Tesla Strategy and Valuation
University of Bath
School of Management
Strategic Financial Decisions
(MN20547)
29th November 2015
Alexander Vega
Contents
Introduction.....................................................................................................................1
Tesla’s Strategy and the Industry .................................................................................1
Competitive Advantage..................................................................................................4
Current Valuation............................................................................................................5
Potential Strategy and Valuation...................................................................................9
Conclusion ....................................................................................................................11
References ....................................................................................................................13
Introduction
Tesla Motors (NASDAQ: TSLA) was founded in 2003 in Silicon Valley, USA, with the aim
to provide electric cars that can compete against their petrol-powered counterparts. Martin
Eberhard and Marc Tarpenning set out with the mission to accelerate the world’s transition
to sustainable transport. The company was named after Nikola Tesla, who invented the
AC induction motor, which was key in building their first product, the Tesla Roadster in
2008. Since then, Tesla has launched the Model S, Model X, expanded into car battery
packs, home solar energy storage and sells parts to car manufacturers, such as Toyota
and Daimler. The convenience of free high speed charging units placed along popular
routes in USA, Europe and Asia has led to more than 50,000 Tesla vehicles being on the
road worldwide. This Supercharger network is continuously expanding. “Tesla is not just
an automaker, but also a technology and design company with a focus on energy
innovation.” (Tesla Motors 2015a)
Tesla’s Strategy and the Industry
Contrary to most start up companies, Tesla entered the market as a luxury brand. They
were able to establish themselves successfully, as it is rare for competitors to be able to
afford the high capital investment required to set up in this select market. Their main
strategy from this position has been to lower prices and increase sales volume, providing
affordable mass-market electric vehicles. Model X exemplifies this, as, although being on
the same price level as Model S, it is a larger and more substantial car, therefore relatively
cheaper. Furthermore, the release of the Model X expands Tesla’s target market from the
niche, luxury sports car, to a mass family 4x4.
Their primary strategy is popular in California, where Tesla has strategically placed
production, surrounded by more innovation than in Detroit, a prominent location for other
1
car manufacturers. With the intention to reduce average prices across their models, but
maintain margins, Tesla has been able to decrease costs by using its high negotiating
power with its 200 minor suppliers. Conversely, main suppliers, such as Panasonic, have a
high bargaining power due to the fact that Tesla is extremely dependent on their quality
products and time efficiency. For example, Tesla’s CEO revealed in August 2015 that
since the Model X and the Model S share the same assembly line, a shortfall by one of the
Model X suppliers could slow down output of both vehicles. This caused analysts to doubt
whether Tesla would meet their plans to increase deliveries by 74% this year, resulting in a
5.8% drop in share price (Hull 2015).
Following the mission to decrease prices, individual buyers’ bargaining power would
remain low, as there is high demand and the availability of comparatively priced
technology is limited. This lack of 100% electric alternatives on the market means that the
threat of direct substitutes appears low. However, hybrids and hydrogen cars can also be
considered as potential substitutes and therefore increase competition. As eco-friendly
living becomes more popular, public transport has become more attractive, especially in
city centres. This is a much cheaper alternative to electric cars. The car industry, as a
whole, is very competitive, yet within the niche sector of electric cars the rivalry is
comparatively low. As the industry expands, competition is expected to increase, as more
companies release similar products. This analysis shows that Tesla is currently in a strong
competitive position, but this may be hard to maintain, as the industry is growing.
Tesla is able to follow the incentive of lowering prices and increasing sales volume as they
have a strong technological expertise in electrical cars. Through this, they have set out to
create a Gigafactory, allowing them to make their own batteries, reducing these costs by
approximately 30% (Tesla Motors 2015b) and increasing the availability of this key
2
component. This expertise is also seen through their CEO, Elon Musk, who has proved to
be a valuable asset to the company. By founding PayPal and SpaceX, he has been able to
use his start up experience to propel Tesla into the public eye and increase brand
awareness. However, Musk’s busy schedule, as CTO and CEO of SpaceX, could be
interpreted as a weakness due to his focus being spread over different projects. This might
not be in Tesla’s best interest. Another major issue is the lack of liquidity due to minimal
profits, which can be linked to the high level of reinvestment into Research and
Development (R&D).
Expanding on the fact that there is an increase in environmental awareness and with the
addition of diminishing oil reserves, Tesla could capitalise on a greener standard of living,
such as developing their supercharger network, which must be done in order to provide a
mass-market vehicle.
