Why Tesla’s stock is in overdrive

(Daniel Reinhardt/ EPA ) - A 'Model S' by Tesla Motors is on display at the company's exhibition booth at the 2013 Frankfurt Motor Show in Germany.

(Daniel Reinhardt/ EPA ) - A 'Model S' by Tesla Motors is on display at the company's exhibition booth at the 2013 Frankfurt Motor Show in Germany.

Tesla Motor’s stock is still in overdrive — and not just because of its sleek cars.

To keep racing forward over the past few months, Tesla has relied on feats of financial engineering as much as automotive engineering, wooing rich investors and selling additional shares as the stock price soared.

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Tesla's financial performance in 2013.
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Tesla's financial performance in 2013.

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“There are many people that thought Tesla would fail. Many of them unwisely chose to short our stock,” Tesla chief executive Elon Musk, 42, said at a June 4 annual shareholders’ meeting. He added, with a laugh, “I presume those people are not here today.”

Since then, the stock has marched steadily higher, hitting an all-time high of more than $183 a share Friday. It has risen fivefold this year, pushing the market value of Tesla above $22 billion, almost a third as much as Ford Motor. Some other comparisons: In the first half of the year, Ford sold 1.29 million vehicles in the United States and more than 400,000 in China, while Tesla sold a total of about 10,500. Ford earned $2.8 billion in profits in six months, while Tesla lost $19 million.

Tesla’s $70,000-plus Model S isn’t your grandfather’s Oldsmobile (or Rambler). The luxury sedan goes from zero to 60 mph in 5.4 seconds, it has retractable door handles, a 17-inch touch-screen display and a liquid-cooled lithium-ion battery that lies beneath the car’s body.

The company isn’t much like any other car company, either. Its stock has behaved like a 1990s-vintage tech company, a firm whose disruptive potential and promise shares more with Silicon Valley than Detroit. South African-born chief executive Musk, who made a fortune on PayPal, the money-transfer service, is a salesman and a brand unto himself. He has turned his Model S into a product like a pricey watch, stylish handbag or nifty gadget rather than simply a way to get to work.

With great hoopla, Musk has unveiled plans for stations that would offer free high-speed recharging or, borrowing an idea from a now-bankrupt rival, a battery swap in 90 seconds. (Musk declined to be interviewed for this article.)

Musk’s cachet has been enhanced by his other futuristic visions, such as his commercial SpaceX company and his outline for a solar-powered, 600-mph “Hyperloop” to carry people in pods from Los Angeles to San Francisco in half an hour. (The details haven’t been worked out yet.) On Wednesday, Musk announced on Twitter that within three years Tesla would build an autopilot car that would drive itself over 90 percent of miles traveled; he also posted a call for engineers to work on the project. “Intense effort underway at Tesla to develop a practical autopilot system for Model S,” he said.

“The expectations are sky-high,” said Craig Pirrong, a University of Houston finance professor. “He has an almost cultlike following among a lot of people. All those things create a risk of a very big fall.”

Yet Musk has been able to build Tesla by relying on big-name financial firms, which have played multiple roles — and given him time to lose money while striving to turn a profit. It is the sort of financial breathing room that few start-ups enjoy.

Goldman Sachs, for example, serves as analyst, investor, underwriter and personal banker. It holds a 0.34 percent stake of Tesla stock, down from 0.66 percent earlier this year. It also underwrote Tesla’s stock offerings and has extended $275 million in personal loans to Musk so he could add to his own stock holdings. Musk owns 23.3 percent of the company, a stake worth more than $5 billion. The stock offering in May was quickly organized and well-timed, just as the share price surged to $92.24.

Morgan Stanley, one of the managers of Tesla’s recent $600 million offering of convertible bonds, owns 4 percent of Tesla’s shares. Toyota (2.4 percent) and Daimler-Benz (4 percent), were both early investors in Tesla that bestowed a seal of approval from the established auto industry.

“One of the things we try to do at Goldman Sachs is to identify the most promising people and companies and provide them banking services. This helps entrepreneurs as they grow their business and hire people, generates wealth for them and investment banking business for us,” said Stuart N. Bernstein, global head of the clean technology and renewables group at Goldman Sachs. “We think Elon Musk is one of the most exciting entrepreneurs of the century. He’s got qualities of Henry Ford, Steve Jobs and Bill Gates all rolled up in one.”

