Tesla Has to Start Acting Like a Car Company
The relationship between Wall Street and the auto industry has always been contentious, with automakers balancing their huge capital needs and long-term business model against investors' relentless focus on short-term returns. Tesla has turned this struggle on its head in its short time as a public company, grabbing market valuations at multiples of earnings that resemble Silicon Valley software startups more than any car company. Now, as the electric automaker struggles to move beyond low-volume production of a single model, investors have to be wondering why they thought Tesla could defy the century-old rules of mass auto production.
Wednesday's news that Tesla continued to lose money in the second quarter surprised precisely no one, yet the markets still sold off Tesla's shares in after-hours trading following its earnings release, driving the price down by 8 percent. This is likely due to Tesla's miss on a non-financial metric: deliveries. Having promised 55,000 deliveries this year, Tesla finished the first half with fewer than 22,000 vehicles sold and lowered Q3 guidance to 11,000 units. This means it would have to deliver about 22,000 vehicles -- or, about the amount they sold in the U.S. for all of 2014 -- in the fourth quarter alone to meet its goal.
Tesla and its bullish investors are quick to argue that this shortfall is the result of production constraints rather than weakening demand, a spin on the story that seems oblivious of the real challenge facing the company. Tesla has had no problem thus far drumming up hype and demand for its cars; where it has struggled is in its efforts to ramp production volumes up to sustainable levels.
Chief executive officer Elon Musk has continually underestimated just how challenging it is to scale up from a low-volume luxury car operation to higher-volume production. He told analysts that the forthcoming Model X is "one of the hardest vehicles in the world" to develop and produce. That is a very naive statement: any automotive engineer can tell you that a compact sedan that sells millions of units each year will always be more of an engineering and production challenge than a six-figure vehicle produced in the low volumes. And though Musk spoke to the challenges of dealing with "thousands of suppliers," he predicted that moving from 55,000 units per year in 2015 to over 500,000 units per year in 2020 would be easier than scaling from zero production to current levels.
This is nonsense. Supply chain and production issues multiply vastly as production volumes rise. Mass-market customers are actually far less forgiving than luxury or early-adopter types. Competition will get tougher and margins will compress as Tesla the luxury brand becomes Tesla the mass-market brand. Musk's breezy dismissal of the challenges associated with scaling up betrays his weak grasp on the brutal realities of manufacturing, even as those challenges push Tesla behind schedule at one-tenth the volume it is targeting in five short years.
This reality will become clearer as Tesla runs out of ways to keep burnishing its Silicon Valley halo. Boosting demand by rolling out performance upgrades -- the latest is called "Ludicrous Mode -- has reached its limits, both in terms of meaningful real-world performance (who needs to get to 60 MPH in less than 2.8 seconds?) and of what the underlying hardware can tolerate. The firm's much-hyped "autopilot" is turning out to be little more sophisticated than the lane-keeping, self-parking and adaptive cruise control features found on many cars currently on the market. Until Tesla gets its new models into production, it will struggle to generate the kind of fawning media coverage it has enjoyed thus far.
Meanwhile, more struggles await: China, long touted as a potentially massive source of demand for Teslas, is both hostile to foreign electric-vehicle makers and in the midst of a major economic correction. Tesla's revenue from California's Zero Emissions Vehicle credit program is also likely to come under pressure, as regulators move to end a fast-refueling credit that nearly doubled the amount of environmental credits the firm could earn. Down to its last billion dollars in cash and burning fast, even as its chief financial officer retires early, Tesla's margin for error has shrunk to almost nothing.
If Tesla can convince its investors to keep taking the long view on its business, it may be able to raise enough debt or equity to bridge the death zone between now and late 2017, when its mass-market Model 3 is due to appear . But that requires finding investors willing to keep faith in a company that can no longer back up the illusion that it is somehow fundamentally different than any other automaker. And even if it can pull that off, sooner or later it has to start actually building and selling cars on schedule and in high volumes. Tesla has to stop trying to convince Wall Street that it isn't "just an automaker" and start acting like one.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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