Supercharger network early 2015
Targeted Supercharger network 2016
(Tesla Motors 2015c)
The danger in increasing volume and expanding into the mass market, however, is that
Tesla is exposed to a greater level of competition from established car manufacturers. Big
automakers have more financial resources and a stable client-base, meaning they could
survive longer in periods of regression. Also, with the aim of progressing from being a
differentiator to one with cost advantages, Tesla risks the possibility of becoming stuck in
3
the middle. This compromise could lead to them being considered overpriced for the
quality of the ‘so called’ luxury product.
Competitive Advantage
Having analysed their position in both the current external and internal environment, it is
debatable whether Tesla’s principle strategy is the main driver towards their competitive
advantage. It can be argued that their distinctive attributes come from the brand and the
products themselves.
Firstly, having established an in-depth knowledge of electric car production following the
Model S, Tesla is able to translate and improve the expertise for the Model X and future
cars. New entrants to the electric car market would have to invest heavily in R&D to reach
the same technological standard. Currently, this is probably one of the most prominent
advantages that Tesla holds over its competitors, as they will be reaping the rewards of
high profits whilst others are still at the investing stage.
Secondly, through this advanced experience they have been able to develop the fastest
charging station in the world, which can charge the vehicle in just over an hour, compared
to the 7 hours required for an 80% charge of the BMW i3 (Tesla Motors 2015b and BMW
2015). The focus on these networks, now spread on many routes throughout the world, is
unique to Tesla. Having established this, Tesla has been able to charge other companies
to use the service. Not only does this increase revenue, but it also differentiates Tesla’s
brand image and gives them further marketing advantages.
Throughout the ten years of operations, Tesla has created a luxury brand image, which is
highly desirable in a world where status comes with the car you drive. This has set the
4
company apart from its competitors and resulted in consumers viewing them as a reliable
and efficient organisation.
Their current strategy is allowing them to obtain competitive advantage, as the opening of
the Gigafactory, which will begin production in 2017, will make them the largest supplier of
battery packs in the world (Tesla Motors 2013). It will seek to improve company
performance by reducing costs and meeting the demand Tesla will face when progressing
into the mass market.
All of these competitive advantage factors, as well as following their main strategy of
lowering average prices and increasing sales volume, have positively impacted the
company performance. This can be seen as sales revenue has increased 28 fold (Market
Watch 2015) and share price has multiplied six times over the last five years (NASDAQ
2015).
Current Valuation
To value Tesla, we focused on the abnormal earnings model, which in this case seemed
most suitable, as Tesla does not currently pay out any dividends and future balance
sheets are hard to forecast. Hence, the discounted dividend model and discounted cash
flows model are not applicable. The following valuation is based on a number of
reasonable assumptions, including the Clean Surplus Relation, to calculate the forecasted
book value of equity.
Firstly, forecasting Tesla’s production timeline (Figure 1), we assumed that each car
manufactured would be sold, as currently demand is greater than supply. Furthermore,
Tesla stated a production target of 500,000 cars by the end of 2020 (Tesla Motors 2015b).
5
Thus, we used an annualised growth rate of 55.5%, a number that has also been achieved
and surpassed in previous years.
The growth rates of the independent cars could be configured, looking at past growth rates,
as well as taking into account the release of the Model X, a direct competitor to the Model
S, resulting in a decrease in demand of the latter. Being direct competitors, we expect both
models to have similar demand in the long run. The Model 3, that is to be released in 2017,
is aimed at the mass market and is expected to make up a significant proportion of the
overall production by 2020 (Young 2015). We also expect the Model 3 to be launched in
the latter half of 2017, similarly to both previous models. However, the expected initial
growth rate will be lower than that of the Model S and X, as competitors will have released
electric substitutes, eventually causing the growth rate to level off. Due to this increased
competition, we have provided a decrease in the average prices to counteract this.
2014 R
35,000
2015 E
55,000
2016 E
85,523
2017 E
132,986
2018 E
206,789
2019 E
321,550
2020 E
500,000
Average Price Model S/$
Average Price Model X/$
Average Price Model 3/$
92,000
92,000
96,000
92,000
96,000
92,000
96,000
42,000
90,000
94,000
42,000
88,000
92,000
41,000
86,000
90,000
40,000
Model S
Model S Growth
Model X
Model X Growth
Model 3
Model 3 Growth
35,000
45,000
29.00%
10,000
54,523
21.16%
31,000
210%
54,376
(0.27%)
40,610
31%
38,000
53,832
(1.01%)
50,356
24%
102,600
170%
51,705
(4.11%)
54,385
8%
215,460
110%
51,302
(0.78%)
56,560
4%
392,137
82%
Production
Figure 1
Moving on to the forecasted income statement (Figure 4), revenue has been compiled by
the forecasted production timeline, multiplying the production volumes with their relevant
prices. The gross profit margin for 2015 is based on the realised three quarters already
given, as well as assuming the final quarter will be 30%, just like in 2016, as stated by
Tesla (O’Hara 2015). The Gigafactory, opening in 2017, is supposed to reduce the battery
6
costs by 30% (Tesla Motors 2015b) (Figure 2), therefore decreasing the costs of sales.
