Dean Barber

Skeptical Me

In Site Selection on March 16, 2014 at 5:17 am

So an old friend from my newspaper days in Columbus, Ga. — we’re talking the early 1980’s – sent me a message via LinkedIn.

He’s now living in Phoenix as a free-lance writer. He didn’t supply me with any information on how he was doing, nor did he ask how I was doing. He must have presumed that we are both hanging in there like old coots do.

He wrote just a single line: “What is your take on this?” And then he added a link to a USA Today story on Tesla.

Unless you have been camping in the wilderness, you probably know that the luxury electric car maker has announced that it will  build a $5 billion, 10-million-square-foot “gigafactory” that will employ 6,500 people to mass produce lithium-ion batteries for its EV vehicles.

So I wrote him back, having done no research or given much thought to the subject at the time.

My Initial Impression

“Sounds way too big of a project in terms of people and capital. Also, I question whether Tesla, which admittedly builds a great product, has the financial means to pull this off.”

That’s what I said then, on March 3 without the benefit of any research, and that’s still pretty much my opinion now that I have looked into the matter. Mind you, I am capable of changing my mind.

There is this mythic quote attributed to British economist John Maynard Keynes who was being chided by a member of parliament for altering his views on an economic question. His reply:

“When I’m wrong, I change my mind. What do you do, sir?”

Keynes also reportedly said: “There is no harm in being sometimes wrong — especially if one is promptly found out.”

Well, let us hope that I will be promptly found out regarding this Tesla project. Again, I do not doubt that a plant could be built in one of four states – Nevada, Arizona, New Mexico or Texas – where the company says it is looking. But I do doubt the published scope of the project.

Might This Sound Odd?

When your specs call for a 10-million-square foot facility costing $5 billion to build and equip and employing 6,500 people, well, that does sound more than a bit ambitious. And all this from a company that has yet to turn an annual profit? Might this sound odd to you?

But reaching for the stars is what Tesla CEO Elon Musk does. He is also, after all, the CEO of SpaceX, which designs, manufactures and launches advanced rockets and spacecraft. 

Certainly, Musk has been a positive disruptive force in the automotive industry. How can you not admire a guy who said this: “Failure is an option here. If things are not failing, you are not innovating enough.” 

Now that is an interesting take on things. I think I will use it on my wife the next time I lose a contract proposal. “Honey, our proposal was just too innovative for them.”

But I do like Tesla, although I have never driven one of their cars. And while I read all these bullish news reports, gushing over the idea of this gigafactory being built, somehow I cannot help but to be Skeptical Me. Again, I think a plant may be built, but my bet is that it will be scaled back in size.

First I am going to tell you why I might be wrong. Then I am going to tell you why I might be right.

Let Us Praise a Good Company

Let us start by praising this American tech-savvy company. This is a wonderful story of underdog making good. I have no doubt that Consumer Reports,  widely considered to be the single most influential magazine among car shoppers, got it right when it called Tesla’s Model S a ‘technological tour de force,’ and awarded the all-electric sedan its top ranking.

While Tesla delivered only about 22,400 electric Model S sedans in 2013, its plans to build the world’s biggest battery plant, expand into China and accelerate production more than 55 percent this year is energizing investors. Tesla shares have raced ahead 56 percent year to date and a mind-blowing 500 percent in the past 12 months.

It is a performance unmatched by any global automaker in at least 20 years. Still, investors are paying a $26.7 billion valuation for a company that’s yet to make money. And because it has yet to turn a profit, there is no price-to-earnings ratio. Tesla shares are trading at 43 times book value and 14 times sales, which is 12 times higher than the valuation on the industry, according to Reuters.

An Overpriced Stock?

Leave it to say that there is murmuring on Wall Street that Tesla stock is “dangerously” expensive based on the current value of its expected future cash flow. (The stock closed Friday at $230.97.) Wait a second, this was supposed to be the good part about Tesla.

Tesla’s share price run-up has given Musk an opening to sell $2 billion of convertible notes, up from an initial plan to offer at least $1.6 billion, to fund his new battery plant. But Musk will still likely need a partner or partners to build this future plant.

Supposedly Panasonic, which currently supplies the batteries to Tesla, is considering investing $1 billion in the venture. Even if Panasonic is in, that may leave a shortfall of a billion or two, which is not chump change.

This all begs the question for me as to whether Mr. Musk might be attempting to bite off more than he can chew. But surely that cannot happen. Titans of industry never make such mistakes.

Running with the Big Boys

But the truth is that if Tesla’s planned gigfactory is to work, the company will have to find ways to cut the cost of its vehicles, now priced from about $71,000, to draw more mainstream buyers, all the while turning back potential challenges from larger, established automakers. You know, companies like Ford and Toyota.

By Tesla’s own estimate, it will produce about 500,000 cars per year by 2020, or roughly 14 times the amount it made last year. (Estimates are that it will sell 35,000 units this year.)

