Competition and Valuation A Case Study of Tesla Motors

Assignment Task

Introduction

You’re now Valuations Level 1 qualified. Noting your good work on the coverage of local technology stocks, your VP has organized your biggest challenge yet – the valuation of Tesla Inc. Tesla stands out as one of the most scrutinized companies globally, eliciting a wide range of opinions. Leading the valuation of such a company is no small feat. A particularly intriguing aspect of Tesla is its dual identity crisis: is it “Big Tech” or “Big Auto”? You’ve skilfully assembled and trained a team dedicated to developing an intrinsic valuation model. They have crafted a comprehensive model (excluding a cost of capital analysis) that maps out the firm’s cash flows (WholeCo) alongside a sum-of-the-parts (SoTP) valuation. Fortunately, you’ve been spared the laborious process of building yet another pro-forma model from scratch. Instead, the responsibility of conducting a relative valuation, including an economic profit analysis, falls to you. As always, time is a luxury you don’t have! The task ahead requires you to deftly weave through the complex tapestry of market disruption, technological innovation, and the cacophony of market opinions. Your expertise will be the guiding light in this intricate endeavour, as you strive to distil clarity from chaos and establish a 12- month price target.

Overview

Tesla, Inc. is an American automotive manufacturer founded in 2003 by engineers Martin Eberhard and Marc Tarpenning. It’s current CEO, Elon Musk has played a pivotal role in the company, from his early investments in the firm through to his appointment as chief product architect and company leader in 2008.2 Originally incorporated as Tesla Motors, its foray into automation, battery technology and artificial intelligence forced a firm rebrand, resulting in the subtle name change to Tesla Incorporated in 2017. Its principal operation involves the design, development, manufacture, lease and sale of high-performance fully electric vehicles, solar energy generation systems and energy storage products. The company also offers maintenance, installation, operation, financial and other services related to its products. The company is also focused on products and services based on artificial intelligence, robotics, and automation. To date, Tesla has sold more than five million vehicles. Tesla is listed on NASDAQ, briefly peaking as the world’s largest automobile enterprise by market capitalization.

The Tesla Masterplans

The original master plan for Telsa, “The Secret Tesla Motors Master Plan (just between you and me)” (website), was written in 2006 by Elon Musk, laying out the company vision. The original company plan contained four basic elements, summarised as: 1. Building a sports car; 2. Using the money gained from sports car sales to build an affordable car; 3. Using the money from the activities to build an even more affordable car; 4. Creating zero-emission (solar power) generation options. The second plan, nearly a decade later in 2016, labelled the “Master Plan, Pard Deux” (website) detailed a similarly ambitious plan to: 1) Create solar roofs with integrated battery storage; 2) Expand the electric vehicle product line to address the greater market; 3) Develop safe self-driving vehicles; 4) Create a Tesla shared fleet to allow user passive income.

Automotive

Tesla’s primary business currently stems from its automative line. The automative business can be divided according to i) Automative sales ii) Automative regulatory credits; iii) Automotive leasing. Among these three areas, the sale of vehicles accounts for the majority of the revenue

Expanding the Line-Up

Tesla’s electric offering has grown from servicing the sedan and SUV vehicle segments into a line-up of products that span a broad range of vehicle types including trucks, busses, and commercial vehicles. The Cybertruck, which was announced in November 2019, swung into production in the second half of 2023 after numerous project delays.4 Looking forward, Tesla has spoken of a next generation model (Model 2 – codename “Redwood”), which is expected to be an entry level compact car with a lower price point relative to the existing fleet. According to reports, Tesla has sounded out suppliers for a mid-2025 start, with the model described as a ‘compact crossover’. This new model requires the development of new factories with mooted locations

Revenue Forecast

Automative revenues are forecast with consideration for price and quantity factors.5 With respect to unit sales, Tesla is targeting c2.3m unit sales for 2024 and c20m by 2030. Given that industry BEV sales are forecast ~41m units by 2030, this would imply ~50% market share which is an exceptionally aspirational target. In the model supplied, Tesla’s unit sales are forecast to reach ~3m units by 2025e and ~8.5m by 2030e.6 Though well below Tesla’s ambitions, this forecast implies delivering nearly c5x as many units from 2023 levels by the end of the decade. In addition to the existing Model 3 and Y, it is expected that the launch of the Cybertruck (2023), the entry segment car (Model 2, 2025e), and its SUV version (2027e) will be the main drivers of the volume growth. The penetration of the pickup truck market in the U.S is nearly 20%, with the Ford F-series comfortably ranked as the market leader. It is hoped that the array of performance, durability, price, and technology and environmental advantages will allow Tesla to develop a foothold in the pickup truck market segment. Despite some execution risk around vehicles in the entry model segment of the market, the working assumption in the provided model is low-cost models will account for close to half of unit sales by 2030.