This is taken into account when analysing the 2017-2020 costs of sales, using 70% of
revenue at original prices, less the reduction in costs provided by the Gigafactory. Hence
gross profit margins will rise.
Price per KW Hour for a
battery/$
500
Model S
Model X
Model 3
60
85
48
30000
42500
24000
New Price/$
21000
29750
16800
Change per car/$
(9,000)
(12,750)
(7,200)
KW Hour
Original Price/$
Figure 2 (Dumaine 2014)
Expenses have been broken down into Research and Development and all other nonfinance expenses, such as Sales and Distribution and Administration costs. We expect the
proportion of revenue spent on the latter to decrease over time to below the car industry
average of 10%, as Tesla do not spent a large amount on advertising (Zart 2014). The
R&D proportion will increase until the release of the Model 3, before starting to decrease.
This amount will still be significantly more than the industry average of 6%, as Tesla
continues investing in their Powerwall, Superchargers and software updates.
The interest rate paid on long-term debt has been stable for many years, causing us to
come to the conclusion that they can increase debt at a constant borrowing price of
5.50%. This is beneficial, as debt has been increasing at a constant rate of 12%. As Tesla
intends to invest a further $1 billion into the construction of the Gigafactory, we have
assumed that debt will increase by 12% year on year with an additional injection of $600
million in 2016 and $400 million in 2017. From 2017 onwards, the rate of increase in debt
7
will decline to 8%, as no further models have been planned and retained profits will be
able to be used. This can be seen in Figure 3.
7
Long Term Debt/$
4,218,894,170
2014 R
2015 E
2016 E
2017 E
1,818,785,000 2,037,039,200 2,881,483,904 3,555,261,972
2018 E
2019 E
3,759,682,930 3,980,457,565
2020 E
Figure 3
Lastly, tax expense has been increasing at a steady rate, but has not been substantial.
Once Tesla starts making profits, we expect the tax rate to be at the worldwide industry
average showing the scale of international sales.
2014 R
2015 E
2016 E
2017 E
2018 E
2019 E
2020 E
Income
Statement
Revenue/$
3,220,000,000 5,100,000,000
Gross Profit Margin
41.93% Cost of Sales/$
Gross Profit/$
7,992,116,000 10,497,143,325 13,887,620,403
18,387,321,436
25,187,930,034
27.381%
26.18%
30.00%
42.20%
42.38%
42.30%
2,338,329,000 3,764,820,000
5,594,481,200
6,067,239,676 8,001,942,665.13 10,608,933,459.50
14,627,312,666.94
881,671,000 1,335,180,000
2,397,634,800
4,429,903,649
5,885,677,737
7,778,387,977
10,560,617,367
% of revenue on S&D etc.
8.00% S&D, Admin etc./$
18.75%
22.40%
20.00%
17.00%
14.00%
11.00%
603,660,000 1,142,400,000
1,598,423,200
1,784,514,365
1,944,266,856
2,022,605,358
2,015,034,403
% of Revenue on R&D
14.43%
18.60%
20.00%
18.00%
15.00%
12.00%
10.00% R&D/$
464,700,000
948,600,000
1,598,423,200
1,889,485,799
2,083,143,060
2,206,478,572
2,518,793,003
EBIT/$
(186,689,000) (755,820,000)
(799,211,600)
755,903,485
1,858,267,821
3,549,304,047
6,026,789,961
% of Long-Term Debt
5.55%
5.50%
5.50%
5.50%
5.50%
5.50%
5.50% Net Interest Expenses/$
100,886,000
112,037,156
158,481,615
195,539,408
206,782,561
218,925,166
232,039,179
EBT/$
(287,575,000) (867,857,156)
(957,693,215)
560,364,077
1,651,485,260
3,330,378,880
5,794,750,782
Tax rate
26.20%
26.20%
26.20%
26.20% Tax Expense/$
9,404,000
10,654,600
12,071,512
146,815,388
432,689,138
872,559,267
1,518,224,705
Net Profit/$
(296,979,000) (878,511,756)
(969,764,727)
413,548,689
1,218,796,122
2,457,819,614
4,276,526,077
Figure 4
To value Tesla we first had to calculate the cost of capital. This was done using the Capital
Asset Pricing Model (CAPM). The market risk premium that was used was 5.5% (VW Staff
2015). This is the only constant in the equation:
Expected rate of return = risk − free rate + β × market risk premium
8
The other values were found to be very volatile. For Beta and the risk-free rate we used
values obtained on the 24th November 2015. However, due to the fact that these values
are constantly changing, calculating the CAPM on a different day would lead to a different
valuation of the company. These figures are 1.12 for the Beta and 2.25 for the risk-free
rate, for which we have used a US ten-year government bond. The US government bond
is the most relevant rate, as the majority of Tesla’s sales are in the US and their stocks are
8
traded on NASDAQ. This gave us a CAPM of 8.41%, which we then incorporated into our
valuation calculations.