Not everyone thinks Musk belongs in that pantheon. An unusually large number of investors have bet against the company by short-selling its stock — a transaction in which investors profit when the stock price falls. So far this year that’s been a bad bet, and the volume of Tesla stock shorted has dropped from a stunning 40 percent of available shares to 25 percent, still 10 times the level considered typical at most companies.

The company has benefitted from glowing media coverage. A Bloomberg Businessweek cover article in August, which surrounded the car with hearts against a pink background, crowed: “Anyone hoping to ratchet the Tesla Motors hype down a notch will want to ignore the company’s second-quarter results delivered on Wednesday afternoon. Tesla turned a profit, much to the surprise of Wall Street analysts, and said it shipped a record number of its Model S luxury sedans that have become all the rage with the wealthy, eco-conscious set.”

In fact, Tesla posted a loss of $30.5 million, which included the sale of regulatory credits. Under California law, auto companies must sell a certain percentage of zero-emission vehicles. Those that fail to do so must buy credits from companies such as Tesla. Tesla also sold credits to companies seeking to meet U.S. fuel efficiency standards. Together, these credit sales amounted to $69.4 million in the second quarter, 17 percent of Tesla’s revenue or $13,475 for each of the 5,150 cars sold.

By year’s end, the market for those regulatory credits will largely dry up as other car companies introduce new electric or hybrid vehicles.

“Right now, he’s been the beneficiary of an enormous amount of great pre-publicity. And he’s built a car that’s worthy of that. It’s clear that he’s changed the conversation about electric-powered vehicles,” said Maryann N. Keller, a leading automobile industry analyst.

“But justifying a $20 billion market capitalization, you’d have to extrapolate out to hundreds of thousands of cars a year, not 20,000,” she said. “It does seem to defy gravity — and common sense.”

Increasing value

It’s been hard for analysts at investment advisory firms to evaluate future sales and potential profits both from the Model S, which only went on sale in mid-2012, and as-yet nonexistent cars designed and priced to appeal to a broader mass market. While the analysts have been pondering that, Tesla’s stock keeps speeding past their price targets.

Over the summer, Morgan Stanley raised its price target to $103. Andrea James of Dougherty & Co. raised hers to $200 from $90. Deutsche Bank’s Dan Galves — who in May upped his target from $35 to $50 a share — raised it again in late July, this time to $160. On Thursday, he jacked it up again to $200.

“We always expected them to be a survivor in the industry, and that’s a pretty tough thing to do,” Galves said in an interview. “There has not been a start-up [car company] to make it in the U.S. in the last 50 years or so.”

Deutsche Bank, however, waited to see some of its concerns resolved before raising its forecast, Galves said. For example, after Tesla raised $1 billion from investors in May, his worries eased about the company’s cash needs. He expects profit margins to widen, economies of scale to take hold, battery costs to come down, and new recharging stations to allay consumer concerns about the vehicles’ range, which could go 200 to 300 miles depending on the type of battery and driving speed. Galves said the next-generation Tesla would be smaller and lighter, requiring a smaller, cheaper battery and making it competitive with other mass-market cars.

“They’ve already produced a car people love, that’s performing very well years ahead of other electric vehicles,” he said, “and now they have to prove that it will be a profitable vehicle and we feel confident that it will be.”

He said he expects Tesla to sell about 220,000 units by the end of decade. That would be one-quarter of 1 percent of the global auto market, but Galves said he thinks Tesla could earn $14.95 a share by then. While Ford sells a lot more cars, he said, Tesla’s profit margin could be better. Also, Galves noted, Ford has billions of dollars of underfunded pensions.

“Investors are valuing Tesla not as a regular auto company but as a tech company that has a big advantage in a technology that could be the technology of the automotive future,” Galves said.

Possible problems

For all of Musk’s design and marketing savvy, Tesla still faces potential potholes. The battery cost has to come down substantially if Musk is going to meet his goal of introducing a low-cost car with a broader market. It isn’t clear how many of Tesla’s customers so far are gung-ho electric car enthusiasts and whether mainstream car buyers will follow. Sales have been concentrated in California; it remains unclear whether other U.S. or foreign markets will be as fertile.