It should be noted that delivery depends on the capacity to produce. Tesla’s stated annual installed capacity as of 2Q23 is ~2.25- 2.50m units. Capacity and production are affected by a range of possible factors including program ramps, equipment uptime, planned downtime and supply chain factors. Of its production facilities, the Shanghai facility significantly outpaces both its Berlin and Texas facility. The introduction of its Mexico facility (pending approvals) which increase capacity, alongside further investment in existing facilities, however, this will require further investment over time. In fact, to reach the aspirational 20mm unit target by 2030, there are suggestions that an additional 10-15 additional facilities would be required.

There are perhaps three key advantages:

1) Cost Leadership – this has been a central driver of the group’s auto ambitions.

2) Technology Leadership A closing gap?

3) Brand Identity and Innovation Culture

Cost Leadership

Tesla’s auto margins have ranged between 10-15% over the last few years. With recent and successive price cuts, these margins have approached the lower end of this range. Nevertheless, Telsa generates higher margins than its EV peers and many incumbent OEMs. Looking at BEVs only, Tesla profitability exceeds all its rivals, with BYD the only other non-loss-making peer (EBIT margin, 3Q23 c4%). Amongst traditional EU carmakers, only Volvo reports BEV profitability with a 3Q23 gross margin of c9.4%.

Tesla has a significant cost advantage in terms of its COGS ratio compared with both incumbent and EV-tech players. With its 2m unit sales, Tesla’s c74% COGS margin ranks favourably to BMW Auto (c85%), GM Auto (c80%), Ford (c85%) and BYD (c84%). A BEV-nature, a dedicated supply-chain insourcing batteries and parts manufacturing and relatively low complexity (i.e. Tesla has 4 models compared to 26 models for BMW respectively) as well as a relatively high level of software vertical integration has helped achieve this. To explain this, one must consider that batteries account for the bulk (c50%) of the cost of an EV. Therefore, a cost advantage in the battery manufacturing process gives a carmaker a considerable value-advantage. Industry estimates suggest that the cost of the Tesla battery pack is at least 20?low the industry average, and given its scale, access to gigafactories, its first mover advantage and the vertical integration of its operations, this may be a reasonable assumption. Whilst further battery cost reductions are almost inevitable, how much further they will fall and whether Tesla can maintain is comparative edge is less certain. During its battery day in 2020, Telsa commented that it would be able to bring battery costs down by 56% by 2025 through a variety of advanced technologies including: 1) better cell design; 2) manufacturing optimisation; 3) Silicon Anode; 4) shifting away from lithium nickel-cobalt-aluminium oxide (NCA) batteries in favour of lithium ferro phosphate (LFP) batteries; 5) innovative battery integration in the vehicle structure. According to the company, not only will this bring the cost of batteries down, but it will also increase Telsa’s range per vehicle by 54% and reduce investment in terms of GWh by 69%.

variety of risks to this battery cost advantage including the fact that competitors are additionally investing significantly in battery cell production, and the risk associated with raw material sourcing. There is also disruptive risk from solid state batteries which have superior range, shorter charging time and better stability than conventional lithium-ion batteries. According to Telsa’s Investor Day in March 2023, Tesla discussed its aim to reduce manufacturing costs further by 50% in the next-gen vehicles (Model 3/Y). To achieve this, it would focus its attention on parallel and series assembly processes and optimising material flow in a bid to shorten the final assembly line. Through this course of action, the firm expects up to a 40% footprint reduction, which would lower future levels of capital expenditure and lower manufacturing costs.

Technical Advantage

EV efficiency along with battery capacity defines vehicle range. The table below summarises Tesla vehicles against comparators which reveals that there are no large efficiency gains held by Telsa over its peer set. Whilst Tesla appears to hold a minor advantage over its peers in terms of the energy density (gravimetric, kWh/Kg and volumetric Wh/litre) at pack level, its vehicles powertrain efficiency which refers to how effectively its engine, transmission, and other components converts energy into useful work after accounting for losses due to friction, heat, and other factors suggests that users do not enjoy any sizeable gains over other BEVs. Similar conclusions can also be drawn from empirical data about battery charging times and degradation.

COST OF CAPITAL:

a) Estimate Telsa’s weighted average cost of capital (WACC). Detail and critique your assumptions, the method used to attain these estimates and how WACC was calculated.

Relative Valuation

a) Should Tesla be valued as a car marker? Comment on this specifically addressing the choice of peers and multiples.

b) How much reliance should be given to a relative valuation and what, if any shortcomings are associated with this approach (specifically in relation to Tesla).

Economic Profit

a) Has Tesla historically generated profits that exceed its dollar cost of capital? Is it projected that Tesla will continue to generate profits surpassing the dollar cost of capital in the future? Calculate the enterprise value and value per share for Tesla using an economic profit model.

b) What does your analysis suggest about historical and forecasted performance?

Discussion

a) Compare and contrast the valuation estimates you have calculated using DCF, relative, economic profit methods.

b) Examine the distinctions between these methods and evaluate the merit of employing a weighted value approach (“triangulation”) to establish a 12-month price target.

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