Net Profit
Book Value of equity (BVE)
Re*Book Value of Equity
Net Profit-Re*BVE
Discount Factor
(Net Profit-Re*BVE)/(1+Re^n)
2014 R
2015 E
2016 E
2017 E
2018 E
2019 E
2020 E
(296,979,000) (878,511,756) (969,764,727) 413,548,689 1,218,796,122 2,457,819,614 4,276,526,077
911,710,000
33,198,244 (936,566,483) (523,017,794)
695,778,327 3,153,597,941 7,430,124,018
76,674,811
2,791,972 (78,765,241) (43,985,796)
58,514,957
265,217,587
(955,186,567) (972,556,699) 492,313,930 1,262,781,918 2,399,304,656 4,011,308,490
1.0
0.9224
0.8509
0.7849
0.7240
0.6678
0.6160
911,710,000 (881,087,139) (827,515,697)
386,397,307
914,220,545 1,602,280,970 2,470,984,358
Figure 5
Following our valuation method, we calculated Tesla to have a market capitalisation of two
billion USD, excluding terminal value. This is made up of the company’s abnormal
earnings from 2014 to 2019, as can be seen in Figure 5. However, including terminal
value, where we have assumed a growth rate of 2.20% for abnormal earnings in the long
run, Tesla’s value will be estimated at just over six billion USD (6,211,398,050 USD). This
translates into a share price of 49.42 USD, compared to today’s actual 229.64 USD per
share (NASDAQ 2015).
We believe Tesla will be able to maintain a competitive advantage and thus abnormal
earnings by investing above the industry average in R&D. Nonetheless, we believe Tesla
to be currently overvalued, even taking into consideration the value added by brand
image, reputation and potential.
Potential Strategy and Valuation
We recommend, in order to increase their value, that Tesla should focus solely on their
electric vehicles and Supercharger network and stop investing their money into Research
and Development of the other aspects of the company. Currently, the innovation and
production cost of their new product, the Powerwall, is a massive drain on resources. This
product is a home battery, which stores solar energy, converting it to direct current to be
9
used in the evenings. Concentrating on a narrower product range would also allow the
company to reduce other expenses, representing for example smaller administration
costs.
By enforcing this alteration, Tesla would be able to increase their profit margins as they
could benefit from reduced expenses. These profits could be redistributed in a number of
ways. One possibility is that they could be used to improve the technology involved in the
production of electric vehicles. This could trigger a multiplier effect, snowballing
attractiveness and demand, therefore increasing sales and leading to yet more profit in the
future. Alternatively, a proportion of the profits that would have been leant to the
Powerwall, could be paid out as a dividend to shareholders. This would be a popular
option amongst investors, as there have been no previous payouts and as long as the
company is performing well, they should acknowledge the patience and continued
financial support of shareholders.
2014 R
2015 E
2016 E
2017 E
2018 E
2019 E
2020 E
Income Statement
Revenue/$
Gross Profit Margin
Cost of Sales/$
Gross Profit/$
3,220,000,000 5,100,000,000
27.381%
26.18%
2,338,329,000 3,764,820,000
881,671,000 1,335,180,000
7,992,116,000
30.00%
5,594,481,200
2,397,634,800
10,497,143,325 13,887,620,403
18,387,321,436
25,187,930,034
42.20%
42.38%
42.30%
41.93%
6,067,239,676 8,001,942,665.13 10,608,933,459.50 14,627,312,666.94
4,429,903,649
5,885,677,737
7,778,387,977
10,560,617,367
% of revenue on S&D etc.
