The vehicle, which went into full production late last year, has quickly become Silicon Valley’s favourite status symbol, a mark of the driver’s superior style, environmental awareness and tech savvy, all in one. The S is now ready for the world stage.

Tesla’s shares hit another high this week – at $13.6bn, its value has risen 250 per cent this year, making it worth nearly a third as much as giants such as General Motors and Nissan, and 50 per cent more than Fiat. But Elon Musk, the company’s visionary and pugnacious chief executive officer, still has a long way to go to justify such a frothy valuation.

To get this far, Mr Musk has benefited from some timely tailwinds. He inherited a car plant at a knock-down price in the depths of the car industry’s post-financial crisis depression. And the cheap capital he has just been able to raise, thanks to Tesla’s soaring stock price, is a self-fulfilling prophecy, carrying him over a yawning funding gap that loomed as he contemplated future models.

In fact, as long as Tesla’s shares keep going up, everyone is happy. Investors who just bought $600m worth of bonds that convert into Tesla stock at a 35 per cent premium have already come within a whisker of seeing the conversion price breached. The short sellers who flocked around the stock have been seen off, at least for now – short interest in the stock has fallen to 27 per cent of the tradable float, from nearly 45 per cent at the peak.

Government subsidies in the US have also been a boon. Selling pollution credits to other car companies that have yet to meet state-level rules for producing zero-emission vehicles netted Tesla some $17,000 a car in the first quarter – equivalent to 88 per cent of its gross profit. Its customers, meanwhile, get a $7,500 federal tax credit and assorted perks thrown in by state governments.

However, it is when the music stops that things will get interesting. Those zero-emission credits and tax benefits can’t be counted on indefinitely and won’t carry Tesla in the global markets into which it is now expanding, with deliveries to Europe this summer and Asia later in the year.

Mr Musk has been rolling up his sleeves for the hard work: refining the supply chain and knocking the glitches out of the production process to show that the S can turn a profit while stealing market share. From barely 2 per cent in the first quarter, he has vowed to lift Tesla’s gross profit margin to 25 per cent by the fourth, even without the pollution credits.

His bigger challenge remains what it always has been: to create demand for a plug-in electric vehicle beyond the early adopters. This means overcoming customers’ understandable resistance to a new technology. Above all, Mr Musk still needs to deal with the anxiety about range that many potential buyers feel when considering an electric car. Tesla’s battery innovations have pushed the range of the S well above 200 miles on a single charge, and Mr Musk has come out with a string of ideas for supplementing this such as rapid charging stations and battery-swapping centres placed on strategic routes. But introducing these rapidly in the markets he now wants to enter will prove a stretch.

With the Model S, Mr Musk at least has a bona fide hit: its styling and performance have won it both awards and enthusiastic reviews. The momentum should be enough to carry Tesla to the launch late next year of an SUV called the Model X – though, like Pixar in its early days, it can’t afford for any of its eye-catching first productions to be a flop.

Only after that comes a shot at the real prize: an electric vehicle priced for the mass market. This is where Mr Musk has always set his sights, and what justifies a share price that is 135 times even 2014’s expected earnings.

Tesla’s ability to break into the big league as the first mass-market electric carmaker is still a long shot. But betting against the persistent Mr Musk, as Wall Street’s short-sellers have found to their cost this year, can be a painful experience.

Richard Waters is the Financial Times’ West Coast Managing Editor

Richard.Waters@ft.com

www.ft.com/insidebusiness

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