Tesla Offering Far From Electric

Tesla develops premium electric vehicles that have proved popular among wealthy individuals, environmentalists, and the media, but we question its ability to drive profitable growth over the long run.

Incorporated in 2003, Tesla began selling the Roadster, its first and only production-ready model, in 2008. The Roadster competes in the premium sports-car segment at a base price of $101,500 and has the ability to go from 0 to 60 miles per hour in an impressive 3.9 seconds. The premium sticker price has allowed the company to integrate technologies and performance capabilities that prior generations of battery-powered vehicles failed to include due to cost restraints. Nonetheless, Tesla's future success hinges on its ability to develop more-affordable vehicles, specifically the much anticipated Model S--expected to debut in 2012. The Model S will compete in the premium-sedan segment and is expected to garner a base price of $49,900. Tesla has already received around 2,000 orders for the vehicle and hopes to achieve an annual production rate of 20,000 cars. For comparison, the company has sold 937 Roadsters as of year-end 2009, with about 220 more on order.

The Obama administration's goal to have one million electric-drive vehicles on the road by 2015 should prove beneficial for Tesla. Consumers currently are eligible for a $7,500 tax credit upon purchase of an alternative-fuel vehicle and the U.S. Department of Energy (DOE) recently created a loan program to provide funding to companies that are developing alternative fuel technologies. Tesla received $465 million in loans through the DOE program, which combined with the proceeds from its equity offering will fund the construction of manufacturing facilities for the Model S.

Although Tesla may garner a first-mover advantage in the premium electric-vehicle segment, we think it will struggle to grow beyond its novelty status. Many of the company's initial customers were affluent individuals that had pre-existing relationships with management. As a result, we think Tesla will struggle to attract new orders and could see its current order book deteriorate if the Model S faces further delays (the vehicle initially was scheduled to debut in 2011). The company also faces stiff competition from deep-pocketed competitors in the capital-intensive premium-vehicle segment. Furthermore, Tesla plans to eventually expand to a mass-market level, which will likely require years of operating large research and development budgets; vehicle development costs could reach upward of $1 billion. The price of gasoline also plays a critical role in determining the affordability of the company's vehicles compared to products powered by combustion engines. At current gas prices, we think electric vehicles will struggle to attract a mass-market audience.

Having yet to generate an annual operating profit, management has suggested losses could accelerate over the near term as the company prepares to launch the Model S and copes with the discontinuation of the Tesla Roadster next year (resulting from tooling changes at a key supplier). Moreover, we think the company will have to revisit the capital markets shortly, given the rate at which it's burning through cash. We also have concerns regarding Tesla's corporate governance, with past financial audits bringing into question its internal reporting controls and several antitakeover provisions compromising shareholders' interest. CEO and chairman Elon Musk's additional roles as CEO of Space Exploration Technologies and chairman of SolarCity make us question his ability to shift Tesla forward into a viable automaker.