S&D, Admin etc./$
% of Revenue on R&D
R&D/$
EBIT/$
% of Long-Term Debt
Net Interest Expenses/$
EBT/$
Tax rate
Tax Expense/$
1,782,194,212
Net Profit/$
18.75%
603,660,000
14.43%
464,700,000
(186,689,000)
5.55%
100,886,000
(287,575,000)
9,404,000
19.00%
969,000,000
16.00%
816,000,000
(449,820,000)
5.50%
112,037,156
(561,857,156)
10,654,600
17.00%
1,358,659,720
17.00%
1,358,659,720
(319,684,640)
5.50%
158,481,615
(478,166,255)
12,071,512
14.00%
1,469,600,066
15.00%
1,574,571,499
1,385,732,085
5.50%
195,539,408
1,190,192,676
26.20%
311,830,481
(296,979,000)
(572,511,756)
(490,237,767)
878,362,195
11.00%
1,527,638,244
12.00%
1,666,514,448
2,691,525,045
5.50%
206,782,561
2,484,742,484
26.20%
651,002,531
9.00%
1,654,858,929
9.00%
1,654,858,929
4,468,670,118
5.50%
218,925,166
4,249,744,952
26.20%
1,113,433,178
7.00%
1,763,155,102
7.00%
1,763,155,102
7,034,307,162
5.50%
232,039,179
6,802,267,983
26.20%
1,833,739,953
3,136,311,775
5,020,073,771
Figure 6
This alteration in the strategy should prove effective and have a positive impact on
company performance, as shown in Figure 6, where the percentages of revenue spent on
R&D and other expenses have been reduced. It also leaves Tesla with the opportunity to
10
move back into the production of the Powerwall in the future, when they are more
established and have greater financial reserves.
2014 R
2015 E
2016 E
2017 E
2018 E
2019 E
2020 E
(296,979,000) (572,511,756) (490,237,767) 878,362,195 1,833,739,953 3,136,311,775
5,020,073,771
Book Value of equity (BVE)
911,710,000 339,198,244 (151,039,523) 727,322,672 2,561,062,625 5,697,374,400
10,717,448,171
Re*Book Value of Equity
76,674,811
28,526,572 (12,702,424)
61,167,837
215,385,367
479,149,187
Net Profit-Re*BVE
(649,186,567) (518,764,339) 891,064,619 1,772,572,116 2,920,926,408
4,540,924,584
Discount Factor
1.0
0.9224
0.8509
0.7849
0.7240
0.6678
0.6160
Net Profit
(Net Profit-Re*BVE)/(1+Re^n)
911,710,000 (598,825,355) (441,399,082)
2,797,230,292
699,360,608 1,283,295,099 1,950,625,481
Figure 7
Recalculating abnormal earnings, as shown in Figure 7, as well as terminal value, gives us
a new total market value of eight and a half billion USD (8,456,132,958 USD), resulting in
a share price of 67.28 USD. This is a 36.14% increase, compared to the pre-change
strategy.
Conclusion
All of the assumptions and values forecasted above have a very optimistic view on Tesla’s
current and future position. The target stated by Tesla to produce 500,000 cars by 2020 is
desirable but not necessarily realistic, despite the fact that we have incorporated it into our
valuations. If there were to be any negative publicity or adverse effects on Tesla’s brand
image or production respectively, these would heavily impact the likelihood of our figures
being accurate. Also, in Figure 1, we forecasted production based on a 55% increase each
year. This is realistic for the first few years, however, as we progress from 2018 to 2019
the increase is 114,000 and between 2019 and 2020 it is close to 180,000. From this point
onward the prediction then begins to seem impractical and unachievable. Our valuation
11
also doesn’t take into account Tesla’s 200 patents, and the other intangible assets that the
company boasts, such as brand image and customer loyalty.
12
The alteration to Tesla’s strategy does increase profits quite significantly, as shown in
Figure 6, and the share price increases to 67.28 USD. Although Tesla is using the
Powerwall to broaden their product range, the primary focus on electric cars would be
beneficial if they wish to maximise profits. We realise that profits have not been a priority of
Tesla’s in the past and they deem growing the brand to be of higher importance. This is a
limitation of our recommendation, but could be a different approach to improve Tesla’s
balance sheets.
This report has found that, although Tesla is trying to pave the way for a more
environmentally friendly generation, it needs to ensure it does not default on their
shareholder’s trust, which has kept them financially afloat for the past decade. Their
strategy of lowering prices and increasing sales appears to be efficient, especially with the
expected release of the Model 3. This should allow them to maintain a competitive
advantage and therefore abnormal earnings, resulting in an elevated valuation.
13
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