But to reach that 500,000 cars-per-year mark, you can bet that Tesla can’t continue delivering cars on flatbeds and battling every state’s franchise laws. Ironically, two of the Tesla’s supposed finalist states for the gigafactory, Arizona and Texas, do not permit the Tesla business model of selling direct to the consumer. Under those states’ laws, and now New Jersey, too, only approved dealerships can sell cars.

What is clear is that Tesla is a cutting edge, tech savvy, luxury manufacturer that has done surprising well by offering a superior product and marching to a different beat. But it has yet to prove itself as a credible player for the mass market, which is my fundamental qualm about this announced $5 billion manufacturing facility.

(Of course, Tesla could always hire me on their site selection project and if I am wrong, I am capable of changing my mind.)

Better Batteries Cheaper

For Tesla to get to the promised land — for its $35,000 “Gen III”  yet-to-be-named EV to become a reality and to sell en masse at that 500,000 mark– the company needs batteries to be produced at a fraction of their current cost.

Of course, that’s the main purpose for gigafactory. Tesla said it would surpass any current lithium-ion cell factory in the world and reduce battery costs by at least 30 percent. I hear you. And I hope you are right. But I still have to wonder.

Batteries are heavy, which likely means that the product will likely be moved by rail from the gigafactory site to the Tesla’s assembly plant in Fremont, Calif., which is served by the Union Pacific Railroad. So a rail served site by the UP is probably a requirement.

Tesla also wants his future gigafactory to make batteries for homes that could store power from solar panels. I’m sure that is a potentially growing market, but it’s not yet a big market. Still, what Teslsa proposes is humongously big – 10 million square feet big.

The fact that Americans are keeping older cars longer than ever and that even electric cars that are being sold for less $30,000 are not exactly flying off shelves would indicate to me that this project may be more inflated with aspirations than analysis.

But sometimes visionary billionaires can pull off building their dreams in a big way and prove us skeptics all wrong. I wouldn’t mind that happening. I’ve always liked stories of an underdog taking on an industry and winning.

I’ll see you down the road.

Dean Barber is the president/CEO of Barber Business Advisors, LLC, a site selection and economic development consulting firm based in Plano, Texas. If your company needs an optimal location for future operations anywhere in North America, we can help. If your community needs to improve its competitive standing, we can help. All requests for information are considered confidential.

© Unauthorized use of this blog is strictly prohibited. Excerpts and links may be used, but only if expressed permission has been granted.

 

 

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  1. I think the side market for storing energy from solar panels could take off depending on timing. There are some companies looking into the solar panel thing here. Goodness knows the energy market needs innovation that makes it more competitive – it still holds a very strong resemblance to a monopoly. The electric car issue I agree is problematic – units will have to be much cheaper to sell on mass and yet still reasonably powerful. There direct sell model helps cost, but I can see why they are getting push back. There shouldn’t be any reason to force franchises really if they are supporting a competitive market – I guess we’ll see how it plays out:). Good article thanks Dean!

  2. Well done Dean. I would like to add 3 additional challenges Tesla faces… I believe subsidies play a key part in their sales, when those go away, margins tighten further. The folks in N. Dakota have something to say about electric cars getting more competitive, as they pump oil like never before. Last but not least, just like solar and wind, there is a guy in town named China, that can come in and undercut pricing on batteries real fast and hard. Dean, it is
    great to see someone question conventional wisdom, again, well done.

  3. The articles are referencing $1 billion in “incentives,” or taxpayers money, from several Sates. There will also be federal support, maybe a $1 billion loan from DOE. $2 billion in public subsidies (40% of the total cost) would demonstrate we are stupid and/or gullible as a Nation.

    If the deal makes economic sense, the private market should finance it. This is in addition to the reality that EVs do not make sense, without subsidies, of course.

    If something is viable it does not need subsidies. This is as just as stupid as public financing for sports stadiums.

  4. There is no doubt that the Tesla business model is a disruptive technology. I agree with Trish that home solar panels, in combination with battery support, could also be disruptive, especially to the existing electricity providers and oil producers. S. Slater also has a point about China as a producer of solar and wind power components, but, if fuel prices rise, China will have a disadvantage when it comes to transporting battery packs to North America. Much of the shipping cost comes from the dunnage charges for retuning empty containers back across the Pacific.

    I remember a few years ago when the British Top Gear TV show compared the ‘greenness’ of a Land Rover and a Prius. The Land Rover won out when shipping of battery components was added in to the equation. That factor may be what Tesla is counting on in building its giga-factory. Shipping charges would be negligible, in comparison to the current arrangement.

    Elon Musk has a tradition of disruption. In addition to Tesla and Space-X, he also founded PayPal, which turned internet financial transactions upside down. Why not the automotive, home electric power, and oil business?

    Thanks for an interesting blog.

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