Tesla could also find mass marketing difficult without dealerships. Current laws in states around the country bar car manufacturers from operating their own dealerships. Instead, Musk has set up showrooms where customers can look but not buy. Tesla sells the cars directly, usually online.

In addition, Musk has made commitments this year that could magnify the pain for Tesla shareholders if the stock takes a downturn. For example, Musk, whose wealth is mostly tied up in Tesla and Solar City stock, personally guaranteed a 50 percent resale value of three-year-old Teslas, a key element in financing purchases or leases. That is slightly more than the average resale value of Audi, BMW, Mercedes, Lexus or Jaguar cars in the same price range. Yet it is hard to know what the resale value of Teslas will be.

Moreover, Musk obtained his two loans from Goldman Sachs by pledging his own Tesla shares as collateral. That means that if the price of the stock drops below his purchase price, Musk might be forced to put up cash or sell shares — what brokers call a margin call. That in turn could accelerate the drop in the stock price.

“The forced sale of these shares pursuant to a margin call could cause our stock price to decline and negatively impact our business,” the company said in its stock offering prospectus this year.

The company’s combined stock and bond offering in May raised enough money to pay off its $465 million very low-interest loan from the Energy Department. That loan had made it possible for Tesla to buy a shuttered GM plant where it now makes the Model S.

On the basis of interest rates alone, paying back the Energy Department meant trading cheap debt for more expensive debt. But Galves said it was good for the company’s image.

The loan granted in 2010 also came with strings attached. It limited Musk’s ability to sell his holdings. And it came with warrants that gave the Energy Department the right to buy more than 3 million shares of Tesla stock at a fixed price after December 2018. At today’s share price, the warrants would have been worth more than half a billion dollars. Since Tesla paid back its loan early, the government had to give up the warrants.

Fighting back

Musk has used his Twitter account — with more than 380,000 followers — to hit back at critics of Tesla and generate enthusiasm about future projects. In January 2012, two key executives — the chief engineer and the chassis engineering chief — unexpectedly resigned and Tesla’s stock sank nearly 20 percent. Musk lashed out on Twitter, saying “Too many people want us to fail and are willing to twist any bit of news against Tesla.”

Tesla stock bounced back, up 17 percent the next day, and Goldman Sachs raised its rating from “neutral” to “buy.” Musk tweeted, “TSLA down ~$500M Friday, but back up ~$500M today. Sorry for the roller coaster.”

Musk also spoke up in September 2012 after Tesla announced it would miss its revenue target, sparking a nearly 10 percent drop in the share price. On Twitter, Musk announced a secondary public offering and revealed that the company was cash-flow positive — a new disclosure. The stock price climbed back up.

Musk took to Twitter again after a February 2013 New York Times article questioned the driving range of the Model S. Musk excoriated the reporter, questioning his account, and the stock again regained lost ground. One reason he jumped on the story: With a shorter driving range, California would have reduced the number of credits attached to every Model S.

Gaining notice

One measure of Tesla’s success is that the big auto companies are paying attention. General Motors chief executive Dan Akerson has assigned a small team to study whether the electric vehicle maker poses a threat to GM’s business.

GM Vice Chairman Steve Girsky told Bloomberg “history is littered with big companies that ignored innovation that was coming their way because you didn’t know where you could be disrupted.”

Musk responded on Twitter: “Oh yeah, well Tesla will study a plan to study the GM team that’s studying Tesla, so there!”

Last week, a GM executive said the company was working on a new all-electric car with a battery capable of a 200-mile range. This time, Musk was more gracious. “Am happy to hear that GM plans to develop an affordable 200 mile range electric car. Right target. Hope others do same,” he tweeted.

“Any good company looks at any company that can disrupt their business,” said Greg Martin, GM’s director of communications strategy. “Competitive intelligence is part of the business. For the auto industry, it’s not 1950 or 1960 anymore.” If the industry was arrogant decades ago, Martin said, now “that’s not the case.”

Moreover, he noted, GM’s Akerson “came from the hyper-competitive world of telecom where change happens at a more breakneck speed.”

“I fully accept that this is a great-looking car that should have executives at every other auto company in the world scratching their heads and asking, ‘Why didn’t we do it?’ ” Keller, the analyst, said. But, she added, “we’ll see how he does next year.”

 
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